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Edited Transcript of EMKR earnings conference call or presentation 2-Aug-18 12:00pm GMT

Q3 2018 EMCORE Corp Earnings Call

ALBUQUERQUE Aug 14, 2018 (Thomson StreetEvents) -- Edited Transcript of EMCORE Corp earnings conference call or presentation Thursday, August 2, 2018 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Erica L. Mannion

Sapphire Investor Relations, LLC - President

* Jeffrey S. Rittichier

EMCORE Corporation - CEO, President & Director

* Jikun Kim

EMCORE Corporation - CFO & Secretary

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Conference Call Participants

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* Jaeson Allen Min Schmidt

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

* Timothy Paul Savageaux

Northland Capital Markets, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the EMCORE Corporation Fiscal Third Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, today's call is being recorded.

At this time, I'd like to turn the call over to Ms. Erica Mannion of Sapphire Investor Relations. Please go ahead, ma'am.

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Erica L. Mannion, Sapphire Investor Relations, LLC - President [2]

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Thank you, and good morning, everyone.

Before we begin, we would like to remind you that information provided herein may include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act of 1934. These forward-looking statements are largely based on our current expectations and projections about future events and trends affecting our business. Such forward-looking statements include, in particular, projections about future results, statements about plans, strategies, business prospects and changes and trends in the business and the markets in which we operate. Management cautions that these forward-looking statements relate to future events or our future financial performance and are subject to business, economic and other risks and uncertainties, both known and unknown, that may cause actual results, levels of activity, performance or achievements of the business or our industry to be materially different from those expressed or implied by any forward-looking statements.

We caution you not to rely on these statements and to also consider the risks and uncertainties associated with these statements and the business that are included in the company's filings with the U.S. Securities and Exchange Commission that are available on the SEC's website located at www.sec.gov, including the sections entitled Risk Factors in the company's annual report on Form 10-K and quarterly reports on Form 10-Q. The company assumes no obligation to update any forward-looking statement to conform such statements to actual results or to changes in our expectations, except as required by applicable law or regulation.

In addition, references will be made during this call to non-GAAP financial measures. Investors are encouraged to review these non-GAAP financial measures as well as the explanation and reconciliation of these measures to the comparable GAAP financial measures included at the end of our earnings press release included as Exhibit 99.1 to the Form 8-K we furnished to the SEC today. These materials can also be found in the Investors section of our website at www.emcore.com.

With me today from EMCORE are Jeff Rittichier, President and Chief Executive Officer; and Jikun Kim, Chief Financial Officer. Jikun will review the financial results, and Jeff will discuss business highlights and fiscal fourth quarter guidance before we open the call up for questions.

Now I will turn the call over to Jikun.

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Jikun Kim, EMCORE Corporation - CFO & Secretary [3]

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Thank you, Erica, and good morning, everyone. Today, I will discuss EMCORE's Q3 FY '18 financial results ending June 30, 2018.

Consolidated revenue for the quarter came in at $17.7 million, within our guidance range of $17 million to $19 million, which we provided on our last earnings call. These revenues were 43% lower year-over-year and 5% lower quarter-over-quarter.

As we discussed on our prior earnings call, over the past 2 quarters, revenue from our cable TV products have been impacted by an inventory correction with our largest cable TV customer. This particular customer chose to consolidate its outsourced EMS into their own captive facility. While the impact of this decision continues into EMCORE's fourth quarter, strong demand from our other cable TV customers offset this decline such that overall cable TV revenues remained flat in Q3 quarter-over-quarter. In Q3 our cable TV revenues were 66% of total revenues, and our non-cable TV revenues comprised 34% of revenues.

Decomposing the non-cable TV revenues. Chips were at 40 -- chips were at 14% of revenues. Satcom video and wireless was at 11% of total revenues, and navigation was at 9% of total revenues.

Cable TV and Satcom video and wireless products remain roughly flat quarter-over-quarter, while chips and navigation products were nominally down due to the timing of shipments during the quarter.

GAAP gross profits in Q3 were approximately $1.2 million or 6.8% of revenues, down from 26.6% in the prior quarter. Gross margin underperformance in Q3 was driven by several unique challenges, including the timing of wafer fab period expenses; inventory write-downs for cable TV-related DFB lasers and long-term inventory; under-absorption by wafer fab facilities driven by lower shipments; new LEML transmitter introduction costs; lower chip deals and higher chip testing costs as we ramped up new suppliers to add on new chip delivery capacity. Taken together, these expenses totaled approximately $2.6 million or 15% of sales. Proforma for these expenses, which we do not anticipate returning in Q4, our gross margins would have been 22% in the quarter. While we typically do not provide gross margin guidance, directionally, we would expect gross margin to be in the low to mid-20s in the fourth quarter as we continue to increase chip capacity and transition LEML-based transmitters to production.

Total GAAP operating expenses for R&D and SG&A were $9.1 million, in line with prior quarters, and $0.3 million higher than prior year. Also in Q3, we recognize approximately $520,000 of G&A expenses related to Satcom and chip customer allowances for bad debt reserves. These are included in our non-GAAP expenses and were not added back in the reconciliations. On a GAAP basis, the consolidated operating loss for the second quarter was $8 million -- apologies, third quarter.

Our non-GAAP operating loss after excluding certain adjustments, all of which are set forth in the non-GAAP tables included in today's press release, was a loss of $6.9 million, a $4.7 million decline prior to the -- compared to the prior quarter, principally driven by higher cost of goods sold that we've discussed. As a percent of revenue, in Q3 FY '18, non-GAAP operating income was a negative 39.1%. Our non-GAAP pretax loss from continuing operations was $6.7 million.

Moving on to the balance sheet and cash flow statement. At the end of Q3 FY '18, the company's cash and cash equivalents, including restricted cash, were approximately $65.5 million or a decrease of $200,000 over the prior quarter. Regarding our working capital metrics, DSOs were at 63 days, flat compared to the prior quarter, lower compared to the prior year of 68 days. Net inventory turns, including non-current inventory, was at 2.1x. Capital expenditures in the quarter was $1 million, and depreciation in the quarter was $1.5 million.

With that, I will turn the call over to Jeff.

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [4]

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Thanks you, Jikun, and good morning, everyone.

As Jikun highlighted, in the third quarter, we continued to experience a headwind due to the inventory overhang at one of our cable TV customers. However, in aggregate, our cable TV products performed better than expected, driven largely by higher demand from our other customers.

With respect to the inventory overhang, the third quarter represented the trough in terms of demand, and we have begun to see orders return. Although this is encouraging, we need to be mindful of the traditional sources of CATV volatility and competitive dynamics between our customers. As such, we're going to restrict our visibility comments to the current quarter.

Looking beyond the specific customer dynamics, we have seen an overall strengthening in demand for our cable TV products, notably for our LEML-based solutions. We shipped a record number of LEML transmitters in the quarter and notched 2 more design wins for our LEML mini-transmitter at the ANGA show in June. The increased adoption of LEML products provide solid evidence that this technology provides a distinct competitive advantage in the markets and enables substantially higher transmission efficiency versus legacy DFB-based products. This technology gives MSOs an inexpensive powerful tool to break bottlenecks in their networks without ripping up and replacing their existing linear-based infrastructure.

As with prior-generation cable TV products such as O-Band, which is a 10-year-old plus technology still shipping in some volume today, we expect DFB products to continue to contribute to cable TV revenue for years to come.

With that said, EMCORE's technological leadership in linear components is manifested in the LEML, and we are thrilled with how quickly these products are being adopted by the market. Last quarter LEML transmitter sales grew by over 75% quarter-over-quarter.

Overall, our other major customers in cable TV continued to meet or exceed their forecast, demonstrating that overall MSO spending levels remain on a solid footing.

Outside of cable TV, as Jikun highlighted, our other broadband products remain flat quarter-over-quarter, with near-term strength in the Satcom product line box-setting lumpiness in the Sat -- sampling activity of our DAS wireless products. While project engagements in this area remain robust, we continue to expect material revenue contribution to be more of a late 2019 to 2020 event when 5G deployments move beyond trial phases.

Moving on to the chip market. In the second quarter, we continued to see strong demand for 2.5G PON products within China. However, as we noted last quarter, we were unable to service all the demand in the third quarter due to limitations in external supply chain. Beyond GPON, the uncertainty around ZTE in China continued to create headwinds for our customers' customers in the third quarter, which, in turn, impacted our overall chip revenue as expected. However, we believe this is more of a timing issue, and would expect to see this demand return in subsequent quarters.

Finally, within the navigation market, production levels for our products remains on plan with the growing backlog of programs. Most notably, we were notified that we have been selected as the winner of 2 new programs for a flagship product that we are expected to formally announce in the coming quarter. Both wins were achieved against strong competition from incumbent suppliers, pointing to the strength in EMCORE's technology. We continue to be encouraged by the major customers that are pulling us into ever more important programs and note that our business development funnel has never been stronger.

We recently introduced our EN-150 Inertial Measurement Unit at the Farnborough Airshow in July. This is an important milestone because it's the world's smallest closed-loop FOG-based inertial measurement unit and demonstrates EMCORE's ability to leverage common building blocks from our EG family of FOGs and our EN family of IMUs to create a broad portfolio of products that address a variety of customer needs. The EN-150 is targeted at munitions applications as well as small platform tactical requirements, delivering a lower-cost alternative to ring laser gyros in a form factor that was previously only achieved with MEMS-based sensors. We continue to work diligently to close the MTS-B long-term agreement with Raytheon and expect this to be resolved in the very near term.

Now turning to the outlook for the entire business. In the fourth quarter, given the relatively limited demand visibility inherent in the cable TV business, we expect revenue to be in the range of $21 million to $23 million. Fundamentally, we expect to see growth across all 3 of our product areas, namely cable TV, chips and navigation. Overall, we are executing in the areas we can control and working to hold down expenses as we return to a normalized cable TV demand level across all of our served customers. I remain encouraged by our progress in navigation, in particular, and believe we'll enable us to build a stronger, larger company over the long term.

Now I'll turn the call over to the operator to open up for questions. Operator?

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Operator [5]

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(Operator Instructions) Our first question will come from Mr. Jaeson Schmidt with Lake Street Capital Markets.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [6]

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Jeff, I know you mentioned you don't want to comment on visibility beyond the current quarter, but wondering if you could provide some color if visibility has worsened at all over the past 3 months, specifically in the CATV business.

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [7]

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No, visibility certainly has not worsened. I would say that there's some competitive dynamics in the market, which I can't elaborate on because it's confidential information, that maybe make the picture a little less clear than normal. But again, at a macro level, what we've been saying for the past couple quarters is that we expect demand to trough in Q3, which we believe that was the trough. We've got orders returning. So overall, the comments that I made about, say, penetration of Remote PHY, those remain on point. And we're encouraged by what we've got here in cable TV in the current quarter, so I wouldn't say that there's anything new to concern ourselves with.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [8]

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Okay. And then shifting gears to LEML, if we look out to 2019 or even a bit longer term, what...

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [9]

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Yes.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [10]

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How should we be thinking about how much that product portfolio should comprise of your CATV business?

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [11]

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I think the -- it's a really good situation. I would say that next year, by far the majority of the product shipments will be linear EML. The customer adoption has been terrific. It's gone about as well as we could hope. As Jikun pointed out, there's a couple little things that we need to square away in the -- on the production side of things, but these are problems we've saw before, the typical sort of sorting for yield issues that occur in chip before they go into module. So yes, it's going to be the majority of the products as we look forward into FY '19, Jaeson.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [12]

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Okay, that's helpful. And last one from me, and I'll jump back in the queue. How should we think about OpEx going forward? It's seems to see a pretty sizeable jump sequentially in June. Just try to get a sense how OpEx should ramp throughout the remainder of this calendar year.

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [13]

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Jikun, do you want to tackle that one?

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Jikun Kim, EMCORE Corporation - CFO & Secretary [14]

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Sure, sure. So, Jaeson, I think I talked about this on the prepared remarks. We had a $520,000 increase in OpEx quarter-over-quarter due to a reserve that we took for allowances for bad debt as well as our R&D expenses jumped up quite a bit in the quarter just due to the acceleration of certain product development efforts on the FOG side. So if you adjust for those, I think you'll see that our SG&A expenses actually went down a bit. R&D, we're expecting it, I think, last quarter or, I mean, this -- Q2 was closer to $3.1 million. In Q3, it was $3.9 million. I think you could see that hovering between those 2 numbers.

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Operator [15]

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(Operator Instructions) Our next question comes from Mr. Tim Savageaux with Northland Capital Markets.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [16]

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A couple of questions. Maybe first, on the GPON side, I did get on a little late, so I may have missed the chip breakout there. Sounds like you had some positive and some negative commentary there, with strong 2.5 peak demand but some ZTE impact. And we've been hearing pretty consistently about somewhat of a burst to the activity around ZTE post the lifting of the ban. I think you talked to growth across product segments sequentially in the September quarter, so I imagine you're seeing some of that, but I wonder if you can kind of amplify on, first, were chip sales, I guess, down in the quarter sequentially? And what do you expect in September, especially focused on any increasing activity at ZTE?

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [17]

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Sure. So the thing is -- let's sort of breakout the contracts between, say, Huawei and ZTE, we've been designed into a lot of applications that ultimately go through Huawei for some time. And so in the cases of GPON, when the spend is more quality centric, things are quite good. If it goes a little more ZTE centric, then we have fewer design wins with the ZTE supply chain, and so it's not quite as good. The other piece to this is that our customers' customers on the higher-margin, higher-ASP chips have more ZTE exposure. So you may see a little less ZTE demand in the net from the GPON side, but we'll see more demand on game chips and other products that go into slightly different applications. So the net is, timing issues aside, and those can always crop up, ZTE coming back means a richer margin picture for us at the expense of possibly damping down some amount of demand on the GPON side. Does that make sense?

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [18]

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Yes, crystal clear actually. And again, I may have missed it. To the extent you made some initial kind of RFI comments or at least I think your indication was you haven't seen much change there, I think we see a lot of kind of conflicting data points out there, some indications of acceleration, some less so. But I wonder if you wouldn't mind kind of at least refreshing those comments around -- and is the pace of RFI adoption one of the competitive factors that you referred to in terms of still having some degree of uncertainty on the cable TV optics side?

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [19]

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Sure. So as we've said in the past, RFI is not affecting us, it's not projected to affect us very much even through '19. I did see the harmonic comments. Was a little bit curious, as they talked about, their architecture's serving 100,000 modems, which is a unique way of expressing what they're doing, I'll just interpret that as homes passed and stated that, that's consistent with the low end of the estimates for the actual amount of RFI penetration at one customer that we're very familiar with. So in fact, what we see is continued robust spending on the linear optics side. Again, it's interesting because there is a data point out there that I think some folks need to heed a little bit, and that is that we're still shipping significant amounts of 1310 O-Band technology, which is 3 generations old. I mean, that stuff's been out there for 10 years. The cable TV industry does not move as fast, especially when you look at it globally, as many people would wish in fact would happen. And there's a lot of engineering that goes into even the smallest Remote PHY applications or rollouts in the test case, and that's all that's really happening now. So our view is that -- and just based on the numbers of lineal -- linear EML transmitter standards that layer optics is going full force, and we don't expect to see that change at least through '19.

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Operator [20]

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And at this time, we have no other questioners in the queue, so I'll turn it back to Mr. Rittichier for closing comments.

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [21]

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In closing, I'd like to thank all of you for your time this morning and your interest in EMCORE. I would also like to acknowledge the entire EMCORE team located around the world, I know there's a few on the call, for their hard work and commitment through a real tough quarter. We're going to do better going forward. Thank you, everyone.

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Operator [22]

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Ladies and gentlemen, that concludes this morning's presentation. You may disconnect your phone lines, and thank you for joining us this morning.