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JDS Uniphase Corporation (NASDAQ:JDSU)

F3Q09 (Qtr End 03/28/09) Earnings Call Transcript

April 29, 2009 5:00 pm ET

Executives

Michelle Levine Schwartz – Director of IR

Tom Waechter – President and CEO

Dave Vellequette – CFO

Analysts

John Harmon – Needham & Co.

Kim Watson [ph] – JP Morgan

Joan [ph] – RBC Capital Markets

Todd Koffman – Raymond James

Paul Bonenfant – Morgan Keegan

Jeff Evenson – Sanford Bernstein

Ajit Pai – Thomas Weisel Partners

Operator

Good day, ladies and gentlemen, and welcome to the JDSU Third Quarter of Fiscal Year 2009 Earnings Conference Call. My name is Alicia, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator instructions) As a reminder, this conference call is being recorded for replay purposes.

I would now like to turn the presentation over to Ms. Michelle Levine, Director of Investor Relations. Please proceed.

Michelle Levine Schwartz

Thank you, operator, and welcome to JDSU's fiscal 2009 third 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 February 10, 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 noon everyone. Let me begin by summarizing our third fiscal quarter results. Despite the tough economic conditions, we continue to improve a number of our key financial metrics. We grew net cash by over $34 million and were over $15 million free cash flow positive. We decreased our inventory levels by $40 million, DSOs were down by three days and our long-term debt declined by $50 million. In effect, our balance sheet improved in Q3.

Our revenue and operating income results were consistent with the guidance we provided three months ago reporting revenues of $280.7 million and an operating loss of nearly 3%. As expected, demand from our NAM [ph] and service provider customers slowed due to the economic downturn as our customers are depleting their inventories and delaying their release of their 2009 capital budgets. We did see an increase in demand over the last two months across our businesses.

JDSU's third quarter gross margins were slightly below 42% due to lower factory absorption and product mix in the test and measurement segment and transition costs associated with the transfer to contract manufacturers. We remain committed to our sustainable model of gross margins in the range of 43% to 47%. Operating expenses of $125.2 million were down for the third quarter in a row and reduced over $22 million or 15% from the fiscal 2008 third quarter reflecting the company wide effort to continue to lower our cost structure.

Although we find ourselves in a changing economic climate, I believe our long-term market opportunities remain strong. Since January, I have spent time meeting with customers across our business segments. In my meetings with our telecom and cable customers who drive revenue for 80% of our product portfolio, I noted that while these customers remain cautious with their current investment level, they clearly expect broadband expansion to continue.

Let me share a few data points with you. According to Cisco's Visual Networking Index forecast, global IP traffic is expected to increase by a factor of six from 2007 to 2012. Video on demand, IP television and Internet TV will account for nearly 90% of all consumer IP traffic in 2012. Mobile broadband handset like iPhones and Blackberries and laptops AirCards are expected to drive over 80% of all global mobile traffic by 2013. Local governments and those abroad are making investments to support broadband growth.

Congress allocated $7.2 billion of the economic stimulus package to increase broadband penetration and coverage and the Australian government announced a new plan to spend roughly US$31 billion to build a new fiber-optic communications network. To capitalize on the long-term growth opportunities in our markets, we will continue to focus on our priorities, which I introduced on our last call. These priorities will enable us to further differentiate ourselves, increase our leadership position in the markets we serve, and improve our financial results as economic conditions improve.

Let me take a few minutes to discuss a few milestones achieved this quarter as part of these priorities. First, simplifying and scaling the business model. A key component to this initiative is moving more of our manufacturing cost structure from a fixed to a variable model. Early in fiscal Q4, we transferred our Shenzhen optical communication final assembly and test manufacturing facility to Sanmina. By transitioning the facility to a contract manufacturer, we were able to maintain the skilled workforce and expertise in manufacturing our product, lower our fixed cost structures and leverage Sanmina's strength and operational expertise in raw material sourcing, all without re-qualifying our product.

Also in April, we decided to transfer our chip manufacturing capability, including the manufacture of vixels [ph] from Louisville, Colorado, to our Rose Orchard facility in California. We're consolidating this activity under one roof instead of maintaining two gallium arsenide fabs. We expect the fab closure to be completed before the end of the first fiscal quarter of 2010. The communication test measurement segment signed an agreement with contract manufacturer Benchmark in order to enable the largest JDSU business to move primary to a variable manufacturing cost model and improve overall scalability. Benchmark has assumed manufacturing activity in Indianapolis and will complete the transfer of production activities to their facilities by August of 2009.

At the same time, benchmark is also transitioning various products from our Germantown, Maryland facility to their facilities. This transition is expected to be completed by May 2010. Finally our lasers group is on track to complete the consolidation of the production of solid state and gas laser products to Fabrinet. These activities in total are expected to reduce our manufacturing overhead costs by more than $35 million per year. We're pleased with the progress we have made to date and we will continue to look for opportunities to lower costs and improve efficiencies.

Second is our continued focus on innovation. We see a unique opportunity for JDSU to further strengthen its leadership position through innovation during these uncertain economic times. We believe our strong and improving balance sheet uniquely gives us the working capital needed to continue to invest in innovation, this is a clear competitive advantage. To maximize our R&D investments, we're utilizing resources in low cost environments. For example, we're outsourcing R&D in Eastern Europe and India and expanding our internal efforts in China. Additionally, we are improving product development processes to enable faster delivery of products to the marketplace.

Highlights of recent innovation and success with customers include the following. Our optical communication group launched the industry's first monolithically integrated and tunable optical transceiver of tunable XFP. This product is being very well received by our customers who have been sampling the product since December of 2008. We expect to be shipping the product this summer and will ramp up volume thereafter. JDSU test solutions are playing a major role in the US telecom industry's highest profile IPTV service deployment initiatives. A tier 1 North American operator selected the T-BERD 6000, a compact multi-service field test room instrument to support metro network expansion and the efficient reliable deployment of video and other broadband services. We expect the T-BERD 6000 to be widely deployed in the carrier's central offices. For this customer, JDSU's new fiber inspection video microscope is shipping with the 6000 as an accessory to further improve field technician productivity, another competitive differentiation we achieved to last year's Westover acquisition.

It is critical that today's field technicians have inspection tools to detect contaminated fiber, the number one cause of network impairment. Our custom optics coating group within AOT has developed new lower cost 3-D cinema glasses for a major entertainment company in response to stream a 3-D film planned for release during the year.

The third priority is increasing our global market presence. We're placing more emphasis on expanding our market penetration outside of a traditionally strong North American and western European markets. We believe that most of our infrastructure with respect to building an international presence is already in place and will not require any significant incremental investments. As you may recall, over the last 6 to 12 months, we rebuilt our sales leadership team in Asia Pacific and Latin America and we streamlined the field sales team, which has increased productivity at a lower cost to the company.

We're seeing success in China driven by 3G and in Latin America through cable deployment. Our optical communication group has gained a leading position in China including customer such as Huawei and Ace Link for specific projects. Many companies in China have selected JDSU as their primary supplier of certain optical components due to our technological innovation, quality, and overall operational excellence, highlighted by the Core Partner Award recently granted by Huawei to JDSU for the second year in a row.

And finally maximizing utilization of our assets, we're focusing on the utilization of assets in order to maximize shareholder value. In Q3, we were over $15 million free cash flow positive, benefits from the transition to CMs are already showing up in our results as we decrease inventory levels by over $40 million and we expect further inventory reductions as more p products are transitioned. Our priorities for cash remained generating more cash, maintaining a solid cash position, completing and advancing our lean initiatives, and making profitable acquisitions.

Now let us move on to our individual business segments for fiscal Q3. First, the communications test and measurement segment. Revenues saw a sharp decline due to the softness in demand by network operators and equipment manufacturers as a result of global economic downturn and the delay in the release of 2009 capital budgets. January and February spending was substantially down from historical levels but we have seen increased momentum in bookings since then. We remain positive about the fundamental trends driving the test and measurement industry as I discussed earlier and are confident of our long-term market position.

One example of a market driver that represents a great opportunity for JDSU is the growth of Ethernet for transport and services. Infonetics Research estimates that shipments of 10 G and 40 G Ethernet ports jumped 86% in 2008 with a compounded annual growth rate of 18% between 2008 and 2013. Today, JDSU is the market leader for field tests of 10 G networks. We have been able to gain share in the marketplace with advanced solutions such as the T-BERD MTS 6000, a test platform that has been widely adopted by service providers.

Although the majority of service provider port shipments remain 10 G, 40 G ports grew 196% in 2008 and are forecasted for healthy growth for the foreseeable future, according to Infonetics. Through our technological leadership, JDSU is a dominant player in 40 G test equipment. Therefore, we're well positioned to be the market-leading supplier of field-tested gear as 40 G migrates throughout the network. A number of our deals over $1 million that booked in the third quarter reflect how JDSU's technology and innovation leadership are being well received by our customers. A tier 1 US operator selected JDSU's PathTrack remote video monitoring system. PathTrack probes will be widely deployed in the central offices of this network operator, supporting remote troubleshooting, periodic quality checks, and trouble isolations for its IP TV services. In another PathTrack win during the quarter, Brazil's largest cable operator expanded its investment in JDSU's remote test system.

One of Europe's largest network operators purchased nearly 300 HST 3000 field test instruments to support its wholesale operations. The carriers wholesale unit support 400 service providers and selected the HST to support cost-effective reliable Ethernet expansion and broadband service delivery. We continue to build our presence in the US government and aerospace and defense market. JDSU's Fireberd platform was selected by a prime contractor for a US military branch to support the deployment of satellite communication system. And JDSU's ONT 40G platform was selected by one of the world's largest names for system verification and test.

Finally in Q3 we announced the appointment of Dave Holly as President of the test and measurement segment. Dave most recently ran our field services business and held various other management roles during his 15-year tenure with the company. Dave's deep industry knowledge, customer focus, and strong management skills will be leveraged to continue this segments focus towards growing its market leadership.

Moving on to our communications and commercial optical products segment, first, our optical communication business. In fiscal Q3, revenue declined as expected as our customers experienced declining demand from their service provider customers and also reduced inventory levels. At the same time, we executed against a number of cost reductions during the quarter, including reducing our product portfolio of unprofitable products. As a result, we realized an improvement in gross margins despite the $20 million reduction in revenue from the prior quarter. We expected demand in optical communications to remain soft in the near term as the slowdown of CapEx spending by service providers and owners of data networks cascades to network equipment manufacturers.

We believe that our focused strategy of technology leadership, cost leadership, and functional integration is in line with our customer's requirement enables us to differentiate ourselves in a very competitive market. There are three customer trends that JDSU is addressing with this technology leadership and innovation. First, agile optical networks, 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 in reconfigurable solutions are ROADMs, tunable transponders and photonically integrated amplifiers.

Next higher transmission speeds. Our customers have focused on 40G followed by 100G in the future. For transmission, we have a partnership with Mintera, in internal component level development. In March of this year Mintera announced the general availability of the jointly developed 40G 300 pin line sight transponder and they have shipped the 1000th module. The jointly develop module has shipped to 11 customers to date. For transport, our products are already designed to work in 40G and future 100G networks.

Finally, functional integration. Over the past year, we introduced a number of platforms that possess high functional integration. The most recent is the tunable XFP. We are very pleased with the accomplishments in creating a tunable solution and with all the functionality in an XFP form factor. The product was designed to provide a wide range of benefits to system vendors including increased density, lower cost and more flexible deployment options. Our design uniquely enables us to serve two markets, the 300 pin market, and the fixed XFP. JDSU began sampling the tunable XFP transceivers with customers in 2008. We are engaged in 12 designs with nine customers and have received very positive feedback. Many of our top customers are already designing the JDSU tunable XFP transceiver into their next-generation system.

We added one new design win for our Mini WSS platform in addition to two design wins each in Q1 and Q2. We expect to report revenue on this new platform before the end of the fiscal year. Finally, we have received positive feedback and interest from customers for our photonic integrated amplifier or PIA platform; as noted last quarter we shipped a Super Transport Blade.

In relation to cost leadership, 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 industry. Our lasers business experienced a decline in revenue as customers worldwide have slowed their demand due to both excess inventory and preservation of cash. We're seeing this mainly from our semiconductor equipment manufacturing customers and to a lesser extent in the biomedical market. This is an industry wide occurrence and we believe we are maintaining market share and are tracking with the slowdown that our customers are experiencing.

Our pipeline for new products over the fiscal year is robust as we continue to invest in R&D in the segment. Our product development will continue to be focused on advanced solid-state and fiber laser platforms. These new products when introduced are expected to increase our served available market by more than threefold.

And finally on to our advanced optical technology segment. The segment provides optical security solutions including brand protection, anti-counterfeiting for currency, transaction card authentication, custom optics for aerospace and defense, and innovative custom caller solutions for helping manufacturers differentiate their products. Q3 revenue was down just under 4% quarter over quarter. The diversity of this group of products in AOT contributes to some resiliency despite economic market conditions. Innovation and custom design are the hallmark of the AOT segment. I would like to spend a few minutes discussing some new customer wins and the innovative products we are supplying to them.

In Q3, we were selected by a major Japanese cell phone provider for our ChromaFlair pigment technology, a multi-layer pigment that gives paint, coatings, plastics, textiles and packaging the inability to change color when viewed from different angles. We have two notable wins for our SpectraFlair pigment technology. We were selected by German automaker for a new 2011 car launch and we are providing the Jacksonville Jaguars of the NFL with our SpectraFlair bright silver pigment for the team's new helmets. Finally, our next-generation optically variable pigment currency solution was launched on two international circulating notes and an Asian country expansion to new denomination of banknotes.

As I conclude my formal remarks, I would like to thank our employees whose focused commitment and tremendous efforts continued 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.

With that, I'll hand the call over to Dave who will take you through the details of our financial performance in Q3 and discuss our Q4 outlook.

Dave Vellequette

Thank you, Tom. Before I start, please note that all numbers are non-GAAP unless I state otherwise. Third-quarter revenue of $280.7 million was down when 21.4% from the prior quarter and down 26.9% when compared to the third quarter of fiscal 2008. As expected, the third-quarter revenue decline was mainly in the CCOP and test and measurement segments, as demand continued to soften. For fiscal Q3, test and measurement represented 46% of total revenues as compared to 49% in the prior quarter. The CCOP segment represented 36% of total revenue unchanged compared to prior quarter and AOT represented 18% of total revenue compared to 15% in the prior quarter.

Third-quarter gross margin of 41.8% of revenue was down from the previous quarter's gross margin of 43.5% and down from the third quarter fiscal 2008 gross margin of 42.6%. The third-quarter gross margin reflects the impact from lower factory absorption, unfavorable product mix in the test and measurement segment as well as transition costs associated with the move to contract manufacturers. Operating expenses for the third fiscal quarter of $125.2 million or down nearly $12 million from prior quarter's $137 million and down over $22 million from the prior year's $147.6 million. The lower operating expenses reflect reductions in discretionary spending, office consolidation, workweek shutdowns, and reductions in headcount.

Our operating loss for the quarter of $7.8 million or a negative 2.8% of revenue was down from the prior quarter's operating profit of $18.4 million or 5.2% of revenue. Our operating loss was due to lower revenue and gross margin. We reported a net loss for the third quarter of $6.9 million or a loss of $0.03 per share. This compares to second quarter of fiscal 2009 net income of $24.8 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 third quarter non-GAAP results exclude among other items impairment of goodwill of $45 million dollars, loss on long-lived assets of $7 million, amortization of acquired technology and intangibles of $19.7 million, a $13 million charge related to stock-based compensation, and $11 million charge for restructuring, and a $20 million gain from the repurchase of our 1% convertible debt.

The goodwill impairment charge resulted from the completion of our mid year analysis for impairment of goodwill and long-lived assets. As a reminder, last quarter we noted that due to the adverse impact of the current macroeconomic business environment in the company's financial outlook and the overall decline in equity values, resulting in a decline in our own market capitalization, we commenced this analysis in fiscal Q2 and recorded an estimated impairment charge. Including the noted items, the third-quarter fiscal 2009 GAAP net loss was $85.2 million or a loss of $0.40 per share, which compares to a prior year third quarter GAAP net loss of $6.2 million or a loss of $0.09 per share.

Now looking at revenue by region, Americas revenue of $117.1 million, 42% of total revenue, was down $48.6 million from the prior quarter, driven by the revenue decline in our test and measurement segment as North American service providers delayed the release of their CapEx budgets and reduced revenue in our CCOP segment as North American network equipment manufacturers continue to reduce their inventory levels and therefore their demand. EMEA revenue of $95.1 million, 34% of total revenue, down approximately 13% from fiscal Q2. The decline is primarily driven by the CCOP segment due to a slowdown in demand from network equipment manufacturers. Asia revenue was $68.4 million, 24% of total revenue, down $15 million from the prior quarter. The decline was also mainly due to reduced demand from service providers and network equipment manufacturers.

Moving to the segments. In the test and measurement segment, third-quarter revenue of $129.2 million was down 26.7% from the previous quarter's $176.2 million and down 23.7% from the previous year's $169.3 million. Looking at the product portfolio, we saw the decline in revenue primarily in our field services products and to a lesser extent in lab and production and service assurance. Book to bill for the quarter was less than one. Fiscal Q3 gross margins for test and measurement of 54.2% was down compared to the prior quarter and below our targeted range of 57% to 61% reflecting an unfavorable product mix, lower factory absorption and incremental cost associated with the transfer to our contract manufacturer. As a result of the lower revenue and gross margin, the test and measurement operating profit of $9.2 million or 7.1% of revenue decreased when compared to the operating profit of $36.7 million or 20.8% of revenue in the prior quarter.

Now moving on to the test and measurement business model, and the initiatives within the segment to achieve this model, we began implementing lean initiative programs one year ago with a focus on reducing structural complexity and therefore improving productivity. We expect to complete the current set of initiatives over the next six 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're transitioning product lines to contract manufacturers, which will reduce our manufacturing overhead. Finally, we will continue to focus on operating expense reductions to improve the operating leverage, discretionary spend reductions, fewer development sites and headcount reductions. We maintain that these initiatives provide the structure to support sustainable operating margins between 20% and 23% at a quarterly revenue level of $175 million or greater.

Now moving on to our CCOP segment, the breakout of the key metrics for optical communications and lasers is as follows. Optical communications revenue in fiscal Q3 was $89 million down 18.7% when compared to the prior quarter's revenue of $109.5 million and down 34.5% when compared to the prior year's $136.1 million. The revenue decline reflects network equipment operators lowering their inventory levels due to lower demand they are seeing from service providers. Revenue also included a $3.4 million recovery from the Nortel bankruptcy. Gross margin for the quarter was 20.7%, up from the prior quarter's gross margin. Gross margin was favorably impacted by the Nortel revenue recovery.

Book to bill was less than one for the quarter. ASP decline was approximately 3% at the midpoint of our historical quarterly range of 2% to 4%. Looking at the product lines, as anticipated, demand for ROADMs declined in Q3. ROADM product revenues continued to represent approximately 30% of our optical communications total revenue. To date, we have shipped nearly 35,000 units, and we believe we're maintaining our number one market share for ROADMs. The decline in ROADMs demand was driven by our network equipment manufacturers reducing their inventory levels and having lower demand from the service providers.

Moving to the business model. We continue to improve the optical communications gross margin structure. Our near-term gross margin goal is for a sustainable margin in the 25% to 30% range and longer-term gross margins in excess of 30%. Our gross margin improvement initiatives include moving to a more variable cost model, pruning products that don't meet our profitability targets, and executing against our lean initiatives. Already in fiscal Q4, we have made further progress against these initiatives with the transfer of our Shenzhen optical communication facility to Sanmina and our plan to transfer our chip manufacturing capability, including our vixels, from Louisville Colorado to our San Jose facility. The Colorado fab is scheduled to close before the end of September. Once completed we will have consolidated our optical communications manufacturing facilities into three fabs; a lithium niobate fab in Bloomfield, Connecticut, a silicon oxide fab in San Jose, and a gallium arsenide indium phosphide fab in San Jose.

In our lasers business, second-quarter revenue of $11.5 million declined 37.5% from the prior quarter. The decline in revenue is due to declining demand from our semiconductor equipment manufacturing and biomedical customers. The operating loss for CCOP was $6.4 million. The improvements were realized through manufacturing reductions and operating expense reductions were partially offset by the decline in revenue and lower factory absorption.

Now moving on to the CCOP business model, moving forward, we believe that the CCOP cost saving initiatives provide a structure that supports operating margins of 10% to 15% and revenue levels of $150 million or greater. For the advanced optical technologies or AOT segment, fiscal Q3 revenue of $51 million down just under 4% compared to the prior quarter's revenue. Revenue in the currency market was strong 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. Transaction card revenue remained stable. We expect to see this business trend upwards once credit is freed up.

AOT book to bill was greater than one for the quarter. Fiscal Q3 gross margins for our AOT business were 52.4% up compared to fiscal Q2's gross margin of 51.3% and up compared to year ago period's gross margin of 50.2%. The improved gross margin was due to a favorable product mix in our lean initiative efforts. This is the sixth consecutive quarter in which our gross margins exceeded 50%. AOT operating profit for the quarter was $19.3 million or 37.9% of revenue, up from the prior quarters 36.7% of revenue. The improvement in operating margin is due primarily to improved gross margins. Our targeted sustained operating profit range for this segment is 34% to 37%.

Moving to the balance sheet, for fiscal Q3, the company was free cash flow positive $15.3 million. Total cash balance was $673.5 million. Net cash for the quarter increased by $34.5 million as we reduced our total inventory by $40.4 million, reduced our days sales outstanding by three days, and reduced our outstanding debt balance by $50 million. Headcount as of April 25, 2009 was 4244, down from 6714 at the end of the second quarter. The reductions in headcount include 2272 for manufacturing and 198 from operating departments.

Moving on to our operating model, our sustainable cost structure is such that we can realize 10% operating margin when revenues are 400 million and gross margins are 46%. We continue to focus on executing against our initiatives to achieve our operating model. Taken 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 lowering the cost structure associated with manufacturing overhead by more than $35 million per year and lowering our operating expenses by more than $120 million per year. These savings are compared against our spending levels in the fourth quarter of fiscal 2008.

In our fiscal third quarter, we successfully lowered both our manufacturing costs and our operating expenses. Our operating income and free cash flow breakeven point absent one-time transition costs has now been reduced to $275 million to $285 million of revenue for the quarter. 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 a unique opportunity to increase our leadership position in the markets we serve.

Now for our Q4 guidance. First, some points to consider as you think about our financial performance over the coming quarters. As noted, there is economic uncertainty in the markets we serve. Book to bill is less than one for the third quarter in a row and in all segments except for AOT. Bookings for the months of March and April have trended up across all segments when compared to the first come two months of the calendar year, at the same time visibility remains limited. We also expect a further decline in our operating expenses in Q4 relative to Q3. Finally we expect a quarterly tax provision to range between $1 million and $3 million. Taking into consideration the factors above and based on our current visibility, we expect fourth-quarter revenue to be between $265 million and $285 million, and non GAAP operating margin to be 1% to negative 3%.

Thank you operator, and we will now take questions.

Question-and-Answer Session

Operator

(Operator instructions) And the first question comes from the line of Mr. John Harmon with Needham & Co. Please proceed.

John Harmon – Needham & Co.

Hi, good afternoon.

Tom Waechter

Hi, John.

Dave Vellequette

Hi, John.

John Harmon – Needham & Co.

Well, first of all I would just like to say thank you for giving us some margins in your targets and business model, it makes things a lot easier.

Tom Waechter

You are welcome.

John Harmon – Needham & Co.

And onto my questions, so if we look at your book to bill ratios for the two divisions that are less than one, which one is the smallest? How would you rank them?

Tom Waechter

How would we rank the delta of less than one?

John Harmon – Needham & Co.

In other words, which book to bill ratio is lower, optical communication or test and measurement for the June quarter?

Tom Waechter

They are both relatively close to each other, just slightly under John.

John Harmon – Needham & Co.

Okay, thank you. And in the transfer of your Shenzhen and factory to Sanmina, you probably have to pay them some kind of transition fee in the meantime. You talked about the total $35 million annual savings for everything you're doing, but how much are you going to have to pay them in the short term, or how does that agreement work?

Tom Waechter

John, so we have with the agreement, we negotiate a certain rate that we will pay them for product since it's already in Shenzhen and really it is them taking over the labor, what I would say the typical transition costs of let us say moving from the US to some other part of the world isn't there. So it is actually a pretty straightforward as far as that goes. There wasn't any incremental charges that we had to pay them. Now we will keep some people there to help with the transaction so that's a small incremental cost that we will incur temporarily as we bring people up to speed and we have some of our own employees there for that period.

John Harmon – Needham & Co.

Just is a follow-up if I may and you talked about some transition costs in moving CM that hurt your margins in the quarter, how big were those?

Tom Waechter

Those are less than 1% of the total revenue and primarily we had Benchmark come in and take over our factory in Indiana, so they are going through the transition of running the product and now moving the product in Indiana from there to their facilities.

John Harmon – Needham & Co.

Okay, thank you.

Michelle Schwartz

Next question please.

Tom Waechter

Thanks, John.

Operator

And your next question comes from the line of Kim Watson [ph] with JP Morgan. Please proceed.

Kim Watson – JP Morgan

Thank you. I wanted to ask a little bit about I guess confining two of the comments about bookings improving over the last two months combined with some earlier comments about your customers plus and what's fixed on my mind it that test and measurement in the optical communication can that be tied together? I guess the real question I'm trying to get at is have you seen an improvement related to the fact that inventories are kind of reaching bottom at this point and where do you think we are in that process?

Tom Waechter

Well, we definitely have seen improvement in the last two months of order intake rate across both test and measurements and optical comms business. So I don't know that that in itself is a trend at this point. We're still cautious but it has definitely improved significantly in these last two months.

Kim Watson – JP Morgan

Okay. I guess in the mix in your revenue guidance which is down at the mid point sequentially again, are you expecting weakness in both of these business or do you expect any seasonality in the P&L [ph] given its fiscal year (inaudible)?

Tom Waechter

For the forecast that we have shown for the fiscal Q4, we see test and measurement rebounding a little bit better than the optical comms business at this time.

Kim Watson – JP Morgan

Okay.

Michelle Schwartz

Next question please.

Operator

And the next question comes from the line of Mark Sue with RBC Capital Markets. Please proceed.

Joan – RBC Capital Markets

Hi, this is Joan [ph] for Mark Sue. Can you help us understand the moving parts in your revenue guidance? Clearly taking the midpoint, it seemed like the rate of sequential decline is beginning to moderate. Looking further out, can we start seeing a sequential bounce in revenues?

Tom Waechter

You know, we feel that the market is still a bit hazy as we look out further over next quarters beyond the June quarter. So we are not providing any specific items on those quarters at this time.

Dave Vellequette

Also, if you look at the revenue we just did, understanding that $3.4 million of it relates to the Nortel bankruptcy, so that we don't expect to get a benefit from any recovery there in the quarter ended June. And as Rom mentioned, the test and measurement business is usually more stable relative to the optical comms in the June quarter because the budgets have rolled out and so we feel that the softness that we're seeing in the June quarter is primarily around the optical communications business.

Joan – RBC Capital Markets

And looking out into the fourth quarter, can we expect any more from you in terms of revenue from the pre-petition claim?

Dave Vellequette

You know, right now, we're going through the process on the Nortel situation. So as we get better visibility there, we will share that with you, but right now we are not expecting anything for the June quarter.

Joan – RBC Capital Markets

Thank you.

Tom Waechter

Thank you.

Operator

And the next question comes from the line of Todd Koffman with Raymond James. Please proceed.

Todd Koffman – Raymond James

Thank you very much. Over the last I guess nine months or so, you have in the optical communications segment, some of the wounded players combined, and I guess all the wounded, but anyway, do you think that the combination of the now players, small number of players, will be helpful to the market or everyone is still struggling, losing money with comfortable cash positions, so the dynamics of that business might not change?

Tom Waechter

I think first of all consolidation is a good thing because there is a very fragmented market with lot of players, so consolidation is a positive for the market. I think it is still yet to be seen how it plays out. I think some of the players in the market in that particular business don't have healthy cash positions, so I think it also depends on how long we remain in these strong headwinds from the macroeconomy to see how they fare in the marketplace.

Todd Koffman – Raymond James

Just a quick follow-up, JDSU over many years has been reorganizing, restructuring, lean initiatives, global realignment, now you are going through an outsourcing program, when might you think – but you have a fresh start here with yourself, when, how long might it be until you think the organization can settle into some steady-state organization? How much time…

Tom Waechter

I think we are settling in. You know the lean initiatives to me are really cultural. They are ongoing. So it is a culture you build inside and I think we have good foundation for that and good traction. I think the other areas, innovation, where we're focusing very heavily and I think our employees are very engaged in that. So I think if you look at our four focus areas that we identified, we have strength and we have a strong foundation now that we can move forward off of. We always adjust to extreme market conditions like we have right now but I think on an ongoing basis you have the right vision and a culture set and we're moving forward.

Michelle Schwartz

Next question please.

Operator

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

Paul Bonenfant – Morgan Keegan

Yes, hi thanks. The first question is more of a housekeeping, when you talked about the $3.4 million benefit from the Nortel revenue that came in this quarter relative to the $10 million deferred last quarter, I am assuming that you had booked the COGS last quarter, so excluding that revenue, where would have margins have been in the quarter for optical communications or am I not thinking about this correctly?

Tom Waechter

You have got it pretty close with almost all that revenue had was 100% margin, not quite all of it, a majority of it, so the margins would still have been up quarter to quarter, they would have been over 18%.

Paul Bonenfant – Morgan Keegan

Okay. But that $3.4 million flowed down all the way through to EBITDA?

Tom Waechter

The majority of it did.

Paul Bonenfant – Morgan Keegan

Okay. Next question, I guess along the lines of housekeeping, you talked about your cost savings in the model being up to $35 million in the manufacturing line, $120 million on the OpEx line, I just want to make sure I understand this is up relative to your last forecast for $28 million and $110 million, is that correct, for those two items relatively?

Tom Waechter

That is correct.

Paul Bonenfant – Morgan Keegan

And this is a relative to the fourth quarter of fiscal 2008 and what quarter do you expect to realize these?

Tom Waechter

We will be at run rate in our fiscal fourth quarter.

Paul Bonenfant – Morgan Keegan

Okay. And last question, it would seem that if your revenues were to increase sequentially, do you have a sense for how much of that is as a result of improving end market demand versus an inventory or channel restocking?

Tom Waechter

You know, that would be contingent on which products you are seeing the demand increase, et cetera. So as those events happen and we report our next quarter results, so we will certainly give comment of where we saw the variations and we will help with understanding what was inventory re-stocking and so forth. So as we get that visibility we will share that with you on the next call.

Paul Bonenfant – Morgan Keegan

Thank you for taking my questions.

Tom Waechter

Thanks Paul.

Operator

Our next question comes from the line of Jeff Evenson with Sanford Bernstein. Please proceed.

Jeff Evenson – Sanford Bernstein

Hi. I was wondering if you could go over some of the details of your significant inventory decline, and specifically how much of that is from transferring inventory from your factories over to the contract manufacturers.

Tom Waechter

Sure. Roughly $13 million to $14 million of it is a reduction of total inventories for us and the remainder was primarily a transfer of inventories to the contract manufacturers.

Jeff Evenson – Sanford Bernstein

In your contracts with the manufacturers, what happened if that inventory becomes obsolete in terms of financials for you guys?

Tom Waechter

So typically they even have a shorter window, right. We look at something that doesn't have demand in a 12 month period. They usually look at something where they're holding it and was supposed to ship within a 60 day or 90 day period, but if it hasn't gone, then there is a – they have the right to call put back that inventory on us. So it really will driver us to have tight coordination with our CMs on the MRP or the demand that we provide them to make sure that we're moving that inventory with them in an expeditious fashion.

Jeff Evenson – Sanford Bernstein

Thank you.

Operator

(Operator instructions) And the next question comes from the line of Ajit Pai with Thomas Weisel Partners. Please proceed.

Ajit Pai – Thomas Weisel Partners

Yes, good afternoon. A couple of quick questions. The first one is just looking at your business model you talked about $400 million – at a $400 million quarterly revenue run rate, you will have a gross margin of 46% and operating margin of 10%. But just looking back at the December quarter of 2007, at under $400 million in that quarter, you had a 46% plus gross margin, and you had 11.4% operating margin. Since then you have restructured quite materially, you have cut costs, you have done a lot of work, hard work. Why would your business model not be more optimistic than what you're projecting right now at $400 million ?

Tom Waechter

So in that $400 million, it has a lot to do with what we call a sustainable model that we're putting in place. So if you look back in December period, you had quite a leap in the revenues from the comm test business with no change in our R&D investments. So we're looking at it as a more sustainable model, not to say that at periods of time if revenue hit certain levels could it be better, that could happen, but we are trying to talk about the model that we are driving the company towards, so that we have the R&D investments we want to have, we have the compensation models we want to have for the employees, and we have got to assume that there would be a more balanced revenue versus – in that quarter, I think 50% of revenue was from comm test.

Ajit Pai – Thomas Weisel Partners

Right, okay. But from an overall profitability perspective, you would expect every business that you had other than comm test to be more profitable relative to the levels of profitability in that particular quarter?

Tom Waechter

Sure.

Ajit Pai – Thomas Weisel Partners

Okay. And then just looking at the comm test business, while you provide some commentary on overall weakness in that side, could you give us some color as to how much of that was cable and how much of that was telecom, the weakness?

Tom Waechter

You know we really haven't been splitting it out in the past but I would say that the cable market over the last two quarters has been pretty depressed compared to the telecom market.

Dave Vellequette

And we saw some recovery in the December quarter as we noted in the call in Latin America and Europe, but generally speaking it has been in a more depressed mode.

Ajit Pai – Thomas Weisel Partners

Got it. And then shifting over to the M&A environment, one of the uses of cash that you have talked about in the past is making – using it for acquisitions. So your balance sheet is being – you have been shoring up, and you are cash flow positive, so could you give us like sort of some color on the kind of acquisitions that you're looking at and whether you're closer to making additional acquisitions or further away than you were a couple of quarter ago? And then also for next quarter, the next few quarters, do you expect to stay cash flow positive?

Tom Waechter

Yes. First of all, I will talk about the M&A part and then I will turn it over to Dave on the cash flow. But we are looking strategically across all of our business segments for opportunities. I think it is fair to say in that in this environment, there are more opportunities today than there were six, twelve months ago, and we're evaluating that. But we are making sure that in that vein that we're looking at it strategically and not just grabbing on to opportunities because they are out there. But it needs to fit in into our overall strategy and to be profitable overall for the company.

Dave Vellequette

And from the free cash flow standpoint, we are now lower at the $275 million to $285 million level. Our goal is to make sure we can be break even or generate cash every quarter. So as we go through every quarter, if we make further adjustments to our cost structure, we will comment about how we move that free cash flow breakeven point.

Ajit Pai – Thomas Weisel Partners

Right. But for the next quarter you do expect to be free cash flow positive?

Dave Vellequette

For the next quarter, I expect the free cash flow breakeven to be $275 million to $285 million and that the revenue range to be to $265 million to $285 million.

Ajit Pai – Thomas Weisel Partners

Got it. Thank you.

Tom Waechter

Thanks.

Operator

Ladies and gentlemen, this concludes the question and answer session of today's conference. I would now like to turn the call over to Mr. Tom Waechter for closing remarks.

Tom Waechter

Thank you operator. As our call concludes, I would like to follow up with a few summarizing points. There is no doubt we continue to face challenges among the current economic backdrop. However, at the same time, we're successfully improving our financial model with our lean initiatives and cost-cutting programs. We were able to force produce positive free cash flow and further strengthen our balance sheet during this challenging quarter. It is our goal to continue this trend. Clear evidence of the leverage in our operating model is expected to be more apparent once the top line improves which brings me to my last point, our long-term market opportunities remain strong. We are participating in markets that have healthy growth potential. Our continued focus on innovation will enable us to grow our market position as the economy improves.

Thank you again for joining us today. We appreciate you taking the time and your interest in JDSU. Have a good evening.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.

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Source: JDS Uniphase Corporation F3Q09 (Qtr End 03/28/09) Earnings Call Transcript
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