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EMCORE Corporation (NASDAQ:EMKR)

Q1 2009 Earnings Call

May 11, 2009 5:00 pm ET

Executives

Victor Allgeier – TTC Group

Hong Q. Hou, Ph.D. – Chief Executive Officer & Director

John M. Markovich – Chief Financial Officer

Analysts

Bill Choi – Jefferies & Co.

John Dorsheimer – Canaccord Adams

Sam Dubinsky – Oppenheimer & Co.

Welcome to the EMCORE Corporation second quarter fiscal 2009 earnings conference call. Today’s conference is being recorded. At this time I’d like to turn the conference over to Mr. Victor Allgeier of the TTC Group.

Victor Allgeier

Today after the close of markets EMCORE released its fiscal 2009 second quarter and six month results. By now you should have received a copy of the press release. If you have not received the release please call our office at 646-290-6400. With us today from EMCORE are Dr. Hong Hou, President and Chief Executive Officer and John Markovich, Chief Financial Officer. John will review the financial results and Hong will discuss business highlights before we open the call up to questions.

Before we begin, we would like to remind you that some of the comments made during the conference call and some of the responses to your questions by management may contain forward-looking statements that are subject to risks and uncertainties as described in EMCORE’s earnings press release and filings with the Securities & Exchange Commission. I will now turn the call over to John.

John M. Markovich

Thank you for taking the time to participate in our call this afternoon. I will start by providing you with some highlights of our fiscal second quarter and first half operating results, highlight several significant improvements to the balance sheet, review our backlog metrics and wrap up by addressing our expense reduction and liquidity initiatives.

Consolidated revenue for the fiscal second quarter totaled $43.3 million, a decrease of $13 million or 23% when compared with prior year second quarter revenue of $56.3 million and a decrease of $10.8 million or 20% when compared to the immediately preceding fiscal first quarter. On a segment basis, our fiber optics segment accounted for $28.4 million or 66% of the company’s total revenue for the quarter which represents a $9.2 million or 25% decrease from $37.6 million reported in the prior year period and a $10.8 million or 28% decrease when compared with revenue of $39.2 million in the immediately preceding quarter.

The year-over-year and sequential quarterly decline in revenue was due primarily to a broad based decline in our customer demand and continued pressure on product pricing, a function of the unfavorable economic environment that we are operating in. Our photovoltaic segment accounted for $14.9 million or 34% of the company’s total revenue for the quarter which represents a $3.8 million or 20% decrease from $18.6 million reported in the prior year period and essentially flat when compared to the preceding quarterly revenue.

Moving on to gross profit and margins, after excluding inventory and warranty reserve adjustments as set forth in the non-GAAP tables contained in the earnings press release, second quarter consolidated gross profit on a non-GAAP basis was $2.1 million translating to a gross margin of 4.8%. On a GAAP basis, the second quarter consolidated loss was $7 million which represents a $13.6 million decrease from $6.6 million in gross profit reported in the prior year period, a decrease of $8.6 million when compared to the $1.6 million gross profit reported in the preceding quarter.

On a segment basis, second quarter non-GAAP gross margin for the fiber optics segment was a -3.9% and a positive 20% for the photovoltaic segment. On a GAAP basis second quarter fiber optics gross margin was -11.7% compared with a 24% gross margin in the prior year period and a -1.1% margin in the preceding quarter with the decrease in gross margin entirely due to inventory evaluation write downs totaling $2.2 million associated with the transition to lower cost, more competitive design platforms, a general decline in average selling prices and unabsorbed overhead expenses associated with the decline in revenue.

Second quarter photovoltaic gross margin on a GAAP basis was -24.7% which is a decrease from 12.8% gross margin in the prior period and 13.6% when compared to the immediately preceding quarter. The decline in photovoltaic gross margin was due primarily to inventory write downs of approximately $5.6 million associated with the earlier versions of both CPV components or systems that have become obsolete due to the introduction of newer high performance product platforms and product warranty accruals associated with our CPV products.

After excluding certain non-cash and other adjustments, details in the non-GAAP tables, the second quarter non-GAAP consolidated operating loss was $14.1 million which compares with a non-GAAP consolidated operating loss of $8.6 million in the year earlier period. On a GAAP basis, the consolidated operating loss was $25.9 million, an increase of $12.9 million from $13 million reported in the same period last year and a decrease of $26.6 million from the $52.5 million operating loss recorded in the preceding quarter that included a $33.8 million non-cash charge associated with the impairment of goodwill and intangible assets.

After excluding certain non-cash and other adjustments, the second quarter non-GAAP consolidated net loss was $14.3 million compared with a non-GAAP net loss of $8.7 million in the prior year period. On a GAAP basis the second quarter consolidated net loss totaled $23.7 million or $0.30 per share compared to a net loss of $17.5 million or $0.27 per share reported in the prior year period.

Moving on to the balance sheet, during the quarter the company made significant progress in strengthening the balance sheet and improving its management of working capital which has been a major focus of the entire company over the last two quarters. The major improvements to the balance sheet that reflect that these efforts are beginning to yield results include a $9.2 million or 60% reduction in the amount of bank debt outstanding, a $2 million improvement in the net of bank debt cash position, a $15.3 million or 19% reduction in consolidated gross inventory levels that included declines in both fiber optic and photovoltaic inventory levels. This represents the first decline in our inventory levels on a sequential quarterly basis in several years. Lastly, a $17.6 million or 39% reduction in the amount of accounts payable outstanding.

I’ll now move on to highlighting the fiscal first half operating results. Consolidated revenue for the first half of fiscal ’09 totaled $97.3 million, a decrease of $5.8 million or only 6% when compared with prior year first half revenue of $103.1 million. On a segment basis, the fiber optics segment accounted for $67.6 million or 69% of the company’s total revenue for the first half which represents a $4 million or 6% decrease from $71.6 million reported in the prior year period with the decline due primarily to significant drop in demand from our customers due to the current economic environment as well as continued pressure on product pricing.

Our photovoltaic segment accounted for $29.8 million or 31% of the company’s total revenue for the first half which represents a $1.8 million or 6% decrease from $31.5 million reported in the prior year period with the decline in revenue due primarily to lower revenue from government service contracts and certain CPV products offset by increased revenue in our satellite solar product lines.

With respect to gross profit, after excluding inventory and warranty reserve adjustments, our first half consolidated gross profit on a non-GAAP basis was $9.2 million which represents a gross margin of 9.4%. On a GAAP basis, first half consolidated gross loss was $5.4 million which represents a $22.2 million decrease from $16.8 million reported in the prior year period.

On a segment basis the first half non-GAAP gross margin for the fiber optic segment was 4.9% and on a GAAP basis the first half fiber optics gross margin was a -5.6% compared with 23.8% margin in the prior year period with the decrease in gross margin due primarily to the items I highlighted earlier in the quarterly gross margin summary. First half photovoltaic gross margin on a non-GAAP basis was 19.7% and on a GAAP basis was -5.5% which is a decrease from a -.9% gross margin reported in the same period last year again, due primarily to the items I highlighted earlier.

After excluding certain non-cash and other adjustments, the first half non-GAAP consolidated operating loss was $25.2 million compared with $15.6 million in the prior year period. On a GAAP basis the first half consolidated operating loss totaled $78.3 million, that includes a $33.8 million non-cash charge related to the impairment of goodwill and intangible assets.

Net of certain non-cash and other adjustments, the second half non-GAAP consolidated net loss was $25.5 million which compares with a $16.6 million non-GAAP net loss for the year earlier period and on a GAAP basis the first half consolidated net loss totaled $77.2 million or $0.99 per share compared with a net loss of $31.9 million or $0.44 per share reported in the prior year period.

Now, on to backlog, as of March 31st, EMCORE had an order backlog of approximately $30.7 million which is comprised of $19.8 million in photovoltaic backlog and $10.9 million in fiber optics backlog. We define order backlog as purchase orders or supply agreements that have been accepted by the company with expected product delivery or services to be performed within the next 12 months.

Now, moving on to liquidity matters, as of March 31st our cash, cash equivalent and restricted cash position totaled approximately $11.6 million. Working capital totaled $57.5 million and loans outstanding, our loan and security agreement with Bank of America totaled $6.2 million. Recently, we amended the terms of our credit facility with Bank of America that waiver the fall of certain financial covenants, adjusted certain covenants for future periods, increased the amount of eligible accounts receivable available under the borrowing base formula, increased the interest rate and fees on loans and letters of credits and decreased the maximum loan availability to $14 million.

These adjustments to the borrowing base formula and the calculation of eligible accounts receivable were intended to provide the company with additional borrowing capacity. As a result of the continuation of very unfavorable economic conditions in combination with adverse credit market conditions, the company has continued to take steps to lower cost and conserve and generate cash.

Over the last two fiscal quarters we have implemented a series of measures intended to align our cost structure with lower revenues including several reductions in the workforce, the temporary furloughing of employees, salary reductions, the elimination of executive employee merit increases and the elimination or reduction of certain discretionary expenses. With respect to measures taken to conserve and generate cash, we have sold our non-core minority ownership positions in Entech Solar and Lightron Corporation, significantly lowered our quarterly capital expenditures and substantially improved the management of our working capital.

During the fiscal second quarter on a consolidated basis, we generated $7.8 million in cash from improved working capital management and for the quarter our satellite business generated positive cash flow from operations. In addition, for the last two months of the quarter, our fiber optics business segment generated positive cash flow from operations. Lastly, we achieved improved payment terms during the quarter with several of our key suppliers.

In addition to the previously mentioned operating initiatives, the company continues to pursue and evaluate a number of capital raising alternatives including debt or equity financing, product joint venture opportunities and the potential sale of certain assets. With that, I will turn the call over to Hong for his operational update.

Hong Q. Hou, Ph.D.

First of all let me summarize the Q2 financials. Q2 revenue was $43.3 million representing approximately a 20% sequential decline of which the revenue from the solar business was flat while the revenue from the fiber optics business declined about 27%. Demand for the fiber optics products in the previous quarter continued to be soft as a new low cost updated functionality design of various telecom product platforms are qualified by customers, we aggressively liquidated the older version products. This effort led to pressure on the gross margins.

Within our photovoltaic segment, the satellite power business was strong but the demand for CPV products was soft as customers started migrating to different form factor solar cells. This new product request deviated from our stand offering as they designed our next generation CPV concentrator photovoltaic systems and as a result we have written off substantial CPV component inventory negatively impacting the gross margin with these non-cash charges. We expect that this inventory adjustment will set a clean baseline to our operating performance going forward.

Now, let me address the market and business development and our strategy in the various sectors of our business. Let me first discuss our business in the fiber optics area. Although we have built a comprehensive product portfolio in fiber optic components and sub systems, the demand in the previous quarter was soft across all product lines as a result of the industry wide slowdown related to the economic downturn.

For our broadband fiber optics business the revenue within the cable TV product lines for the second quarter declined sequentially. Capital spending by the US cable service providers remained constrained in the March quarter and our customers have been managing down their inventories. The good news is that we have qualified and started shipping three new product platforms last quarter, the revenue from this new broadcasting and QAM transmission products will start generating revenue this current quarter.

The booking activity for the end of March quarter started to pick up. We are hopeful that this sector of our business has reached the bottom and that demand will improve as customers replenish depleted inventory levels. We are one of the only two qualified suppliers to the telephone service providers for fiber to the home, [inaudible] infrastructure build out. We continue to leverage our expertise and unique skill set within cable TV and fiber to the home and achieved multiple design wins in the radio frequency over glass or RFoG product line.

We started sampling customized components to multiple customers last quarter. We believe that this product line will be the future trend of [inaudible] deployment for cable TV networks where fiber will be brought all the way to the home or business. Another exciting development on the product front is the demonstration of integrated fiber optic gyroscope in our specialty photonic area. With our unique capability of ultra stable lithium-niobate based modulator together with our engineering partners we have developed and demonstrated a complete gyroscope for existing gyros with much improved performance and lower cost. The application for this gyroscope is primarily for tactical missile guidance and it represents a large potential market.

For the telecom business, we finished the product transition in qualification with all major customers for updated design of external cavity laser based tunable laser modules, integrated tunable laser assemblies and tunable transponders. This updated product platform provide better product performance margin and high yields therefore, low costs. However, we have significant inventory of previous version products to work through. We had to offer incentives to move this inventory before they become obsolete.

While this focused effort impacted average selling prices and gross margins it reduced the inventory and generated positive cash flow in the fiber optics segment for February and March. We continue to invest in our telecom business. We are lab rating the depreciating capability of our ECL technology and vertically integrated infrastructure to focus our engineering resources in the development of tunable XFP products and applications of our ECLs for next generation 40 and 100 gigabyte applications.

At the optical fiber communications conference this March we demonstrated new full band tunable XFP products. Our tunable TXFP is capable of replacing six wave length divisions multiplexing XFPs as well as high performance tunable 300 pin transponders. Empowered by EMCORE’s still proven tunable ECL technology the TXFP provides excellent optical performance while tuning across more than 90 channels on the 50 gigahertz ITU grid.

The TXFP can be optimized for lower power consumption to comply with existing XFP designs or for high optical performance to meet the requirement of existing 300 pin designs. This product is categorized by a prominent research analyst as the holy grail of the telecom communication industry and highly embraced by a leading telco service provider. It generated tremendous interest from service providers, equipment OEMs and component and subsystem suppliers.

We are in the process of partnership evaluation and finalization to help accelerate the time to market of this product with the objective of leap froging our competition. For datacom product lines the demand in the last quarter was soft as customers were working off their inventory. However, we started seeing much more active bookings in the last couple months as inventories led off.

The demand for our Connects Cable product line which are active cables with electrical connectors based on parallel optical transceivers on both ends of the fiber cables tends to be lumpy. Last quarter represented a slow period of demand. However, our new product a quad data rate cable offering an aggregated bandwidth of 40 gigabytes per second is near completion for qualifications. As the transmission bandwidth over cables increases, it becomes more and more advantageous and cost effective to replace the copper cable with fiber.

Our competitive position for this product line is further strengthened by the award of patents for active optical cable technology. This new patent with broad claims covers all fiber optic active cable applications and it’s believed to be fundamental to current and future market segments and platforms related to the data communications links. There are already a number of discussions on the possible licensing agreements with other companies who are or planning to participate in this product space.

Now, let me discuss the photovoltaic side of our business. First, the satellite power business; our satellite solar power product lines experienced an increase in revenue on a year-over-year and sequential basis. This product line generated positive cash from operations for the March quarter. We believe that profitability of this product line is sustainable and the selling prices have increased across several recent long term purchase agreements and the cost has decreased through engineering improvements and improved supply chain management.

The visibility within our satellite business continues to improve through the end of this year. In addition to a long term purchase agreement we signed in the latter part of last year with a major aerospace company, we have reached a new purchase agreement with another major existing customer for their future demand totaling approximately $70 million. We will begin shipping products against this new purchase agreement this current quarter. We expect to be the sole or primary supplier of space solar cells and solar panels for three out of four major aerospace companies in the US.

Furthermore, we are making significant headway in to some major European aerospace customers. We expect our enabling product performance offered by our most advanced triple junction solar cells [inaudible] and the world record results and advanced product roadmaps of inverted metamorphic multijunction or IMM solar cells will eventually overcome the local geopolitical advantages of European solar cell suppliers to European aerospace companies. This should result in substantial revenue growth through the extension of our customer base.

We continue to make great progress in technology advancement and product commercialization of IMM technology. After demonstrating record converting efficiency of 33.7% in [AM zero] the space illuminating condition with the quadruple junction IMM solar cell design we have made tremendous progress in improving the manufacturing process. A recent technology review by a number of government funding agencies indicated that we are significantly ahead of our closest competition. The unique combination of high efficiency and ultra lightweight of the IMM solar cells will enable disruptive new applications for [amend] high flying aircraft for communication and reconnaissance applications. We expect major program wins in the next couple of months.

It is anticipated that efficiency levels of approximately 45% could be achieved when we adapt this design platform for use under a 500 to 1,500x concentrated illumination for terrestrial applications. We expect to commercialize this technology through applications for space power first and then for terrestrial applications by the end of 2009.

Now, let me turn the discussion to terrestrial solar power business. The products we are offering include concentrator photovoltaic components and systems. We continue to be the leading supplier of CPV components including solar cells and packaged solar cell receivers and we continued to expand our customer base in the March quarter. Due to the slow demand of the solar modulars and price reductions of competing technologies most CPV component customers are redesigning their [inaudible] systems for a cost reduction.

They’re requesting more customized designs including product form factors to better match with their optical and mechanical designs. Their new design and requests deviate from our standard product offering. As a result, we expect that the standard form factor products will be consumed relatively slowly. We have reserved all the CPV components currently in the inventory.

Our strategy continues to focus on the development of broad customer penetration. We are happy to see some customers pushing forward for large scale deployments. We expect sales of the CPV components to pick up in the second half of the year. We have the capacity to serve the needs up to 250 megawatts, therefore, we do not anticipate the need for additional cap ex spending for this line of business in the next couple of years.

As for CPV systems, we received three orders in the past quarter from US and European customers. We expect to improve customer confidence and see more heritage with this emerging CPV technology. We have also connected a 50 kilowatts Gen-II CPV system in our solar test [inaudible] near our facility in Albuquerque for the utility power grid. We are generating electricity to [inaudible] our consumption.

In addition, we are receiving renewable energy credits from the distributed generation program of the utility company. As we work through this process of permitting and interconnect, we are planning to expand our business through more installations for this program. This may well be the avenue of near term revenue for our CPV systems.

We continue to work with strategic partners to bid on utility scale projects and continued site readiness study and development for land parcels near our facility and a major power switch station. With the close proximity of our power station to [inaudible] is the ideal location to build a [inaudible] solar power plant. However, we are seeing challenges in financing large scale projects of emerging technology in the current credit market.

We have been working with a couple lobbying firms to try and access additional government incentives, for instance DOE’s loan guarantee program to help promote this promising technology. In addition, there are a number of funding programs we are actively developing to advance and deploy emerging CPV technology. We are also working with a number of municipalities to develop distributed solar power with the aid of their allocated stimulus money.

The development of our Gen-III CPV system products is progressing well. The demonstration system of Gen-III is up and running in our solar test field. It looks like we can achieve module efficiency of 30% at a cost which would be very competitive with the future price of the silicon and thin film products. We expect the production of the Gen-III products to begin in the second half of 2009.

Now, let me discuss the management’s focus in this challenging economic environment. Cost reductions and liquidity are clearly the focus of the management team as John discussed. We have undertaken numerous cost cutting initiatives over the last couple of quarters including reduction in work force, temporary furloughing of the employees, salary reductions, elimination of merit increases and bonuses. While it is painful to implement we have seen positive impact to our cost structure.

In the past quarter we have been managing our inventory very closely. We aggressively monetize excess and obsolete inventories, as a result our inventory levels have reduced by $15.3 million or nearly 20%. The inventory quality has improved substantially. We generated cash in the fiber optics area the second half of the quarter. Considering the current level of our business, we still have significant inventory to work through.

We will continue to closely manage working capital and drive product cost reductions. The effective monetization of the inventories will help us with the liquidity position and the gross margin improvement will be realized after we manage through this on hand inventory. With the cost reduction initiatives the inventory monetization a long ways, and the increased borrowing base as discussed by John from the amended credit line with Bank of America, we expect to have enough liquidity to ride through this economic downturn if the situation does not deteriorate.

On the financing front, we continued to pursue and evaluate a number of capital raising alternatives including debt or equity financing, product joint venture opportunities and the potential sale of certain assets. We expect to finalize a definitive agreement within this quarter.

In summary, the decline in demand that we experienced in our fiber optic segment over the last several quarters continued in to the second quarter of our fiscal year. However, the order activity began to pick up towards the end of the quarter indicating that the industry conditions might be stabilizing. The fiber optic segment generated positive cash flow from operations during the last two months of the quarter.

Despite the recent [inaudible] demand in the fiber optics sector, we have continued to invest in developing new leading edge products. During the quarter we announced the introduction of the industry’s first full band tunable XFP optical transceiver product at the OFC conference where it was extremely well received. In our photovoltaic segment, we continue to see very favorable trends in our satellite business and are making solid progress in the development of Gen-III CPV terrestrial solar power systems with a very competitive cost structure.

During the quarter our satellite business generated positive cash flow from operations and over the last several months we signed several contracts and expect to sign a significant multiyear supply agreement with a major aerospace company in this month. On the terrestrial side, we received three additional purchase orders of CPV systems last quarter. With a performance advantage of the IMM technology and the introduction of Gen-III CPV systems in the second half of this year we are aggressively developing solar utility opportunities with our strategic partner.

With that, I will turn it over to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Bill Choi – Jefferies & Co.

Bill Choi – Jefferies & Co.

Just a few questions, first on the fiber optics turning cash flow positive here in the last two months, can you talk about what the gross margins sort of look like and what would be key to keeping that to a more positive cash flow in the current quarter? Is it largely just the quarter’s coming back or is there some additional actions that you’re taking specifically on that division? Then, I have a couple more questions.

John M. Markovich

A significant contributor towards the business being positive cash flow for the last two months Bill was the management of the working capital. So, most of that contribution was from changes in the balance sheet.

Bill Choi – Jefferies & Co.

What kind of pro form gross margins are you seeing in the last two months or did that not change materially?

Hong Q. Hou, Ph.D.

Within the three months of the quarter, the first month the gross margin was the worse because of the unabsorbed overhead in the beginning was negative the first month of the quarter. But, the second and third month, the gross margin was improving to the positive territory and continued to improvement. But, as John said, the positive cash flow was primarily from the balance sheet move, basically the monetization of the working capital and the inventory.

John M. Markovich

Bill, we did experience sequential month-to-month improvements over the course of the quarter at the gross margin line.

Bill Choi – Jefferies & Co.

Are you able to talk about a range at least for Q2 where you think cash flow can go? I know a lot of it still depends on working capital but, some level of orders coming back from stabilization in gross margins, are you able to talk a range at all?

John M. Markovich

The guidance that we’re providing Bill is limited to the top line in terms of revenue.

Hong Q. Hou, Ph.D.

But, you have seen the trend, the December quarter we consumed roughly $22 million cash, the last quarter we consumed about $10 million cash. On top of that we paid down significant liability on accounts payable. The reduction on accounts payable was almost $17 million so, going forward it’s hard to predict and we will give the guidance at this point only on the top line.

Bill Choi – Jefferies & Co.

My final question, just in terms of capital raises, the options of doing licensing agreements, etc., so various ways to try and raise cash here, I know it’s a very difficult environment but are you able to talk about at all whether any of the delay is related to commercializing the Gen-III on CPV? What’s some of the challenges today and how confident can we be about some kind of deal getting done in Q2?

Hong Q. Hou, Ph.D.

I think the financing activity is specifically targeted to plan for the worse case. We talked about the cost reduction initiatives, the inventory monetization we have made a lot of progress but we still have a long way to go. The current level of inventory still way to high compared to the level of business and together with the increase of our borrowing base we think we will have enough cash to ride out this storm if the situation does not deteriorate. But, what if it continues to deteriorate, for that reason we continue to evaluate a number of options for the capital raisings just in case the situation doesn’t improve.

Operator

Your next question comes from John Dorsheimer – Canaccord Adams.

John Dorsheimer – Canaccord Adams

A couple of questions, one just guidance I must have missed this, what is the guidance?

Hong Q. Hou, Ph.D.

We guided in the press release basically saying that the fiber optics revenue to decline moderately on a sequential basis but our photovoltaic revenue to improve by at least 10% from the second quarter.

John Dorsheimer – Canaccord Adams

Is it sort of a moderately 5% to 10% range or is it a 1% to 5%? Can you bracket any of that?

Hong Q. Hou, Ph.D.

I think it is probably the 5% to 10% range is safe to say.

John Dorsheimer – Canaccord Adams

Nice job on the cost control here guys. Just curious, on the Bank of America John, the change in covenants does that remove – is there any subordination issues with that loan at this time? It sounds as if you’re paying a higher rate and all the covenants have been removed. Is that the right way to look at that?

John M. Markovich

No, the covenants were reset on a go forward basis. So, for the December and March quarter the covenants we were in breach of were waived and the covenants have been reset for the next year.

John Dorsheimer – Canaccord Adams

Would they have subordination rights on this loan in terms of I guess any equipment or any hard assets of yours at this point? It sounded like it’s straight debt so they probably would.

John M. Markovich

It’s a senior secured credit facility. So it’s secured by company assets.

John Dorsheimer – Canaccord Adams

Employees, could you just help us walk through the reduction and the furloughing? What were the numbers of employees employed and what is it now?

Hong Q. Hou, Ph.D.

It depends on the starting point. We had before this storm happened we had already transferred some product from the domestic manufacturing to the contract manufacturer so some of the headcount reduction as a result of that but in average since September we reduced the headcount by about 30% and currently we have about 580 people on our payroll. So, about 30% reduction, about 150 people on furlough so now we have about 580 people for the entire company.

John Dorsheimer – Canaccord Adams

Will you see additional op ex benefits from that 150 furloughing next quarter or have we already seen it? Looks like op ex excluding one times ticked down about $2 million, have we already seen the cost savings play out here?

John M. Markovich

We’ll continue to see benefits from that for the June quarter.

John Dorsheimer – Canaccord Adams

I guess just a couple more and I’ll jump back in the queue, the CPV systems, that is cash flow negative at this point, that business?

Hong Q. Hou, Ph.D.

Yes the CPV system was, because of Gen-III, it’s in a qual space and we still had inventory in Gen-II so we’re not going to continue to offer that version of products on an ongoing basis so we’ve reserved the inventory and also increase the warranty accruals. Other than that, the cost is really totally under control right now.

John Dorsheimer – Canaccord Adams

Why not shut that business down so that you maintain your fiber optics and then the CPV cells both for terrestrial and for the space division. I’m just curious what your thought process is of keeping this systems business running at a negative cash flow.

Hong Q. Hou, Ph.D.

You are right from a financial point of view at this snapshot the system is consuming cash and because we still have to develop and finish the qualification of the Gen-III product. The component side as a standalone business will be profitable and this profitability as we discussed will be sustainable. But, the CPV system still representing a very significant upside going forward, so our strategy is not forcing the deployment prematurely but really take our time to leverage the IMM technology advantage and the Gen-III low cost focus to develop a disrupting system solution to the utility scale applications going forward. So, certainly near term there is some investment but we believe in the long run it’s going to pay off.

John Dorsheimer – Canaccord Adams

Just talking about the competitive environment we’ve seen poly fall from spot above the 400 range to now at or below contracted levels of sort of $70 which makes the traditional solar cells much more competitive in the market place. I know you mentioned that you were short listed on some projects I think in the New Mexico area. I was wondering how has the competitive position changed for you and then just using that as sort of a litmus test, were you able to win or did that get awarded to another traditional solar cell provider?

Hong Q. Hou, Ph.D.

The silicon poly pricing continues to decline. We’re watching that very closely and really the high tech area the competition is not only keep your head down develop low cost product but also you have to look at the competition and what we have done for the Gen-III design principal is not only designed the best or competitive dollar per watt but also in the fully installed basis because the CPV system design has a lot to do with the cost of installation. So, our goal of the Gen-III design is the most cost effective in the fully levelized cost of energy point of view. We believe that from the model we have done, even considering the poly pricing goes to $70, to $50, even to $35 per kilogram we’ll still be able to be very competitive on a fully installed basis.

John Dorsheimer – Canaccord Adams

I guess maybe if you could, because I’m sure others are wondering the same thing, maybe if you could elaborate on that because what we’re seeing in the market is actually a sub $5 install cost now for traditional solar cells and maybe if you could help outline what the metrics are for your CPV system to get it cost competitive in the marketplace? Then also, given the unproven nature of the CPV cells, what type of discount do you need to offer to entice being that sort of first mover to go with a CPV system?

Hong Q. Hou, Ph.D.

That’s a very good question. Right now our internal cost target for the system at the hardware level is $1.65 per watt and at a fully installed basis in the $2.70. I think certainly we need to makeup some for the profit and we believe at this level we will be very competitive, cost competitive in some certain geographic area where the direct normal ingredients is high. Also, CPV’s advantage in [inaudible] development projects will start to become more and more clear that high energy density and the advantage of operating in the high temperature without a whole lot of power degradation certainly offers advantage compared to silicon module.

John Dorsheimer – Canaccord Adams

Hong, can you just throw a couple of more metrics around that $2.70 number because it sounds awfully compelling. What concentration is that at? What efficiency is the cell at and is EMCORE standing behind it with a 20 year guarantee?

Hong Q. Hou, Ph.D.

The key design features of our Gen-III is from the optics point of view it’s a refractive design, concentration ratio is 1,050 times and it’s more modular, it’s not like our Gen-II systems so Gen-III systems can be installed with two people mount the modular on the [tractor]. It has a better assemble management so the solar cell will be operating at substantially lower temperature compared to Gen-II.

The tracking technology we’re going to be using tilt and roll instead of the [inaudible] on a stick, pedestal type. It’s still the two access tracking but it gives us a tremendous advantage in cost and reducing the material consumption and improved the cost in the installation tremendously. And, the solar cell technology, with base line right now is about 40% triple junction based CPV but by the end of the year we should be having available 42% or 43% IMM based technology. As I discussed, we have worked out, made tremendous progress in the past quarter on the manufacturability.

So, currently at the module level, after all the optical loss, tracking loss, everything, if the module efficiency is 40% and we believe we can improve by another percent or so two when we start using the IMM technology.

Operator

Your next question comes from Sam Dubinsky – Oppenheimer & Co.

Sam Dubinsky – Oppenheimer & Co.

Could you give some more color on your optics business segments? What percentage decline was in broadband, telecom and datacom? I have a couple of follow ups.

Hong Q. Hou, Ph.D.

Sam, we do not break up in to the level of granularity but overall the fiber optics sequentially dropped by about 27% in revenue compared to last quarter.

Sam Dubinsky – Oppenheimer & Co.

You mentioned the weakness is broad based, is any one segment weaker than the others are they all pretty much down?

Hong Q. Hou, Ph.D.

It’s pretty much all sectors. I hate to say this, that’s in a way too we said it’s really the industry phenomena. In many areas we’re the leading providers of cell source, if there is demand from customers, we should be seeing orders but we did not see as strong orders so it’s pretty much across the board. But, by saying that, to us the latter part of the quarter, especially in March, the booking activities really start increasing pretty substantially compared to before so I think the market might have bottomed out and we might be on our way climbing out of this trough.

Sam Dubinsky – Oppenheimer & Co.

Did you mention was terrestrial solar revenue was this quarter? I know you mentioned what solar was in whole but how much was the terrestrial CPV?

Hong Q. Hou, Ph.D.

We did not break down between the terrestrial and space but the majority of the solar revenue was from the space side.

Sam Dubinsky – Oppenheimer & Co.

I know you didn’t give gross margin guidance for next quarter but will gross margins be up next quarter or how should we think about that? If we can just have an absolute op ex dollar to work from for the June quarter, could you maybe just give us an op ex number for Q3 pro forma?

John M. Markovich

I can address your margin question, the margins this quarter on a GAAP basis were very adversely impacted by the inventory and the warranty accruals so we’re expecting a sequential improvement in our margins, a sequential quarterly basis. I can’t quantify that for you. Op ex should be relatively in range and possibly slightly down on a sequential basis principally due to the impact, continued favorable impact of the employment furlough.

Sam Dubinsky – Oppenheimer & Co.

Is that like [inaudible] one time charges in here, is that like a $15 or $16 million number, something like that?

John M. Markovich

I can’t quantify that for you.

Sam Dubinsky – Oppenheimer & Co.

How about this one, how should we think about gross margins in each of your business segments once you burn through all this sort of high cost inventory you have stockpiled? So, what’s the target op ex gross margin? Historically, they’ve never really been this low, how should we think about that on the recovery?

Hong Q. Hou, Ph.D.

I think Sam you can think about it this way, on the solar side the space as a steady state after clean up should be at about 25% and then the solar side, the margin will be complicated by the mix between the CPV product, especially the system level compared with a space and component business. Then, on the fiber optics side, our broadband side of the gross margin has always been in the 26% to 31% range. I think after the inventory adjustment should be close to the historic level if the top line can carry enough fixed cost and the wildcard being the datacom area where we have a lot of inventory.

We made a lot of progress on the older version products but we still have some inventory in there and those inventory, we wanted to provide incentives to get them out because we have newer version, lower cost, higher performance product waiting on the deck but we need to work out this inventory first. So, that will be adversely impacting gross margin and that’s kind of going to make it a little bit difficult to give you a clear [inaudible] on that.

Sam Dubinsky – Oppenheimer & Co.

I guess my question is on the optic side, if you’re sort of participating in more aggressive pricing than the industry to clear through internal inventory to generate cash, are the products that you’re selling are those being deployed yet or are those sort of sitting at customer’s hubs?

Hong Q. Hou, Ph.D.

It was deployed. I think the customers, none of them are using this time to build of inventory. We have seen that, the customers had a comment, if they don’t have demand even if you offer very strong incentive, they wouldn’t buy it.

Sam Dubinsky – Oppenheimer & Co.

Lastly, on the strategic alternative front, are there any businesses that you want to exit today or you think you can sell if you needed the cash? Can you just talk about sort of strategically where you can prune further if you had to?

Hong Q. Hou, Ph.D.

We at this point explore all different options and what is the best for the shareholders and what is the least interruptive to our business, that’s the general guideline for it. But, we want to first solve the operation issues through operational solutions namely like what we did monetizing inventory, getting very close working capital management, cost reductions. So, the strategic side is really meant to improve the shareholders value.

If there are no more questions, let me just make some closing remarks and repeat the Q3 focus and guidance. For the fiscal third quarter management will continue to focus on cost reduction and liquidity management. We expect our fiber optics revenues to decline moderately, quantifying that as 5% to 10% on a sequential basis and photovoltaic revenue to improve by at least 10% from the second quarter.

In addition, we expect the satellite business to be profitable on an ongoing basis due to the increase revenue due to improved product pricing and lower cost at [inaudible] engineering projects and more effective supply chain management. I want to thank you very much for your attention today and we look forward to the next call.

Operator

That concludes today’s presentation. Thank you for your participation.

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Source: EMCORE Corporation Q1 2009 Earnings Call Transcript

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