JDSU F2Q06 (Qtr Ending Dec 31, 2005) Earnings Conference Call Transcript (JDSU)

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JDSU Corp. (JDSU)

Q2 2006 Earnings Conference Call

February 1st 2006, 5:00 PM.

Executives

Jacquie Ross, Director of Investor Relations

Kevin Kennedy, Chief Executive Officer

David Vellequette, Chief Financial Officer

Analysts

Subu Subrahmanyan, Sanders Morris Harris Group

Michael Genovese, Citigroup

John Harmon, Needham & Company

John Anthony, Sg Cowen & Co

Brant Thompson, Goldman sachs

Ehud Gelblum, J.P. Morgan

Paras Bhargava, BMO Nestbitt Burns

Operator

Good day ladies and gentleman and welcome to the JDSU Fiscal 2006 Second Quarter Results Conference Call. My name is Maria and I will be your coordinator for today. Operator Instructions At this time I would now like to turn the presentation over to Ms Jacquie Ross, Director of Investor Relations, please proceed.

Jacquie Ross, Director of Investor Relations

Thank you Maria and welcome to the JDSU Fiscal 2006 Second Quarter Conference Call. Joining me on the call today is Kevin Kennedy, Chief Executive Officer and David Vellequette, Chief Financial Officer. Before we get started, 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 factor section of our Form 10-Q filed for the quarter ended September 30th 2005 and 10-K filed for the year ended June 30th 2005. The forward-looking statements including guidance provided during this call are valid only as of today’s date, February 1st 2006. And JDSU undertakes no obligations to publicly update these statements as we move through the quarter. Our comments today will include non-GAAP measures. A detailed reconciliation of these non-GAAP results to our GAAP results as well as the discussion of the usefulness and limitations of these non-GAAP measures is included in today’s news release announced 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, again, at www.jdsu.com/investors. I would now like to introduce JDSU’s Chief Executive Officer Kevin Kennedy.

Kevin Kennedy, Chief Executive Officer

Good afternoon and thank you for joining us today. JDSU’s Fiscal 2006 Second Quarter Results consistent with prior guidance, includes some important milestones for the company with our strongest revenue and profitability improvement performance in many years. So, the framework for today’s discussion, I would like to first share with you on my observations on JDSU progress to-date and on our continuing journey.

First, after a period of revenue re-engineering that involved simultaneous expansion through acquisitions and divestiture of non-core or unprofitable products, JDSU is emerging as a leading player in a number of growing markets.

Second, we have invested in a portfolio of products that reaffirms JDSU’s position as an innovator. While many products are in early stages of adoptions, customers have begun to embrace our portfolio including components for Agile, Optical Networks, Triple-Play Service Testing, Solid State Lasers, Anti Counterfeiting Coatings and Custom Optics.

Third, with our improving business model and reputation of technical expertise, JDSU is very well positioned to benefit from strength in broadband markets.

And finally, we remain intensely focused on improving the company’s bottom line performance. I will touch on each of these things today.

Taking the top line first, we achieved our calendar 2005 objective to increase our opportunity in growing profitable markets. Importantly, JDSU is now a more diversified business that serves the needs of 100s rather than 10s of customers. With the outcome of our revenue reengineering taking shape, our second quarter results reinforce that JDSU represents a billion dollar year business. This compares to the $636 million in fiscal 2004 and $712 million in fiscal 2005.

There are three complimentary initiatives that taking together underpin JDSU’s revenue reengineering. They are invested in organic new product introductions, ongoing portfolio review and selective acquisitions. Taking organic investment first, our focus has been on potentially high growth, higher margin opportunities, design for leverage our technical expertise and deliver differentiated products to the market. JDSU was first to volume, for example, reconfigurable Optical Add/Drop Multiplexes, which have the potential to transform the way optical networks are configured.

Innovations such as these underscore JDSU as the industry leader in Optical Broadband. Concurrently, we initiated an ongoing review of our product portfolio and identified candidates for divestures or exit, depending upon market growth rates and operating contribution. As a result of this exercise, we exited or initiated plans to exit businesses that would were not profitable for JDSU.

Our December 31, 2004 result included a revenue contribution of approximately $30 million from products that we have since exited. Excluding this revenue, JDSU factored revenues for the second quarter of fiscal 2006 actually increased 14% year-over-year, which compares today’s reported year-over-year decease of 6%.

The third major tenant of our revenue reengineering strategy was the acquisition of companies serving well defined growing and profitable markets. To that end we acquired four companies during calendar 2005 of which Acterna and to a lesser extent Lightwave had an immediately positive impact on our top line performance.

The number of moving pieces on our top line has made quarter-to-quarter and year-over-year comparison more challenging. Of course, we will continue to experience seasonally and quarterly revenue fluctuations. We will also continue to critically assess each product’s contribution and make adjustments to our portfolio accordingly. While our second quarter results start to illuminate the path for an emerging JDSU’s business model.

We have been equally focused on initiatives to drive bottom line performance. Although these initiatives tend to take a longer to positively impact our results and in many cases have a negative impact in the near term. Dave will give you an update on each of our actions. However, in summary, our previously announced initiatives are on track to deliver the targeted cost reductions. It’s important to remember that our revenue reengineering cost reduction programs are designed to enable JDSU’s to achieve profitability overtime, and to have some growth in the Optical Communications industry, this said, the environment that we experienced over the last quarter continue to be favorable.

Now back to second quarter results. Benefiting from a full and seasonally strong contribution from our Communications Test and Measurement business and continued growth in our Optical Communications segment, JDSU reported non-GAAP revenue of $315 million representing our strongest performance since September 2001. Book-to-bill was once again greater than one. Optical Communications segment revenue of $109.6 million was up 9% sequentially representing our strongest performance since the quarter ended March 2002. Excluding approximately $3.5 million of Instrumentation revenue included in this segment in our year ago results, this segment was up 5% year-over-year. Communication Test and Measurement non-GAAP revenue of $146 million included CommTest’s strongest quarter in more than three years. And, the consumer and commercial segment revenue of $59.4 million was down 6% from the previous quarter due to our ongoing phase out of unprofitable products.

Moving to profitability metrics, non-GAAP gross margin improved to 36.3%, our best results since March 2001 and up from 31.6% in last quarter. GAAP gross margin improved to 33.3%. As previously guided, we delivered non-GAAP earnings before interest tax depreciation and amortization or EBITDA of $7.9 million. This compares to a loss of $4.3 million last quarter into a loss of $25.7 million in the year-ago quarter, and represents the first time, in almost five years that JDSU has reported, non-GAAP EBITDA positive results. And non-GAAP net loss now to $3.7 million was just below break-even on a per share basis representing JDSU’s best EPS performance, since March 2001.

And now, I would like to update you on each of the three business segments. For the revenue of $109.6 million, our Optical Communications segment benefited from a favorable environment, which drove demand for our more highly integrated and intelligent modules and subsystems. Customers now demand higher levels of integrations and as a result, our differentiated optical subsystems are performing well.

During the second quarter JDSU was awarded a three-year exclusive contract from multiple circuit packs for a major North American OEM. At the same time, we see increasing interest from customers outside of North America. JDSU’s end-to-end Agile product portfolio continue to gain momentum, with notable activities including the double digit million order for our Wavelength Select Switch, as well as follow-on multi million dollar deal for our PLC ROADM products. JDSU’s Agile, Optical Network portfolio offers unparalleled reconfigurability, scalability, and robustness as the optical layer, designed to lower operator’s capital and operating expenditures while enabling next generation services. Highlighting our technical expertise in Agile Optics, we believe that JDSU’s share of this growing market is currently in excess of 60%.

Looking forward, to dealt the impact of tunable lasers on the communications industry, with the discussion now firmly focused on ‘when’ rather than ‘if’ tunables will become a standard element of the agile optical network. We believe that our Agility acquisition, positions JDSU very well, to play a leading role in this growing market. Overall customer demand continues to be positive with solid activity in long haul, metro and enterprise. We believe that JDSU’s technical expertise and leadership will enable us to benefit from favorable conditions as carriers continue to expand their networks to accommodate growing demand for IP based services.

Our Communications, Test and Measurements business performed well in it’s first full quarter as part of JDSU. The December quarter is historically been seasonally strong and this proved to be the case in our second fiscal quarter with non-GAAP revenue of $146 million. The underlying drivers of the CommTest business remain strong. The adoption of JDSUs HST handheld triple-play service tester continues to accelerate as service providers deploy IP based services including Voice Over IP or DSL, IP video and others. During the quarter we closed a multimillion dollars Voice Over IP services assurance systems contract with the major US based operator.

JDSU is positioned with the broad test and measurements portfolio’s to support service provider investment in Fiber-to-the-X Networks and triple-play applications. Unlike competitors who offer test products for certain portions of the network, JDSU offers an end-to-end FTTx triple-play service test portfolio. Our solutions span the entire set of requirements from our DTS product line which analysis the quality of video before it enters the network, to fiber and copper characterization solutions as well test instruments and systems for service installation and ongoing service assurance.

Our fiber optic test portfolio includes the recently released MTST Metro Network fiber optic test instrument, which is also gaining momentum. We continue to believe that our metro and long haul fiber optic test portfolio was well positioned to benefit from growing demands for test solutions capable of supporting the higher transmission speed necessary for broadband. Moving to our commercial and consumer segment revenue of $59.4 was down 6% sequentially, as we continued to execute our program of product phase out designed to improve the profitability of our custom optics business.

Our laser business, now under the management of Lightwave’s former CEO Philip Meredith, performed well with a portfolio that is strongly positioned to support the industries ongoing transition to solid state. As a result JDSU continues to gain recognition for its high power, high performance precision lasers. As a leading innovator in this space JDSU has just introduced a new Industrial Diode Laser system that leverages the telecom-class Single-Emitted Diode Lasers to deliver telecom-class levels of power, life expectancy and reliability to a wide range of non-telecom applications.

Our brand protection in the quarter of business Flex was once again inline with our expectations contributing gross margins well in excesses of the corporate average. Brand protection continues to garner increasing attention from brand owners, particularly in the pharmaceutical industry.

On the decorative side, we announced the co-development of a line of custom automobile finishes with Dupont during quarter. As anticipated we experienced further downward pressure in our custom optics business as we transitioned our Front Surface Mirror business to Cardinal Glass Industries. This transition which we expect to be complete by the end of the March 2006 will further reduce custom optics revenue by several million dollars but we will improve operating results starting in the fourth fiscal quarter.

Summing up our business segments, it is interesting to note that a year-ago, more than ¾ of the company was focused on restructuring. To put in another way, less than 25% of the business was free from the distraction of manufacturing downsizing.

Today more than half of JDSU’s business is concentrated on sales growth. Of equal importance across our entire product portfolio JDSU has invested in next generation technologies that serve young, growing markets. In our optical communication segments we are leading the market with our Agile Optical network products such as ROADMs and Tunable Lasers.

With products such as our complete service assurance, our Communication Test and Measurements segment is a key innovator in market. In our laser business we are playing a leading roll in the industry’s transitions to solid state. So, while we have been focused on reducing the cost of our legacy businesses JDSU has also been indulgence in building a strong forward looking product portfolio.

Now few comments on cooperate development since our last call. We had been focused the several quarters on recruiting additional talent to compliment our very experienced and long serving Board of Directors. Last year we had a Quantum CEO Richard Belluzzo. Kevin DeNuccio President and CEO of Redback Communications was the next join us in December, allowing us to benefit from his wealth of experience in broadband communications.

Our third new board member announced in January is Harold Covert, Executive Vice President and CFO of Openwave. JDSU is very fortunate to have the opportunity to benefit from the combined experience these executives have amassed in sales and finance in turnaround context.

In other cooperate developments, I am happy to announce the appointment of Mike Clark to the position of Senior Vice President of Global Sales for Optical Communications. Formerly a sales leader focusing on network equipment manufactures in our CommTest business, Mike brings an extensive background in sales and business development to the role. Before joining at Acterna in 2001, Mike held a series of increasingly senior positions at Agilent Technologies. Finally since our last quarterly conference call stockholders authorized the JDSU Board of Directors to execute in its discretion a reverse stocks split in the ratio 1:8:9 or10 at anytime prior to December 1, 2006. As previously noted the Board continues to believe that reverse stock split will allow investors enhance visibility into the company’s performance on per share basis. It will also increase JDSUs attractiveness to a broader range of institutional investors. The exercise of this authorization would be a matter of discussion for our Board of Directors.

As we progress through the remainder of this fiscal year first, we continue to execute our program of manufacturing transfers and headcount reductions necessary to achieve the previously identified cost savings. Dave will give me more color on our progress.

Second, we must decrease our operating expense.

Third, we must continue to strengthen our finance team to reduce the strain on the financial organization as well as streamline our processes.

Fourth, we will remain focused on integrating our recently acquired companies notably on implementing Oracle in our communications, test and measurement segments.

And finally we will be spending more time on managing the manufacturing supply chain and our responsiveness where there are signs of strain.

In conclusion, let me recognize JDSUs employees for their work to return JDSU to non-GAAP EBITDA profitability. That said non-GAAP EBITDA profitability marks a milestone not the end stage for JDSU. We must maintain our intensity as we execute our program of cost saving initiatives and further our journey to non-GAAP net income positive results. I would now like to invite our CFO David Vellequette to discuss the financial in a greater detail.

David Vellequette, CFO

Thank you Kevin. Let me remind you before I begin, that all numbers are non-GAAP unless I state otherwise. To recap second quarter non-GAAP revenue of $315 million included the first full quarter of communications, test and measurement revenue, as well as the partial quarter contribution from our Agility acquisition. On a geographic basis North America reported revenue of $195.7 million or 62% of non-GAAP revenue. Europe contributed $74.8 million or 24% revenue and Asia Pacific contributed $44.5 millions or 14% of revenue.

GAAP revenue of $ 312.9 million excludes $2.1 million of deferred revenue associated with our Communications Test and Measurement business. This revenue is excluded from GAAP revenue as result of purchase accounting. Non-GAAP gross margin improved from 31.6% last quarter to 36.3% benefiting from a full quarter of Communications Test and Measurement revenue and the savings from our cost reduction initiatives.

As a percentage of revenue non-GAAP operating expenses where 38.1% slightly up side near term target range for 35% to 38% as we absorbed the full quarter of expenses associated with our Communication Test and Measurement business and one month of a Agility related expenses. In the longer term we are targeting operating expenses at less than 35% of revenue. Non-GAAP net loss was $3.7 million, which compares to a non-GAAP net loss of $15.4 million in the prior quarter.

Non-GAAP EPS for the second quarter was slightly below breakeven which compares to a loss of one penny in the prior quarter. On a non-GAAP either basis the company earned $7.9 million, which compares to an non-GAAP either loss of $4.3 million of the prior quarter. This is our first non-GAAP EBITDA positive quarter since March 2001. A detailed reconciliation of our non-GAAP results to a GAAP results is available in today’s press release announcing our fiscal 2006 second quarter results, our non-GAAP results exclude amortization intangibles of $15.6 million reflecting a full quarter impact from Acterna acquisition.

Stock related compensation expense of $3.4 million and a $14.9 million charge for restructuring and non-recurring expenses primarily associated with the activities we announced on November 8th relating to our Ottawa, Rochester and Santa Rosa operations. Including new guidance GAAP gross margin improved from 20% last quarter to 33.3% and operating expenses improved from 55% last quarter to 50%. Net loss on GAAP basis improve from $67 million last quarter to $42.1 million for the second quarter.

In total our sequential results reflects the work we have done to improve our cost structure in the JDSU traffic business and the strong contribution from our recent acquisitions notably our new Communications Test and Measurement business.

Moving to the quarterly result, for the business segments. Optical Communications revenue of $109.6 million was up 9% from the previous quarter and included a one month contribution associated with our Agility acquisition. For the four consecutive quarter the segment’s book-to-bill was greater then 1.

The higher revenue in addition to our cost reduction program resulted in improved operating results for the segment, with an operating loss narrowing from $80 million last quarter to $10 million this quarter. As you know we have made multiple announcements regarding cost reductions in our Optical Communications segment over the last year. So, in the interest of clarity, allow me to recap our initiatives and update you on our progress to-date.

First, our Mountain Lakes, New Jersey facility was transferred to a contract manufacturing partner, last May. Next our products from Ewing, New Jersey facility was either transferred to a contract manufacturing partner, End of Life or sold during calendar 2005. Following the completions of our manufacturing transfers our Melbourne, Florida facility was closed and sold. And finally within the last few days we have sold our undeveloped land in Raleigh, North Carolina.

Looking forward the closure of our Rochester, Minnesota facility is on schedule and we continue to expect to exit this location before the end of fiscal 2006. Product to manufacturing transitions from Ottawa, Canada site are progressing in accordance with our previously discussed plans and are expected to conclude as planned before the end of calendar 2006. Additionally we have received an expression of interest from a potential asset buyer that could accelerate this schedule. If we sell this asset and accelerate our schedule, we expect to increase our previously communicated transition cost by mid single digit million of Dollars.

The financial benefit of the Ottawa, Rochester initiatives is heavily backend loaded in the last two quarters of the current calendar year. Once we exited the Rochester and Ottawa site, the number of Optical Communications manufacturing price in US will stand at two. Bloomfield, Connecticut and San Jose, California. At the same time we will continue to maintain a JDSU center of R&D excellence in Ottawa. In summery the restructuring and cost reduction programs for our Optical Communication segment continue to progress with more than 80% of our optical communications revenue now derived from lower cost manufacturing locations. These locations include both our own Shenzhen site and our contract manufacturing partners.

Moving to Communications Test and Measurements, this segment benefited from seasonal strength and delivered strong revenue of a $146 million in the second quarter. This compares to the two months contribution of $95.4 million in the fiscal first quarter. As previously noted the Communications Test and Measurement segments had historically benefiting from seasonal strength in the December quarter, this has historically been followed by sequentially declining revenue in the quarter ending March and June.

All the time contributed gross margin excess of corporate average product mix for the quarter reduced the segment gross margin by more than 2 points. This decline in gross margin along with the impact of the full quarter of operating expenses resulted in an operating contribution of 18% in the second quarter, which compared to 20% last quarter. On the dollar basis however, segment operating contribution include the $19.3 million to $26.4 million. Our commercial and consumer business delivered revenue of $59.4 million, beyond 6% from the previous quarter inline with our expectations because of the phase out of the Front Surface Mirror business. The segment once again delivered positive operating results with operating income flat the 13% of segment revenue.

On a dollar basis segment operating contributions was down from $8.4 million last to $7.7 million associated with the lower revenue. While our commercial laser brand protections and decorative businesses continue to perform well. We have taken a series of actions over the last several quarters to improve the profitability of our custom optics business. These actions included exiting the consumer integrated light engine business from the fourth quarter fiscal 2005. Exiting the coded micro display business in response to unfavorable marketing dynamics transitioning our crucial customer optics business to contract manufacturing partners, selling our laser marketing and micro laser business in the first quarter of 2006, and finally the sale of our Front Surface Mirror business due to be completed in the third fiscal quarter of 2006. Looking forward the previously announced headcount reduction in Santa Rosa is expected to be completed by the end of the calendar 2006.

To summarize while it is clear we have more to do to reach acceptable levels of gross margin profitability, we did achieve the additional $5 million of cost savings brining our cumulative total to the targeted $ 9 million. Remember that the basis for comparison is our third quarter and fiscal 2005 results. Also we continue to extract cumulative savings in the total $ 17 million in the third fiscal quarter and $22 million in the fourth fiscal quarter of 2006. I would also like to remind you that we yet the quantify the cost savings associated to the most recently announced initiatives impacting Ottawa, Rochester, and Santa Rosa. And we continue to critically access both our operations and our product portfolio for the additional opportunities to reduce cost.

Moving to the balance sheet, total cash, cash equivalents, short term investments and restricted cash totaled $843.9 million. Net accounts receivable increased to $223.4 million due to the higher revenue in the last month of the quarter and our DSO was 65days. Net inventory increase to $181.2 million in part due to the Agility acquisitions and also some increased inventory positions to accommodate lengthening lead times in Optical Communications. Assurance ph) was 4.6. As of December 31st 2005 headcounts were 7234 up from 6938 in the previous quarter. During the second quarter we added additional headcount at our Shenzhen, China facility associated with the transfer of manufacturing as well as approximately 100 headcounts associated with the acquisition Agility. Taken together these additions more than offset headcount reductions in North America.

Now to our financial guidance. The December quarter has historically demonstrated seasonally strength in our Communications Test and Measurement segments, as result you should expect our Communications Test and Measurement business to report lower revenue in the fiscal 2006 third quarter. However with the strong demand in Optical Communications we expect the total company to a report revenue between $304million and $321 million. As previously stated we continue to expect our cost savings to ramp in third quarter as the benefit of our initiatives continue to closer to the bottom line.

In the third quarter we expect to achieve an additional $8 million of cost savings bringing the cumulative quarterly savings to $17 million when compared to our operating results to the third quarter of fiscal 2005, we expect majority of the cost savings to be in the cost to goods portion of the income statement. I will now hand the call back to Kevin.

Kevin Kennedy, Chief Executive Officer

While we do not underestimate the challenge posed by execution across multiple front. We remain focused on deliberate and timely execution of our product transfers and exit from select North American sites. Restructuring inevitably brings risk, so I am very pleased that we have been able to execute our program on schedule while also growing revenues investing in our future without loosing our commitment to customers. JDSUs commitment to both innovation and expansion, organically and through acquisitions, uniquely positions our Optical Communications and CommTest segments for the proliferation of broadband. Despite an aggressive restructuring agenda, the financial benefits of which are largely just been realized. JDSU is playing a leading roll in the adoption of transforming technologies such ROADMs, Tunable Lazers and Transponders, Solid-State Lazers and our End-to-End portfolio of the Fiber-to-the-home products. With that I would like to open up the call for your questions. Operator you may now begin the Q&A.

Questions-and-Answer Session

Operator

Operator Instructions Your first question comes from the line of Subu Subrahmanyan with Sanders Morris Harris Group. Please proceed.

Q - Subu Subrahmanyan

Thank you. My question is gross margin, Kevin. If you could talk about what’s the gross margins are right now for the Classic JDSU business especially in Optical Communications and how the restructuring you are doing with manufacturing, how much more benefits that we can see from that and then just in terms of the communications or I should say the commercial consumer products, can you talk about how much more down tick in revenue there is from the Front Surface Mirrors as you exit that business.

A - Kevin Kennedy

Yeah. Sure Subu, we don’t breakout the gross margins per se on per segments basis but it is suffice to say that in active portrayal of what happens in general was that both the CCP as well as the Optical comps gross margins went up. The CommTest slide down a little bit due to mix within CommTest and of course for the company, because the absolute value of the CommTest gross margins is so much higher, the mix was very favorable given the revenue growth. So that was sort of the general scheme, the institution license and structural piece of the mix was very favorable, the structural piece of the cost of reduction was favorable up on the JDSU classic side and we had some jitter on the CommTest side. As I have mentioned in a prior disclosure we have a long tail on the manufacturing cost reduction, so when you see to get gross margins improves the immediate transfer tends to raise your cost structure. Second thing that happens is you get it ratchet down because you have less overhead and so you do that when you actually exit factories. To-date we are physically at or about two of the ones we have started in the September August timeframe. The next pieces you get bill materials improvement the cost of localization and of course lower headcount costs. But that tends to take probably in the 3rd or 4th quarter, so this tail on manufacturing cost reduction of course after that you have value engineering so it’s probably about 5 or 6 phases to it and the tail can anywhere from 3 to 6 quarters. Of course in parallel with that you have ASP compression. So as Davis said the cost numbers that we were trying to take out are on track, the tail is fairly long so we have to physically get out of buildings now that we have we done a resources on both shores as you note our headcount is actually in total up which is an indication of that. But in terms of removing the costing we are very much on track. Okay.

Q - Subu Subrahmanyan

Just a follow up on Front Surface Mirrors are most of those revenues out so we can get direct comparables quarter-to-quarter for CCP or is this, more, can be taken out.

A - Kevin Kennedy

There I think Dave has mentioned there is more to be taken out that would be in low single digits.

Q - Subu Subrahmanyan

Thank you.

A - Kevin Kennedy

Okay.

Operator

Your next question comes from the line of Michael Genovese with Citigroup please proceed.

Q - Michael Genovese

Thanks guys. Nice start on a quarter, good to see things there continue to develop. Could you just give us first of all, your outlook right now, having just brought in the Test and Measurement segment and it seeming like optical is strengthening, within those two segments what are your current views on seasonality it sort of help us out with a four quarter view. You talked about your fiscal 1st, 2nd, 3rd and 4th quarters. What are the thoughts about seasonality in those businesses?

A - Kevin Kennedy

We don’t’ have any reason to change our view of seasonality that we’ve expressed on the CommTest site, meaning that the prior two quarters, the last quarter would be the highest, the next two will sequentially drop. On the other hand if you think about the guidance that Dave gave and the fact that we had book-to-bill, that was fairly favorable. It means that we foresee a strength in the Optical comms piece of the business right now. The Optical comms business has in general not been highly seasonal. Sometimes a little bit of slowdown in this quarter that we are in but not typically highly seasonal for us.

Q - Michael Genovese

Okay and then finally sounds like you still talking about this 88 million in cost savings, but then you mentioned you reminded us that you haven’t quantified those three locations at Ottawa, Santa Rosa etc. Can you remind us the size of those reductions and is there any further thoughts you can give on further quantification or the time frame?

A - Kevin Kennedy

The reason we haven’t quantified it Mike is because we haven’t set a specific timeframe and that is really what drives the numbers. My recollection is that it was measured in hundreds a, the numbers we talked about on the previous call was slightly over a hundred people out of the Santa Rosa facility, about 80 people are in Rochester and around 300 people out the Ottawa. So a total of about 500 people in that range Mike.

Q - Michael Genovese

Great thanks there.

A - Kevin Kennedy

Thanks very much.

Operator

Your next question comes from the line of John Harmon with Needham & Company. Please proceed.

Q - John Harmon

Hi good afternoon. Looking at the segment numbers you gave, I’m just curious about what are some of the operating margins look like. In your remarks you talked about the contribution for segment, I mean for example the Test and Measurement division had an effective 18% operating margins last quarter, it looks like pretty good margins for that kind of business. Are those numbers accurate and one thing I wanted to ask about was a $30 million other operating losses which looks like an overhead charge, can you tell me what means please?

A - David Vellequette

Sure John. this is Dave Vellequette, let me help you with that. First as you look at each segment and yes the numbers are accurate, the other thing to point out is in the, you look at the Communications Test and Measurement, If you look their historical these are about the ranges that they have been at, they will change up or down a few percentage points based on their margin and mix. The other thing to remember is in the Optica Communications area, if you think it historically, we talked about the favorable, the benefits we got, the one time benefits we got from warranty and E&O in previous periods. Those benefits are basically gone and so if you look at our financials from the last December 2004 there is about a $4 million benefit that optical communications realized and now that is no longer there. So as we transitioned the product lines, the portfolios also the E&O and warranty benefits we once received, are no longer in the number and yet we are still improving on our results. Going to the other number you asked about, included in that are the proxy expenses that we incurred because of our shareholder meeting, we have a some legal activity related around the defending our IP and also we are doing a Oracle implementation of the Test and Measurement area and it is certainly expensive there that we cannot capitalize and therefore run through that part of the P&L.

Q - John Harmon

Okay, thank and then one clarification as I said. It sounded like you said $30 million of revenue in the quarter represented on discontinued product line, did I get that correctly.

A - David Vellequette

Well no, when you relate it to the year ago period we have taken out $30 million of revenue that we realized in the quarter December 31st 2004, so when you look at the revenues for JDSU Classic of a $180 million in the segments report and now you look at a number of about a $170 million, you should note that $180 million included $30 million of revenue from products from that we no longer ship.

Q - John Harmon

So that’s, I am sorry, so that is just Telecom.

A - David Vellequette

That’s in the Optical Communications and the CCPG.

Q - John Harmon

Okay and where do on going revenues trough at those businesses, in other words where do you stop divesting things.

A - David Vellequette

Well we will continue to divest from product lines that are not meeting our profitability goal we will continue to expand or portfolio where we see opportunistic investments. So as we said the Front Surface Mirror, we expect the impact of that to be low single digit millions in the coming quarter.

Q - John Harmon

Okay thank you very much.

A - David Vellequette

Thanks John.

Operator

Your next question comes from the line of John Anthony with Sg Cowen, please proceed.

Q- John Anthony

Good evening gentlemen. Couple of quick questions and I apologize if you went over any of this. Did you say that lead times were stretched and could you quantify by how much and in what products if you could give some more detail there. And then also if you could also discuss whether in your guidance there is any meaningful contribution from Agility and lastly could you talk about the capacity utilization trends in Shenzhen and at the contract manufacturer what the trend was quarter-over-quarter and any relevant in book-to-bill. thanks.

A - David Vellequette

So let me John take step try to answer a few of those. I don’t think we explicitly said anything about lead times. We did, the last time say that lead times stretched on a number of products and that is probably, I don’t know if they have stretched out any further by they’ve probably haven’t got any better and so I say that is a comment that is true at the high end of the portfolio as well in specific cases where we have struggled with specific transfers. So, we have very broad portfolio, I wouldn’t know how to begin to enumerate on them on the call here but I say that the two colossal realities of where there is new products that are introduced and there is more demand and than we can deliver quickly. Secondly is, probably where we had some transfers.

On the second piece on utilizations, we, I wouldn’t know what the top of them have, what utilizations are at the contract manufacturers or Shenzhen. Shenzhen has built up significantly, probably double in terms of amount of the revenues that we have there in last year, so that utilization is trending in a very, very capable fashion. The two primary contract manufacturers are moving in a very favorable fashion simply because the amount of percent of our portfolio that is now coming from Asia. So, really, that the key for us is fully get out of North America and be able to close down number of our operations, that’s what will help us, in terms of our overheads. On the Agility piece, in terms of what percentage is forward guidance, I wouldn’t break that right now, but, what I would tell you is that, we had about a month of contribution in this particular quarter and that probably represented approximately a percent of the optical communications piece of the business. And in terms of book-to-bill, I simply said, it was better than one for the company and clearly, given that, we still believe that we will see seasonality in CommTest and that there is still some revenue downside on the CCP segment. You should interpret that we saw a good strength in our Optical Communications too. Is that helpful.

Q - John Anthony

Yeah very, thank you much.

A - David Vellequette

Thank you

Operator

Your next question comes from the line of Brant Thompson with Goldman sachs, please proceed.

Q - Brant Thompson

Yes. A few things that I wanted to hit on. First, as we look at the second half of next quarter in terms of, you were indicating with the revenue mix shifting with Optical Communications really being stronger relative to the other one on a sequential basis. Could you talk about, just should we think about that versus the cost savings that we are going to be getting and where we are in that and how we should think about margin’s impact in the next quarter. Second thing, it’s clearly, a lot of expense going into building financial infrastructure, putting in that place. At what point, do you think, we can kind of get into that when will that start to come off the book. And then lastly, any kind of comments around cash flow targets?

A - David Vellequette

Sure Brant, this is Dave Vellequette. So, we don’t really go into the different segments and how each segments specific revenues are going up or down. We did comment on, as you know that the CommTest will come down, we believe that the strength that we have in the last of four quarters of book-to-bill is greater than on as I noted and we believe that strength that’s what supported the guidance that we gave which was slightly up from the prior quarters guidance. So, and we expect that the improvement in the cost will obviously help offset the impact of the mix change between Norcom and Test and Measurement. But we really don’t comment about the specific changes in the gross margins. From the expense side, the implementation of Oracle across the Test amd Measurement group, that’s, it has a long feel on it also but at the same time, we are going to be very focused on reducing the expense structure, to help pay for those cost. So we are not anticipating, I think, our OPEX increased as the percentages we noted, we are targeting to get that percentage of revenue down below 38% so, that is a focus for the company and Kevin mentioned is the focus that we have to have to keep that OPEX below the 38% range and to longer term to get the OPEX below 35%. On the cash flow prospective, we did benefit from the sale of two facility during the quarter which generated about $25 million of cash during the quarter, at the same time we are actively reviewing our cash requirements and keeping our cash use and generate from operation the impact to the cash use I should say minimized so, to keep that loading on a cash. Does that help?

Q - Brant Thompson

On the cash, any ideas when you were get just operating cash flow when do we so to contribute more cash out of that record if you will?

A - David Vellequette

Yeah, well that will be heavily dependent obviously about the improving the profitability of our financial results so, it will comes as we realize more of the savings and as we continue to get once we start to get the benefit of these initiatives that we announced that we said will happen by the end of the calendar year.

Q - Brant Thompson

Okay so, by year end.

A - David Vellequette

We are on a plan that continues improvement.

Q - Brant Thompson

Thank you,

Operator

Your next question comes from the line of a Ehud Gelblum of J.P. Morgan, please proceed.

Q – Ehud Gelblum

Thank you, very much. Couple questions if I might. First of all, at the end of, on your conference call last quarter I think you mentioned that you have by constraints that limited your revenue by about $5 million, do you see some of the $5 million this quarter that, half of this quarter, if it is an unnatural phase, or is that revenue pretty much lost?

A - Kevin Kennedy

No. There is specific areas, where we had challenges, I don’t know if I remember all of them but the once that stick in my mind, we actually made significant improvements on shifted that revenue side I think you had ask whether I thought the revenue would be lost, I think I told you that I didn’t think it would be and if my recalls on the same parts we have 100% rewards, but our flow through is very positive right now on that particular area.

Q – Ehud Gelblum

Okay, Dave if you look at the Agility and Lightwave, you mentioned the other month Agility and I think in the beginning certainly you mentioned Lightwave was still less of a contributor than Acterna was this quarter but is it enough if you have mentioned it, can you help us think that roughly how large that were in the quarter from the contribution they have?

A - David Vellequette

As we said on Agility, it’s about 1% of the revenue in the Optical Communications group. The Lightwave revenue we haven’t really broken that up in the past but it is a key contributor to our commercial and consumer products lasers part of the business but we don’t really break those revenues is out, specifically.

Q – Ehud Gelblum

Okay and I assume that both if you look at them on the margin basis those of businesses are how is the margin?

A - David Vellequette

Yes, We have gross margins.

Q – Ehud Gelblum

Gross obviously I hope so, put it on operating margin business?

A - David Vellequette

The Agility is, as part of your question I think you are asking is it EBITDA positive and its not EBITDA positive at this time, Lightwave is EBITDA positive.

Q – Ehud Gelblum

Okay. Thank you. The deferred revenues, a little bit difference between GAAP and non-GAAP revenue. I am assuming that was Acterna, was there any deferred revenue portion in the last quarter, that I don’t understand that?

A - David Vellequette

It was 900K, if you look on the segment report, you will see a small amount that’s why you see the six months number for the deferred on the segment reported $3 million and $2.1 million being this quarter

Q – Ehud Gelblum

Okay and do you we expect that any next quarter or its through the deferred revenue?

A - David Vellequette

It is less then $2 million, somewhat to differ.

Q – Ehud Gelblum

So we should expect the positive EBITDA, next quarter, definitely-

A - David Vellequette

The majority of that should come up this quarter.

Q – Ehud Gelblum

Okay and your guidance 304 to 321?

A - David Vellequette

It is non-GAAP.

Q – Ehud Gelblum

Okay there is about $2 million discount between the two?

A - David Vellequette

In as far as we are hearing obviously a lot about fiber builds from the RBOC unit, down stream end users. That depends on the curve will be noted, etc., if I remember correctly at you analyst day, I think you had a slight update but that you address, I don’t remember that number but it is something like a 17% of that market or something of that sort. Do you have products that move forward to be able to address a greater portion of that now, do you expect to benefit from these fiber build going forward this year. I remember at the time, it seemed like a shocking low percentage of exposure you have directed at us, this fiber-to-the-home?

A - David Vellequette

You know Ehud, must from my old age, I am not clicking on the particular slide but what I can tell you is our, where we are participating is largely in the back halls, the metro access, metro core and in fact this quarter long haul was probably stronger than we anticipated coming into the quarter. So we absolutely benefit in the optical components piece we have not decided to play in the pond because I don’t the profitability structure is there yet. And that we’ve said before and I’m still sort of in that mind set so we are picking our place not by revenue growth but actually by profitability at this stage. The good news is on the CommTest side we tend to play well both in optical transport testing as well as the services that we can put on top, very, very strong position of Voice over IP and very strong position in video services on top of the fiber. And that was an overt choice my view was is that you had to go up the stack in order to find profits in fiber-to-the-home build ups.

Q – Ehud Gelblum

Okay two last questions as I said. Early in the year I think at a conference you made a comment that it is actually is cheap but it has great talent, that is the entire industry is manufacturing and had been in your plans, this is back in the beginning of ‘05. You will still be I think the number was 50% utilized only. Can you update us on given the anomaly, you had a lot bank closings, the industry seems to be a little bit stronger the revenue is a little bit higher and there’s been a lot bank closing in other parts as well. How does demand fit versus supply or shall I give another utilization versus capacity, however you kind of you look at it. How does demand and supply of components sort of climb up now versus they did.

A - David Vellequette

I’d say that there is still more capacity than there is demand and I think that will be the case in terms of facilities for several years. The reality is that there is a lot of fabs out there in the world. So the good news is I think across the board most of the companies that have been encumbrance in this market have taken strong strides in reducing their overheads and into getting Asia is a great thing. So big improvement there, but there is still of capacity. And the question is there is still lot of competitors. And there is still lot of competitors in this market so but both are real.

Q – Ehud Gelblum

Which, I mean the second part of the question was pricing. How do you see pricing change over the last 6-9 months is it better now and how do you describe the pricing environment?

A - David Vellequette

You know I say a year a more ago I’ve always answered the question in three parts meaning that, what we saw in transmission tended to be different that what we saw in transport which tended to different than what we saw in switching or subsystems. That statement is still true, at one point in time some of those areas such as transmission were almost on double digit declines. I’d say the pricing contractions has slowed somewhat I think in the last that somebody asked us the question we said low double digits per quarter if you amalgamate all three that’s what low single digits per quarter, if you amalgamate all three that is probably still true. So it hasn’t got worst, it’s probably better that it was a year ago.

Q – Ehud Gelblum

That is below some more digits quarter-over-quarter, sequentially.

A - David Vellequette

Yeah.

Operator

Your next question come for the line of Paras Bhargava with BMO please proceed.

Q - Paras Bhargava

And thank you and couple of questions if I might. The testing operating margins at 18%, how does that compare with the 5% that you disclosed, testing had before you took over you filed a couple of 8Ks in October, is that on the same basis or is it a different basis.

A - David Vellequette

This is Dave, Paras that 5% was the after tax and so this an operating margin which before interest income and taxes.

Q - Paras Bhargava

Then 5% Dave, was a pre tax operating margin. If you look at the operating income you disclosed in that 8K not the net income, it was 5% of revenue.

A - David Vellequette

5% of revenues on the, okay, I was thinking into the $5 million net income, okay so the 5% as they were, as they were build, I think basically stronger momentum especially for the quarter, this is their strong quarter, in fact a year ago the same quarter was a very strong quarter for them so, you are looking at a 12 moth number there.

Q - Paras Bhargava

Yes.

A - David Vellequette

And so what happen to, this quarter number is always the strongest quarter and so that’s why they are hot in the teens here. Also there are certain expenses that we have now put in the all other that relate to corporate support such as auditing, that are now build to corporate that day we have had the historically so, we have not allocated to those groups

Q - Paras Bhargava

I am just try to understand how if you done in the same basis would have been more like 12% or what has been more like 15% if you are on the same basis as the five so, we can use that forecast to profitability, going forward figured it with the seasonally strong quarter, just so much higher than the annual leverage its hard to take a look at trends and figure out we are doing profitability wise capacity?

A - David Vellequette

Yeah I think that this quarter because of the strong revenue as their expenses send to be the operating expenses is tend to be more consistent or flat I would call other than the sales expenses which is a percentage their revenues so this quarter is always going to be strongest on our operating margin, we really don’t comment about where they are which was the total but that they have improved from the 5% level that they were in the numbers we are looking so and as we noted that the year-to-date they stand in at about, I am looking at that rate, what is that, a 8% range.

Q - Paras Bhargava

Well that is very helpful. Now on the commercial side there is a bunch of moving parts here and that business used to have 20% operating margins as you reported, its sort of stabilized the 13, after you finished some of the actions there probably it can go up to 20 but can it get above 13 or is it just going to stick around here?

A - Kevin Kennedy

You know, we have, as we said with that once we get through the we have not quantify the initiatives we have going on at Santa Rosa, obviously we are looking at improving those operating margin and I think once we get those savings quantified for you, I think you will be able to see that there, we hoped that there is more to come in that area

Q - Paras Bhargava

That’s very good and then the, I didn’t quite understand the answer to the other loss I understand there is some one time advance in their net $30 million $29 million, is it possible that it is going to come down by $10 million a quarter, where you see that element come down but it seems to be was stable and at certain time that of course its going to be some other from testing and just try to understand how much of is from testing and how much of that is sort of one time stuff or transitional stuff as you working through this very large project.

A - Kevin Kennedy

There is some transitional as we look at the last quarter its about and that’s what I have explained the increase from the prior quarter, in the previous, if you look at the year ago quarter it was a $25 million so we have incurred some incremental there, as we close the factories at to some of the other get implementations completed, we hoped to bring it down but right we now we have put a number on that but the $10 million I assumed like very large number to take out of there

Q - Paras Bhargava

One final question for Kevin, as you are going, you are one of this company it sounds like what you are saying you didn’t get, you are trying to get OPEX down to 35, what sort of businesses do you want to staying and you want to sort of keep on exiting businesses with the certain gross margin hurdle or, how are you actually exciting business that is having more stuff on, is there success of target using, how you go by doing.

A - Kevin Kennedy

Probably we have the setback to start actually bearing, but we have been pretty explicit with the lines that we used in the past of the investor conferences, the starting point is to look at revenue growth rates as well as gross margins and if your negative growth rate and negative gross margin you probably not long for the real gear, you have high gross margins and we have to fix something to get the revenue growth up and it is fixable, we do have and if we have great revenue growth but low gross margin but path to improve the gross margin then we go fix that. So we do have a very disciplined minds with which we do it, the second once that we use is, in general if we look at many of the businesses that are optics in general and specifically we are part of legacy of JDSU, they were business that I would classify professional services business where you have one or two customers for some unique technology and that was great when you were the only game in town, when the, there are four other competitors that entered who don’t have a unique level of intellectual property, that is probably not great place for gross margin sanctuary in the future. So we are in general have been exiting what I would call professional services business that are not protectible and we are investing in what we would call markets where they are clear gross margin structures, commercial lasers would be an example of we have expertise product and has a clear structure, CommTest is a place where I can say the same thing. Hopefully it helps you.

Q - Paras Bhargava

Thanks a lot.

Operator

Thank you for your participation in today’s Q&A session, ladies and gentleman, you may now all disconnect your line, enjoy your day

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