EMCORE's CEO Discusses Q3 2011 Results - Earnings Call Transcript

| About: EMCORE Corporation (EMKR)

EMCORE (NASDAQ:EMKR)

Q3 2011 Earnings Call

August 03, 2011 4:30 pm ET

Executives

Mark Weinswig - Chief Financial Officer and Principal Accounting Officer

Victor Allgeier - IR, TTC Group

Hong Hou - Chief Executive Officer, President And Director

Analysts

Alex Henderson - Miller Tabak + Co., LLC

Cobb Sadler - Catamount Strategic Advisors LLC

Edward Zabitsky - ACI Research

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the EMCORE Corporation Third Quarter Fiscal 2011 Earnings Conference. [Operator Instructions] As a reminder, today's call is being recorded. At this time, I'd like to turn the conference over to Vic Allgeier of TTC Group. Please go ahead.

Victor Allgeier

Thank you, and good afternoon, everyone. Before we begin, we would like to remind you that the 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 EMCORE's current expectations and projections about future events and financial trends affecting the financial condition of its business.

Such forward-looking statements include, in particular, projections about EMCORE's future results, statements about its plans, strategies, business prospects, changes in trends in its business and the markets in which they operate. Management cautions that these forward-looking statements relate to future events or its 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 its business or its industry to be materially different from those expressed or implied by any forward-looking statement.

Neither management nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We caution you not to rely on these statements without also considering the risks and uncertainties associated with these statements in EMCORE's business that are addressed in its 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 its annual report on Form 10-K and its quarterly reports on Form 10-Q. EMCORE assumes no obligation to update any forward-looking statements to conform such statements to actual results or to changes in its expectations, except as required by applicable law or regulation.

With us today from EMCORE are Dr. Hong Hou, President and Chief Executive Officer; and Mark Weinswig Chief Financial Officer. Mark will review the financial results and Hong will discuss business highlights before we open the call up to questions. I'll now turn the call over to Mark.

Mark Weinswig

Thank you, Vic, and good afternoon, everyone. Today, I'm going to focus my discussion on the third fiscal quarter operating results and our balance sheet. Consolidated revenue for our third fiscal quarter totaled $49.5 million, which is an increase of $2.3 million or 5% over the previous quarter. This was is in line with our prior guidance of $48 million to $50 million in revenue. On a segment basis, our Photovoltaics, this has accounted for $16.2 million or 32% of the company's total revenue. This represents $1 million or 6% decline from the revenue for the segment in the prior quarter. The decrease in revenue was in line with our prior expectations for our Space Solar products business. We believe that the Space Solar business will continue to experience year-over-year growth, although revenues in any given quarter maybe a bit lumpy. With a higher bookings levels we saw this quarter, we believe that this business will grow over the next couple of quarters.

The Fiber Optics segment accounted for $33.3 million or 67% of the company's total revenue. This represents an increase of roughly $3.2 million or 10% from the prior quarter with the increase primarily driven by higher sales of attributable product and broadband business, partially offset by reduction on our legacy products. As we noted last quarter, we are continuing to move into the end of life phase of a few product lines. We expect this to be a $1 million to $1.5 million reduction in these products from this evolution over the next quarter or 2. I would discuss this trend in more detail later in the call.

Consolidated gross margin decreased to 19.1% or 22.4% in the prior quarter primarily attributable to the significant deterioration in our Photovoltaic margin. On a segment basis, Photovoltaic gross margin were 18.6% which is a sizable decrease in the 30.2% report in the prior quarter. This is primarily due to 3 factors: First, fire departmental expenses have been geared up for a significant ramp in our business. This was primarily a one-time related charges, and we should expect to be back to normal levels this quarter. Number two, a new excursion issued at the beginning of the quarter that increased our scrap metals. We consider this to be an unusual expense. Number three, higher startup expenses on new products launched in the manufactured -- manufacturing during the period. It's important to note that we believe that these new products help further differentiate our product lines due to better performance, improved quality and higher eventual gross margin.

In the fourth quarter, we believe that our margins will improve for this segment. We look forward to updating you in the future on our progress in terms of improvements in our gross margin. Fiber Optics gross margin was 19.4% or 1.4% improvement from the prior quarter primarily due to higher revenues. The telecom and datacom division is experiencing a products mix shift as customers move towards newer technology platforms. We believe that this evolution will cause margins in this division to improve, while our new products begin to ramp in the latter part of calendar 2011. As we increase capacity and move these new products into full production, we will see an increase in certain startup costs including NREs and capital expenses. Operating expenses, excluding the litigation settlement loss in Q3 and litigation settlement gain in Q2, increased to $1.9 million from the prior quarter to $19.2 million, primarily due to higher R&D investment in both our Fiber and Solar segment and higher stock comp of [indiscernible]. The higher Solar investments that relate to the Soliant acquisition and the higher Fiber Optics investment relate to the Tunable XFP product. We believe the investment level will remain flat to slightly decline in the next quarter.

Our Solar CPV joint venture, Suncore, had a loss of $0.3 million for Q3. We expect those losses to increased slightly until the facility is up and running to producing product and volume. I will discuss the Suncore strategy and opportunity in more detail. On a GAAP basis, the consolidated net loss for the third quarter was $11.1 million, a deterioration of $5.9 million from the prior quarter. From the quarter-to-quarter variant, $4 million related to the change in legal settlement about. Our GAAP net loss per share was $0.12 versus $0.06 in the preceding quarter. Our non-GAAP adjusted EBITDA, after excluding certain adjustments, all which was set forth in the non-GAAP tables included in today's release, with a loss of $3.2 million. Please note that we have included additional information regarding depreciation, amortization, stock comp and other items in today's release to provide further clarity on our results.

Now onto order backlog which we defined as purchase orders or supply agreement accepted by the company with expected product delivery and/or services to be performed within the next 12 months. At June 30, the company had a consolidated order backlog of approximately $66.2 million, which is a roughly $16 million increase or 31% from the prior quarter. On a segment basis, Photovoltaics order backlog totals $39.6 million, a 50% increase primarily associated with new contracts signed in the quarter, including the Morale contract signed in May. In addition, we also saw some significant international bookings for the quarter. Fiber Optics order backlog were at $26.6 million, an increase of 10% from the prior quarter, primarily driven by higher backlogs in our Broadband Fiber Optics division. Moving onto the balance sheet. During the 3 months ended June 30, the company's cash and cash equivalent balance increased to $21 million, primarily driven by the proceeds from the sale of equity. During the quarter, the company completed investments with Suncore with the $8 million investment. At this time, we do not expect any future investment to the Suncore joint venture. DSOs improved at 68 days within our targeted range of 67 to 73 days, and we also saw a slight improvement in our inventory turns to 4.9x.

With that, I will turn the call over to Hong, who will discuss the company strategic and operating initiatives and provide revenue guidance for the fourth quarter.

Hong Hou

Thanks, Mark. Good afternoon, everyone. As Mark discussed in detail, we achieved consolidated revenues of $49.5 million in the June quarter. Within the guided range of $48 million to $50 million. This represents a 5% of sequential increase. Our revenue in the Fiber Optics business for the June quarter was $33.3 million, representing a $3.3 million or 11% sequential increase compared to the March quarter. The increase in the June quarter revenue is primarily due to continued strength in 40 and 100 gigabits ITLA product and our broadband business. The gross margin improved sequentially as well. And we expect the trends to continue.

Our bookings for the Fiber Optics in the June quarter was close to $36 million, making the book-to-bill ratio approximately 1.1 which is a pretty impressive given the microeconomic development. With the successful Californian qualification of a new Tunable XFP product and a strong backlog, we expect revenue from the Fiber Optics business in the current quarter to increase sequentially again. In addition, we are expecting strong bookings in our Tunable XFP product line from Q1 customers. Now, let me discuss the market dynamics and our position in view to our major business areas.

Let me start with the Broadband Fiber Optics business first. We continued to experience robust demand for cable TV equipment in the June quarter. Furthermore, we continue to expand the product offering to our current customer base. The new product who are the most copied effective solutions to have additional bandwidth on the existing HSP infrastructure. Full-band quadrature amplitude modulation transmitter or QAM transmitters continues to be the leading solution for this application. Our vertically integrated structure from semiconductor laser and detector chip to transmitter subsystem chip as well. Demand for our RFO/GOR product lines which transfer radio frequency over glass Fibers in which provides a lot of miles Fiber Optics solution in the traditional hybrid fiber coaxial network utilizing [indiscernible] optical light transceivers has been picking up significantly. This is becoming an increasingly viable solution to operate the SHB network from to an all optics solution.

In addition, the next generation DVI video transport products were virtually introduced are starting to generate meaningful revenue and business focus with the customers. This product line delivers approximately 50% of gross margin. To summarize, our Broadband Fiber Optics business continues to show strong results. New products introduced within top gear accounts for a significant portion of our current revenue. And as a new product in terms of wide info [ph] with a competitive advantage.

Now let me discuss our telecom Fiber Optics business. The revenue from the tunable laser and IPLA sales into 40 and 100 gigabits perspective application through more than 20% quarter-over-quarter and it reached a new record in the June quarter. We shipped a volume [ph] products through a new Tier-1 customer this quarter which contributed to the revenue drill for this product line. As we discussed in the past, our full-band tunable external cavity laser based products have become the laser of choice for the 40 and 100 gigabits market for coherent system. In our Tunable XFP product line, we made some significant space [ph]. The product has been shipped to more than 15 powerful customers for qualifications. Customers are extremely impressed with the performance of our modules and are designing using all products as 300 tunable transponder replacement.

Despite the progress made on many fronts we fell short of our $1 million revenue expectations in the June quarter due to the timing of completing quantification, which has been at the end of the quarter, completing transponder qualification historically has a major challenge for suppliers, and we believe that EMCORE is one of the only 2 companies that has achieved this milestone for Tunable XFP product so far. We are the final stage as the multiple customer qualifications after concluding our own product flow and expect to secure more Tier 1 customer qualifications quarter.

We believe that the adoption of a higher performing Tunable XFP for replacement up the incumbent 300 transponders is just starting. The majority of Tunable XFP products shipped today has been for [indiscernible] XFP transceivers. EMCORE has been in excellent position to address this premium market without depreciated performance, and this has always been the cornerstone of our product strategy. We continue to believe that our designs are one of the few in the industry which will be successful at cannibalizing the $300 million or $400 million market currently served by 300-pin transponders. As discussed in our last conference call, market demands for Tunable XFP product is expected to drill at over 100% year-over-year over the next 4 years. As we look out over the next few quarters, we believe that the durable market conditions will bode well for the increased order activities with Tunable XFP. And our new Tunable XFP products should improve our overall operating performance as we exit this year and enter into fiscal 2012.

Today we're producing that Tunable XFP modules in our facility in the bay area leading this targeted yield and throughput requirement. Concurrently, our second one is being reviewed at our contract manufacturer's overseas. We expect to finish our process integration to host a customer audit can be in rolling production in the current quarter.

We have been developing parallel object-based 12x10 gigabit per second CXP transmitters and receiver modules for high-end port [ph]router and the enterprise applications. During the June quarter, EMCORE was finally selected by a leading datacom systems integrator for this next generation parallel optic product, which included those active optical cable and a plausible margins for high-speed interconnect from 40 to 150 gigabit per second aggregated bandwidth solutions. Our first commercial shipment are expected in early 2012. Another parallel optic product is Active Cables. Today, the active optical cables are used primarily in the high-performance computing clusters, replacing heavy and rigid electrical cable. In this product area, we are the leading supplier with EMCORE Active Cables product connecting 4 out of the top 6 boxes supercomputers in the world, including the #1 and #2 fastest supercomputers. The revenue from this product line, however, has been lumpy due to its nature of the primary use in supercomputers.

In addition to expense, the total addressable market, we have developed an application to expand Active Optical Cables through computer servers and ethernet. And we expect substantial revenue from this application to start before the end of the year.

As noted a few quarters ago, within our current product portfolio, there are some products which are either approaching the end of their life cycles or we are no longer competitive in cost. We have largely completed the product transition in our current level for end-of-life products is about $1 million to $1.5 million in revenue. We believe that in revenues from the new product will offset the declines of the legacy products in the future period. And now gross margins should improve due to a better product mix.

Now, let me move on to give you an update on our Solar Photovoltaic business. As we have discussed previously, the revenue in our Space Photovoltaics business can be somewhat lumpy due to the program timing. In the June quarter, we experienced and expected sequential decline of about $1 million. However, we have secured a healthy level of our purchase orders in the multi-years by contract of $111 million over the top 12 months. The backlog for deliveries within the next 12 months increased sequentially from $25 million to $29.6 million. As a result of strong bookings, we expect the revenues to grow on an annual basis in 2011 as well.

Our accumulative annual growth rate after the space business since 2004 has been over 15% year-over-year, which is now is more impressive when you consider that as the majority of the skills rate was achieved through thing in market share. We expected this market to continue to grow at 5% to 10% year-over-year and although to drill the business at a higher level by taking additional share especially here in government application. One key way that we are differentiating ourselves is by our technical superiority. In the June quarter, we made strides in improving our Solar Cells performance for applications in both space and transfer in system. We have achieved the new world record performance measured on a 4 junction inverted metamorphic or IMM for Solar Cells with a converging business being in excess of 36%. And there's a space elimination condition. The flavor of this design was successfully deployed through August by [indiscernible] on the final mission of the space shuttle program last month.

And currently, our similar 3-junction IMM design for CPV applications has reached the 43.5% conversion efficiency and their 300x concentration, matching the world record reported a couple of months ago. The improvement of solar cells conversion efficiency is the key to reducing the overall system cost for our customers. We have established manufacturing infrastructure for IMM solar cells over the past year and that we are confident that advanced product will enter into rolling production phase in the near future.

Last quarter also marked a major shift in our Solar product mix, where our customers transitioned to the latest and most advanced designs for both space and terrestrial products. As the result in the June quarter, we saw a record-high product mix on the production floor. This transition resulted in higher-than-anticipated material and labor costs and lower overall yield for the June quarter. In the June quarter, we also incurred higher cost in labor and a lower overhead absorption due to hiring, redeploying and the trending of the new work force in anticipation and preparation of significant ramping of revenues in the following quarters.

This significant business shift and their impacts on labor and material cost adversely impacted the margin in the June quarter. However, the product transition is complete and we expect that gross margin will improve significantly in the current quarter and the company to buy a substantial increase in space PV revenue as we ramp up to meet the growing needs of some of our satellite customers.

Now, let me give you an update on the recent development of Terrestrial CPV business and our CPV joint venture. Early in the June quarter, we successfully completed third-party testing certification and listing of our Gen-III CPV modules to IEC, UL, CEC, as well as OSHA MRTL [ph] standards. The test results confirm that our Gen-III CPV module fully satisfies the product safety performance. This is a significant achievement. Our CPV module is among the first to fully comply with all sectors of most current industry standards and requirements. This certification and listing should provide additional confidence to our customer base in the performance and the reliability of our CPV product.

Regarding the CPV products hub and the capacity of CPV joint venture, Suncore Photovoltaic, is in the construction phase up in the facility in Huainan City of China, which is a plant to be capable of producing 200 megawatts CPV modules per annum. The facility construction is on schedule, we expect the joint venture manufacturing lines to be up and running for producing CPV components and system by the end of October 2011.

During the facility construction phase, the EMCORE and the Suncore team have been working very closely over the past several months to transition the Gen-III CPV system manufacturing processes to Suncore's temporary facility in Xiamen. Their manufacturing process transfer and tuning are predominantly complete, and Gen-III systems made in China successfully obtained certification by China's qualification standard with neo-generation on our Gen-III product. With that, our Gen-III product officially qualified for Chinese terrestrial solar market.

During the June quarter, we also completed our entire $12 million capital contribution requirement to the joint venture. With a capital contributions from the shareholders and a significant cash and land grants that Suncore received from Huainan City, the joint venture had a very strong balance sheet to execute its business plan of facility build-out, equipment purchase, and the initial working capital to cover the production.

As we discussed in the last quarter, at the end of March, we acquired certain assets of Soliant energy of Monrovia, California. Soliant Energy was a leading provider of CPV systems for commercial rooftop applications. The integration of the operations to our existing facility in Alhambra has been completed and successful. The addition of the rooftop CPV product line gives EMCORE an immediate access to the multi-billion dollar rooftop PV market as reported by Greentech Media.

That expanded the reach of EMCORE's existing ground mount products offering. With the successful certification of IEC, UL and CEC listing of our latest CPV module, combined with the establishment of a low-cost manufacturing joint venture, positions EMCORE to supply the most competitive in the high-performance CPV systems in the industry. We believe that we have most of the critical business to be successful in the Solar business, and our key focus moving forward is to establish strong capability to view business pipeline.

On the revenue outlook for our fourth fiscal quarter, we expect the consolidated revenue to be in the range of $51 million to $55 million, which represents a 3% to 11% sequential revenue increase. We expect the [indiscernible] to be from both the Fiber Optics and Photovoltaics business segments. In the quarter, we will continue to solidify our strong market position in our more established segment, photovoltaic, and run the Broadband and Fiber Optics businesses. At the same time, we'll focus on booking orders and capacity buildup of the Tunable XFP production so that we'll be well positioned for a significant ramp up in demand.

In addition, we'll bolster our efforts in business development and product development for transfer CPV. Overall, we feel that this quarter will begin to illustrate our new product line ups and the results of our business strategy and strong execution.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Edward Zabitsky with ACI Research.

Edward Zabitsky - ACI Research

I wanted to ask, first of all, on that newer TXFP products, what maximum distance you're quoting and when you expect the product to be available?

Mark Weinswig

The distance of our product, 40 kilometers, I believe, that's our main specification. And I know for different customers, they have different specifications. We'll be introducing a few derivatives based on our main design to address the different business needs.

Edward Zabitsky - ACI Research

And timeframe?

Mark Weinswig

The 40 kilometer right now is general availability. And the different derivatives is really achieved through performance bidding, though can be immediately available. It doesn't need additional development.

Edward Zabitsky - ACI Research

And on the TXFP again, are any of the OEMs looking at wider tunability as an important factor?

Hong Hou

I believe our products from the tunability point of view is about the best. We offer the full-band tunability. That really works well for most of our customers, who are asking for that kind of specification. And we heard they're coming up with [ph] a product in the development phase by our friends in the same industry...

[Technical Difficulty]

Operator

Mr. Zabrisky, your line is now open again, Sir. Can you please continue with your question?

Edward Zabitsky - ACI Research

I believe you were just telling me about JDS's actions or JDS's product in relation to wideband or wider tunability for the TXFP.

Hong Hou

I did not talk about that specific. Just in general terms, our design -- the product design enables our customers to achieve the full-band tunability while we heard some top comments from our customer base that some of the products they are looking into can provide partial tunability over the T band. So I think from the tunability side, your question, our products should be able to cover our customer requirement.

Edward Zabitsky - ACI Research

So does it matter to them in the near term? Is this a factor in the purchasing decision?

Hong Hou

Certainly, they prefer a full-band tunability, and I think that certainly as the first. I don't know that's become a determining factor, that our products is the only one being used or not.

Edward Zabitsky - ACI Research

And the contract manufacturer, I'm wondering if the ramp is still on schedule.

Hong Hou

Yes, largely, one assembly equipment was delayed for a couple of weeks. That this quarter, our expectation has been summing up our different process phases and getting the process integrated and producing parts to a delta of qualification in enlightening customers to come in and do audits. From that perspective, we are still on schedule. We, as I said, expect the line of our contract manufacturers be ready for volume production in this quarter.

Edward Zabitsky - ACI Research

Okay, that explains it. Could you give us a sense as to what was the driver for the higher cable revenue? You said something about the full-band QAM product, was that the main driver? Or what made it grow, please?

Hong Hou

So we talked to many customers in the broadband equipment manufacturing space. They were commenting that about 2/3 of their revenues are from the domestic infrastructure upgrade and about 1/3 of their revenue are from the overseas market. So I will say the drivers come twofold. One is the domestic cable TV infrastructure upgrade, the other one is an emerging market internationally.

Edward Zabitsky - ACI Research

I have one question for Mark on the Photovoltaic's gross margin. Obviously it's a significant number, so could you tell us how much scrap there was in Q3?

Mark Weinswig

That's a little bit less than about -- the excursion issue is a little less than about $400,000 of losses in the quarter.

Edward Zabitsky - ACI Research

And in terms of the yield, is it just part of a normal ramp that you're seeing lower yields?

Mark Weinswig

That is normal. It actually was very interesting. Our yields were fairly high in April and May, but actually in June, we began to see a little bit of reduction in our yields. And for us, just a percentage point or two of reduction in yield has a significant impact on our margin. So we ended the quarter, actually, getting back to our normal levels. So far in July, we're pleased to announce that our numbers are actually at or above our normal historical range. We feel very good about where we are going into the quarter.

Edward Zabitsky - ACI Research

So just to sum up, basically, do you expect both sides of the business to grow this quarter and gross margins to go up on both sides, is that fair?

Mark Weinswig

Well, definitely on the Photovoltaics side, we're seeing that on the -- with the end of life product that we've been talking about. That does cause a little bit of volatility in our margins. But overall, we believe that throughout this -- going in the next calendar year, we will see a nice significant increase in our gross margins on both the Fiber and Photovoltaics side.

Edward Zabitsky - ACI Research

And do you expect revenue from both groups to grow this quarter sequentially?

Mark Weinswig

What Hong mentioned, is that we do expect to keep flat to up with our optical revenues, and we do expect to see a fairly nice ramp in our Photovoltaic business.

Hong Hou

So the visibility and the outlook for the facility on Photovoltaics side is more firm and the range we guided for revenue was largely the past risk in fiber optics area. But, as Mark said, the worst case, is probably flat and we do expect a sequential gross in the current quarter from fiber optics side.

Operator

Our next question comes from the line of Cobb Sadler with Catamount Advisors.

Cobb Sadler - Catamount Strategic Advisors LLC

I have another question on the Tunable XFP and the applications -- so you're probably like focusing on the 300-pin replacement opportunity and not the fixed XFP, as I understand it. Is that correct?

Hong Hou

Yes, I think the 15 or 16 customers were sent samples too, for our qualifications, as far as we understand, most of them are targeting for the 300-pin replacement.

Cobb Sadler - Catamount Strategic Advisors LLC

And I guess, JDS is targeting the fixed XFP pretty ugly. So do you think you could be the largest supplier of 300-pin tunable replacement parts? Or was that too early to say?

Hong Hou

That has been our product strategy. Since I think from our experience so far, it's probably cannibalizing 300-pin transponders, it's taken a little bit longer time, because they have to redesign the line cards. It's not the same form factor as you're -- that you're replacing fixed wavelength XFP. So yes, but ultimately, I think our product strategy to cannibalizing 300-pin transponder market, we're really shine in that area because of product performance.

Cobb Sadler - Catamount Strategic Advisors LLC

And do you know -- is there a third vendor that's through the Telcordia process? Or materially, through the Telcordia process, or do you have that kind of visibility?

Hong Hou

Not as far as we know. From the public announcements or from the customers' comments.

Cobb Sadler - Catamount Strategic Advisors LLC

And of the 15 trials, tough question, but like what do you think the hit rate might be? I mean would you expect to get a majority of those as customers or would it be fewer than that?

Hong Hou

So we, right now, get allocated from 2 major customers, so far. That means, they finished qualification, and our product is good as a qualification of our rep products, integrated in their system. And they release until production and we're getting share allocation. Our expectation is before the end of this quarter, we don't have to go to number with 4 to 5. But as the amount of 15, 16 customers, we send our product team for qualifications range of the progress. So again as I said, our expectation is 4 to 5, we'll reach to the finish line by the end of this quarter.

Cobb Sadler - Catamount Strategic Advisors LLC

When do you expect -- I guess your internal production capacity breaks up your Tunable -- as what -- you want a couple of million dollars or $1.5 million a quarter. Is that correct? I guess, when do you expect to start using the contract manufacturer?

Hong Hou

I think for product shipments, the majority of the product in the current quarter will be served through our Bay Area manufacturing. But I think our expectation is to have customers sign off the production line -- the contract manufacturers overseas -- by the end of the -- quarter-end of this quarter. And we'll be shipping the volume product to customers, the majority of the product will be shipped from contract manufacturers in the December quarter.

Cobb Sadler - Catamount Strategic Advisors LLC

And the $1 million kind of target, I mean could you possibly do that in this quarter, in the September quarter?

Mark Weinswig

On the comment, you heard us September quarter, yes.

Cobb Sadler - Catamount Strategic Advisors LLC

Okay, that's a new target, I got it. And then last question on the parallel optics, can you remind us how big of a business that was for you a couple years ago? And also when you think the generation 2 awards will be made? And who do you see, I guess it's been heavily Avago, and then for generation 2, it sounds like there maybe some other players involved like yourselves, a major networking vendors. So when do you think those award might be made?

Hong Hou

To answer your first question, at a historic level, a couple of years ago before we had the ITC ruling, the parallel optics revenue was at a $4 million to $5 million a quarter. So right now, that revenue from parallel optics dropped to about $1 million to $1.5 million a quarter. And as I said, you were done selected as a supplier to leading datacom customer for supplying parallel optics, next generation products. We believe including us, 2, 3 strong players are going to play. And the final product of qualification is going to be before the end of this calendar year and the volume will be -- start picking up early 2012.

Operator

Our next question is from the line of Alex Henderson with Miller Tabak.

Alex Henderson - Miller Tabak + Co., LLC

I just want to make sure I got the information straight. You're saying that the Tunable XFP target for the September quarter is now $1 million?

Hong Hou

Yes. Because the delay in our customer finishing the qualification in utilizing in their systems. So we meet our target in the June quarter to achieve $1 million revenue, and that we expect right now in the September quarter, we'll be able to reach that level.

Alex Henderson - Miller Tabak + Co., LLC

I'm a little confused. Why would you be shifting an entire quarter based on that timing of the Telcordia announcement? Telcordia announcement was certainly well within the window for whole shipment this quarter. And if your production is up to the target you said in your day facility, you ought to be able to produce considerably more than $1 million?

Hong Hou

Yes, you're right. It's not a problem that we don't have products or we don't have qualified products, we have qualified products and we have the capacity but our customer here, the timing is to -- before they send us the qualification, they wouldn't be buying the same flavor of products to any risk by -- they call it, release until production. And if that is now your true customers, just to release through production, we should be seeing the demand asking for us to ship the products to their production. And most of the others, they buy enough parts to finish their product qualification and integration at their level, but they are not ready to commit on high-volume because their product production schedule, they have to look at other components involved as well.

Alex Henderson - Miller Tabak + Co., LLC

You're good in making comments in prior periods that quote, "You're totally qualified," 2 customers that are waiting on capacity, availability and now, you're telling me that you have capacity availability, but you're not able to ship to those customers because they're not taking the product? That doesn't seem consistent with your past comments. Is there some reason why the customers are now less interested in taking quantities immediately?

Hong Hou

You're right and that's part of our confusion and frustration as well. Before we finished the qualifications, we we're told that they're ready to go. Our product is qualified that when we finish our qualification and they release to the production, is taking them just a little longer to ramp to the volume. So again, I don't think we did an extensive look into the situation, I don't think we're losing as fast, as a number 2, I think we believe for 300-pin replacement applications, we're on the top spot in many places. I don't think that we lost that. It just seems to take longer time for them to get into this new form factor, integrated in the long curve, in rental production.

Alex Henderson - Miller Tabak + Co., LLC

What is the capacity availability at the base facility at full production?

Hong Hou

So our facility, in full production for the Bay Area will be 2,000 to 3,000 perhaps, per quarter, and our contract manufacturer will be about 10,000 to 12,000.

Alex Henderson - Miller Tabak + Co., LLC

So you had said that the 2,000 to 3,000 units per quarter run rate capacity would be completed by the end of the June quarter, is that currently the case?

Hong Hou

Yes. We have the capacity in 2,000 to 3,000 pieces in place in the Bay Area right now. And clearly, the contract manufacturing capacity is being built up, and we're not there at the 10,000 to 12,000 yet.

Alex Henderson - Miller Tabak + Co., LLC

But you had said that you would be there by the end of September. Is that still the target?

Hong Hou

Yes.

Alex Henderson - Miller Tabak + Co., LLC

So the production is on the exact same slant that you had given at the end of last quarter in terms of your target, the only thing that shifted is the willingness of the customers to take product in the window.

Hong Hou

Right.

Alex Henderson - Miller Tabak + Co., LLC

And when they come on, is there any reason to believe that they won't come on in a larger volume than the near sampling volume? Is it where you were stuck with when you barely had capacity? I'm a little surprised that they've come on in such a small amount, given the availability of the capacity. Usually the ramp of those products is a little bit more discontinuous than that.

Hong Hou

Right. I think we have talked about this a lot. Certainly, we were expecting a strong demand for this after our qualifications, but has been a little bit low. As I said, it may have something to do with that other application, is the replacement of 300-pin transponder on the line side, and it's probably more disruptive for them to design and qualify on the line side, a different form-factor product, compared to application of replacing fixed wavelength Tunable XFP on the fan[ph] side.

Alex Henderson - Miller Tabak + Co., LLC

So you think it's a function of the redesign of the blade that take a little longer than you anticipated?

Hong Hou

That's our understanding at this point.

Alex Henderson - Miller Tabak + Co., LLC

Just for the record, there are 2 other companies other than yourself that have publicly stated they have done completed Telcordia testing on their Tunable XFP. So, just for the record. Can you talk a little bit about your expectation for growth in the ITLA side? You have -- better than your 15% to 20% growth target for the current quarter, you're going into the back half of the year, obviously, that area is the fastest growing area in the Optical segment. Is it reasonable to think that you can be producing another 15% to 20% growth quarterly into the back half?

Hong Hou

Yes. So the Tunable ITLA application into the 40 and 100 Gigabit transponder in the coherent design, we have experienced a very robust growth. If you know in the last couple of years, we have doubled the revenue twice -- doubled the revenue in 2009 and doubled the revenue in 2010. And sequentially in the June quarter, we experienced better than 20% of quarter-over-quarter growth. But in the September quarter, right now, we expect at least at the same level as June, and we -- revenue guidance we give a range, because we're a little cautious in listening to the equipment manufacturers in their outlook for the future. We feel a little bit uncertainty, but one thing we are pretty certain that, we will be at least, getting to the level of revenue in the June quarter.

Alex Henderson - Miller Tabak + Co., LLC

I'm sorry, so you're telling me that ITLA business, which is 40 gig, 100 gig, that your customers are saying that or do you just listen to their conference calls? Because I haven't heard anybody tell me that the 40 gig, 100 gig market has slowed.

Hong Hou

Right. I haven't heard that either. It was just more on the macro level, and we're a little cautious. I do expect to drill sequentially. If the 20% or 15% is hard to tell, but at least, it's going to be a positive trend in the September quarter.

Alex Henderson - Miller Tabak + Co., LLC

So has any of your customers come you and said, "Gee, we've been taking product and we're slowing our expectations down." Or is this just because you're reading the Wall Street Journal and the rest of us have been scared about the inactivity in Washington? So what is the data point that suggested some slowdown in that business?

Hong Hou

Yes, so it's more the latter. There's no specific customer that came to us and say, "Hey, look guys, I'm telling you, we're slowing down." No single customer coming to us telling us that, we're just cause-effect -- everybody else.

Alex Henderson - Miller Tabak + Co., LLC

And on the cable side, am I assuming that, that's fairly, sequentially fairly flattish share in your expectations? Because that's the normal pattern?

Hong Hou

Yes. The cable side is interesting. It does not exactly track the trend in a traditional telecom side. And we have been experiencing pretty robust growth in the first half of the year, and we're reading the equipment manufacturers, their CapEx plan, which is publicly available. And looks like they at least, are holding the demand steady for the areas that they were, they need our equipment, which is the upgrade and the scalable user structure deployment. So the backlog, as we discussed in the Fiber Optics area, it's still -- be a sequential interest and that's pretty encouraging. And most of the backlog increase was from the cable TV area. We expect the sequential growth in that product.

Alex Henderson - Miller Tabak + Co., LLC

So one more question. On the phased-out products, you made the comment that the cost in the gross margins in the third quarter calendar, they're -- your fiscal fourth would be experiencing increased pressures, as a result of phasing out of older products. Yet my understanding is that, that business is coming down pretty hard, I would think that given as essentially no margin attached to it, that the elimination of a no-margin product would help your margins not hurt your margins. Is there some end of life scrappage assumptions going on there? What's the mechanics around that? What caused you to make that cautious comment on gross margin.

Mark Weinswig

That probably confused you. Sequentially, our Fiber Optics consolidated gross margin, increased by 1.5 percentage points.

Alex Henderson - Miller Tabak + Co., LLC

I know. But the guidance you made negative comment on.

Hong Hou

The guidance, going forward, we only have exposure at the revenue level at about $1 million to $1.5 million per quarter from the legacy product. While we stopped the legacy product, the gross margin is going to increase because of better product mix. You're absolutely right. Those products, while they contribute into revenue as a leader of negative gross margins. So we're not interested in continuing to sell those products at all. But we have to view a goodwill with the customer base to gradually and gracefully putting those products...

Alex Henderson - Miller Tabak + Co., LLC

But there's nothing new about that. And you made the comment relative to the first question set that was asked, that when asked about revenue growth and margin expansion in both segments, you said yes, revenue growth in both segments, but we would expect margin expansion only in solar. And I'm a little confused about why that would be the case. And when asked -- when you were responding to that, you had said that the phased out products were weighing on the numbers in the September quarter. And I don't understand why that would be the case if they're half what they were in this June quarter and the September quarter.

Hong Hou

Maybe I can, can explain that and kind of clarify a little bit. So didn't actually expect it as the same thing, that was to be pretty much out of all the end-of-life products growing by the end of June. But we're still getting demands with some of these products and we still have some inventory. So right now, by the end of September, we thought it would be 0, and yet right now, we're expecting to still have some revenue going forward in the September quarter. And right now, how we're looking though[ph], there may be some, that we're actually been given tail off of the beginning of October and November.

Mark Weinswig

So it doesn't explain why it would hurt your margins though, it's still less than it was in the prior quarter, it should cause your margins to expand.

Mark Weinswig

There is -- and then the only other item that we still are working through is, we do have -- some inventories, we still have that we are basically buying, and we are looking to sell to customers. So obviously, there is, some of you know, is still associated with that. This quarter, our P&L fell pretty substantially. But it still is close to, a little bit close to $0.5 million quarter of P&L that we actually have in the business.

Alex Henderson - Miller Tabak + Co., LLC

But you're still not answering the question, Mark. The question is pretty straightforward. Why does that cause a decline sequentially in the margins in the Optical business?

Mark Weinswig

I'm sorry, Alex, we never said it was going to cause of decline.

Alex Henderson - Miller Tabak + Co., LLC

In response to the question earlier, asked earlier on the call, the question was asked, point-blank, do you expect revenue growth and margin expansion in both businesses? The answer was yes, revenue growth in most businesses. Margin growth in Solar, but you declined to imply that there would be growth in margins, implying that it wouldn't grow, implies it will probably declined or be flat, and why would that be the case?

Mark Weinswig

So why don't we clarify that comment, Alex, that you brought up, and that's a good point. We expect our margins to be flat to up next quarter. The only thing that you had mentioned that our revenue will be flat to up next quarter, so that would then lead our margins to also be flat to up.

Alex Henderson - Miller Tabak + Co., LLC

Well, wouldn't the decline in that business from June quarter to the September quarter still positively impact the margins? And since the products that are coming on are higher-margin, shouldn't that positively impact the margins?

Mark Weinswig

I mean, Alex, we sure do hope so, and that's what we're definitely going for, but that's the guidance, that's the guidance I'm giving out today.

Hong Hou

You know, Alex, we're not expecting the margins for fibers will go down in either really the -- the worst case is flat and it should be going up. There are no reasons to be not.

Operator

Our next question is a follow-up question from the line of Edward Zabitsky with ACI research.

Edward Zabitsky - ACI Research

I want to ask a little more just on the reasons for caution out there. One is, of course, the inventory and another is China. Now with inventory, it appears that the areas that has the most inventory or areas where you guys just didn't play in the last few cycles, you haven't really been in the telecom market in a big way since X2 at least, as far as transceivers go and XENPAK. So I'm wondering if you think maybe that protected -- buffering you from the inventory cycle that's going on, number one? Number two, I understand that you have limited exposure to telecom in China. I'm wondering if you could just comment on that and number three, would be, do you see growth for broadband in China? What's the latest broadband initiative?

Hong Hou

Okay. So Xerox and the writenav [ph] complete, do not have as a broad product portfolio, at the industry leaders in this area. So we did not see as broad an impact to the demand from the reported regulatory issues in the China slowdown. So that's why we're probably on a different trajectory, compared to our brand in the same area. In a while, you'll see most of the companies possibly experiencing their revenue decline and guided down sequentially, we have achieved better than 10% because of growth in the June quarter, and we expect to continue to grow in September quarter. And that's the very reason that we do not have exposure on, as broader product which we're seeing that, if they have a revenue impact, regulatory impact. And also you know, I think another reason is the R&D investment, the product line in the last few years starts paying dividend that generally have a continued strength because of the maturity -- well a lot of the revenue, high percentage of revenue is from the new product. As for the revenue from China, the mix has been very slow and they're very low in the past, less than 10% of our revenue from China and going forward, we have a couple of the customers, have jumped onto the top 10 list, the Chinese customers, so we are certainly gaining more traction in China and deriving more revenue from the Chinese market. we're growing in that market.

Edward Zabitsky - ACI Research

Would that be telecom or broadband?

Hong Hou

In both. One is a Broadband customer, one is telecom customer. So the broadband actually, we have been seeing a very healthy growth. The broadband product we sold to China, primarily through our distributor. And I think this year, we'll be achieving about 20% growth compared to last year. So the broadband, we did more, that's plain in a component level, mainly packaged lasers and packaged receivers and that event[ph] has been very healthy.

Edward Zabitsky - ACI Research

Obviously, you're not going to give guidance for the December quarter at this point. But with the TXFP ramp, assuming that, that occurs in that quarter, in late in this quarter and going into the December quarter, shouldn't we see another good -- another very good revenue quarter from both sides of the business?

Hong Hou

I think from this point, I'm, I'm not going to give that number and say how much revenue we are going to be for the December quarter from Tunable XFP, but I definitely expect the trend is going to be positive because we are getting more and more customers to the finish line of the product qualification, and the validation. If that happens, most of the places we are on a number 2 slot, a couple of places, we're in a number 1 slot. So I think that's going to be materialized. The demand is going to be materialized more and more with the time.

Edward Zabitsky - ACI Research

Is there any chance you'll do significantly better than 1 million in the TXFP in this quarter? Is there any evidence, any suggestion that those lines are out in the market right now? That maybe they'll be simple in the near future?

Hong Hou

There's always a chance. But then we thought for the June quarter, we knew they will come. We do it -- they come a little slow. So I am just a little talkative to be more optimistic than I am right now on the September revenue for Tunable XFP.

Edward Zabitsky - ACI Research

Right, but there's nothing telling you now to get really excited in the short term about that revenue but nothing telling you that it's impossible at this point?

Hong Hou

Exactly.

Operator

And at this time there are no further questions. I'd like to turn the conference back to management for any closing remarks.

Hong Hou

Thank you for dialing in today. We apologize for the technical difficulties. Just for your information, we'll be presenting at the Morgan Keegan Technology Conference on Tuesday, August 9 at 4:25 p.m. in New York City, the New York Palace Hotel. And we will also be presenting at the Citi Technology Conference on Thursday, September 8, 1:35 p.m. in the Hilton New York Hotel in New York City as well. We look forward to speaking to you soon. Thank you, again.

Operator

Thank you, sir. Ladies and gentlemen, this does conclude the EMCORE Corp. third quarter fiscal 2011 earnings conference call. Thank you very much for your participation, you may now disconnect.

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