EMCORE's (EMKR) CEO Jeff Rittichier on Q1 2017 Results - Earnings Call Transcript

| About: EMCORE Corporation (EMKR)
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EMCORE Corporation (NASDAQ:EMKR) Q1 2017 Earnings Conference Call February 7, 2017 4:30 PM ET

Executives

Erica Mannion - Sapphire IR

Jeff Rittichier - President and CEO

Jikun Kim - CFO

Analysts

Joe Maxa - Dougherty and Company

Jaeson Schmidt - Lake Street Capital

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the EMCORE Corporation Fiscal First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will be given at that time. As a reminder, today's call is being recorded.

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

Erica Mannion

Thank you, and good afternoon, everyone. Before we begin, I 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 our current expectations and projections about future events and trends affecting our business. Such forward-looking statements include in particular, projections about future results, statements about plans, strategies, business prospects, changes and trends in the business, and the markets in which we operate.

Management cautions that these forward-looking statements relate to future events or future financial performance and are subject to business, economic, and other risks and uncertainties, both known and unknown, that may cause actual results, level of activity, performance or achievements of the business or our industry to materially differ from those expressed or implied by any forward-looking statements.

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

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

Now, I'd like to turn the call over to Jikun.

Jikun Kim

Thank you, Erica, and good afternoon everyone. Today I will provide details of our Q1 FY'17 financial performance. Please note that consistent with prior quarters, these results include the effects of classifying what remains of EMCORE's Telecom and Photovoltaic businesses as discontinued operations.

Consolidated revenue for the quarter totaled $30.2 million, which is 18% higher than the prior quarter and above the high-end of the revenue guidance of $28 million to $30 million.

Cable TV market continues to drive revenue both for our DOCSIS 3.1 and RF over Glass products. We also recognized phenomenal [ph] growth on our SatCom Video and Fiber Optic Gyro product lines. Our emerging chip products held steady in the quarter.

GAAP gross profits in Q1 were $10 million, which is 10% higher than the prior quarter. Gross margin in the quarter was 33.3%, down from 35.6% in the prior quarter. The primary driver of the reduced gross margin during the quarter was a $350,000 accelerated spending related to the Beijing manufacturing transition efforts. On a non-GAAP basis, which takes into consideration adding back FAS 123R expenses as well as after-retirement obligation accruals our non-GAAP gross margin came in at 33.6%.

Normalizing for the effects of the accelerated Beijing facility transition expenses, our non-GAAP gross profit margins would have been closer to 34.8%. As Jeff will discuss further in a few moments, it is worth noting that our gross margin may fluctuate from quarter-to-quarter due to changes in product mix and other non-recurring factors. Through our discussion last quarter, we remain focused on optimizing profitability at the operating income level versus gross profits.

Total GAAP operating expenses for R&D and SG&A were $7.8 million, approximately $400,000 higher than the prior quarter, primarily due to higher stock-based compensation expenses, annual performance bonus accruals, and year-end audit fees, all offset by lower R&D investments during the quarter. On a non-GAAP basis adjusting for FAS 123R and other non-recurring items, operating expenses would have been flat. For further details please see the GAAP to non-GAAP reconciliation table in the press release.

On a GAAP basis, operating income for the first quarter was $2.2 million, an increase of $500,000 over the prior quarter. On a non-GAAP basis, operating income was $3.5 million or 11.5% of revenue compared to $2.5 million or 9.9% of revenue in the prior quarter.

Normalizing for the effects of the accelerated Beijing facility transition expenses, our non-GAAP operating profit margins would have been closer to 12.7%, exceeding the operating margin target of 12.5% we discussed at the end of last quarter.

Our GAAP pretax income from continuing operation was $1.9 million in Q1, or $150,000 higher than the prior quarter, primarily due to higher gross profits offset by higher operating expenses and FX losses. Our non-GAAP pretax income after taking into consideration certain adjustments, all of which are set forth in the non-GAAP tables included in today's press release was $3.5 million or $0.13 per diluted share compared to $2.6 million or $0.10 per diluted share in the prior quarter.

Please note that we have included additional information regarding unique transactions, litigation-related expenditures, severance stock compensation, amortization, and other items in today's press release to provide further clarity on our results.

Moving on to the balance sheet and cash flow statement; at the end of Q1 FY'17, the company's cash, cash equivalents were approximately $62.2 million. Moving on to the balance sheet -- I'm sorry, regarding our working capital metrics, DSOs were at 77 days, a slight increase from the 74 days in the prior quarter, driven by the timing of the shipments in the quarter. Net inventory turns including non-current inventory was at 2.7 times, slightly lower than the prior quarter. The increase in the inventory was driven by the build up of finished goods and the working process inventory ahead of the Chinese New Year and factory transition efforts.

In Q1 FY'17, we invested $3.2 million in capital expenditures and recognized approximately $750,000 in depreciation and amortization. Capital expenditures remain elevated due to the Beijing facility transition and the investments that we are making in our laser file [ph].

In summary, we continue to make solid financial progress during the quarter with strong top line growth as market continues to adopt the DOCSIS 3.1 solutions. We are also beginning to realize the benefits of operational improvement initiatives we began a year ago. Taken in combination, our operations continues to grow profitability and meet our commitments.

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

Jeff Rittichier

Thanks, Jikun. Good afternoon everyone. As Jikun highlighted, we continued our momentum into the first fiscal quarter, delivering sequential revenue growth of 18%, which was at the high-end of our guidance.

More importantly, during the quarter we demonstrated our improved manufacturing efficiency and operating leverage by growing non-GAAP pretax net income sequentially by approximately 35%. With that said, I'd like to provide you with some additional color on the trends we are seeing in each of our served markets as well as in the operations of the business.

Within the Cable TV market, in the first quarter we continued to see strong sequential growth with the business up roughly 19% from the fourth quarter and up 91% from the prior year. The overall strength in infrastructure side of cable television not only demonstrates the MSO's commitment to deploying DOCSIS 3.1 Fiber Deep Networks, but also highlights EMCORE's leadership position within the space.

As we discussed last quarter, we believe we are still in the early innings of this network build-out, and are poised to benefit from our new products such as our LEML-based solutions, which are being integrated across our product lines. We remain optimistic about growth opportunities in this business, and expect to see strong upgrade spending for major and regional MSOs.

As we look to expand our addressable market within the Cable TV space with new products such as RF over Glass, it's worth reiterating that our focus is on opportunities which are accretive to overall corporate operating margin. In our RFoG products, sales, marketing, and engineering expense scaled down in lockstep with product margins. We expect to see a bit heavier mix of the low end of our RFoG product in Q2 driving revenue and non-GAAP net income up in dollars, but at the expense of the gross margin line.

Moving on to the Chip market, revenues remain flat in the first quarter, which we expected. We've begun production shipments of 10G parts at low volumes, and we're continuing our product development work to address the wireless and datacenter markets which we plan to enter toward the end of 2017. As we've stated previously, EMCORE is working to become broad supplier of chip-level products to the entire telecom industry, thereby optimizing our production mix between captive and merchant use, driving a higher blended margin for both our chip business and for the company overall. Within the SatCom and video markets EMCORE continues to enjoy strong market share and close relationships with customers in our legacy markets, while continuing to make progress on introducing new products for adjacent markets such as L-Band link used by services such as Dish and DirecTV.

As I highlighted last quarter, we're currently in the process of outsourcing our SatCom products to TAA, which is essentially Made in America, an ITAR compliant manufacturing facility operated by our EMS partners. This transition was largely complete by the end of the first quarter. We expect to see modest growth in the SatCom product line in fiscal '17. Within the Fiber Optic Gyro market we continue to make progress in building our presence in the market and winning designs against larger competitors in the defense industry.

In addition to the orders we publicly announced, we continue to see increasing momentum for potential new orders in the current fiscal year. In addition to delivering production product for the MTSB program and other key program, our primary emphasis this year is to deliver pre-production volume for very important new program that we expect move to revenue needle in FY '18.

We recently created an airspace and defense business unit and have brought a new VP General Manager with significant experience in the industry to manage this business. We will be retrofitting one of our Alhambra campus buildings to house key pieces of capital equipment by about the end of the calendar year. These upgrades are necessary to support the growing FOG IN new business, and we -- and remain expectations remain that we will exit the year with navigation product running at about 10% of revenue and higher thereafter.

Shifting gears to the operation side of the business, our transition to a hybrid EMS manufacturing model is nearly complete at the end of Q1, we have largely completed the shift of that car manufacturing to EMS suppliers, by the end of Q2, we will have finished the relocation of our assembly operation in Langfang, China to EMCORE Asia, which is our new automated facility inside the Beijing.

The new facility has been audited by all of our major customers at this point and we received nearly all of the customer approval for PCM. This means that the transition schedule is quite firm with very few moving parts, we expect to see some acceleration of expenses related to timing in certain activities over the next quarter or two that may push margins around a little bit, but we have included within the window of guidance our non-GAAP net income, I am sorry non-GAAP operating margin which are targeted at 12.5% as we exit Q4.

When completed these actions coupled with the numerous initiative, we continue to implement as a result of our Six Sigma Training program, we will have significantly transformed the operations of EMCORE from where things were nearly two years ago. From a personnel standpoint, our automation activities will have made us 180% more efficient on a cost to goods per employee basis, while our outsourcing initiative continue to transform fixed expense to variable costs as we focus on processes where we can demonstrably add value over competing merchant EMF. Perhaps the most significantly evolve these actions will result in the reduction of our breakeven point by $1 to $1.5 million per quarter.

Again, I would like to point out the unique aspect of our manufacturing strategy for Mixed Signal Optics. The automation processes and cable TV module assembly that are responsible for the dramatic improvement in our commercial business were designed to duel use in our military program, allowing us to drive cost reduction and quality improvement in our U.S. manufacturing operation, even though the equipment was originally developed by our team in China, you should expect to see more of this automation development from us going forward, as we strive to make our U.S. manufacturing operation capable of competing with offshore low costs labor.

As I mentioned before, Six Sigma is driving a new culture here at EMCORE. In a recent investor meeting, where we were discussing the savings, we have achieved one of our investors asked me whether all the low hanging fruit is now off the tree, I replied that indeed a lot of it has been harvested but the juiciest fruit of all was now within our reach because Six Sigma has thought the organization, how to climb the tree.

My point was that the problem solving skills in this organization have improved markedly and organization wide, making EMCORE able to tackle even more lucrative albeit challenging problem. We have actually moved all of our management training and evaluation processes out of HR into the quality organization and are treating management system and organizational development the same way, we treat every other process. Leading for being audited and improve the same way that we solved manufacturing process problem preparing the organization to manage its growth in a controlled and positive structure.

Turning to our outlook for the business, for the second fiscal quarter, given the continued strength we are seeing in the Cable TV business, we expect revenue to be in the range of $29 million to $31 million, with non-GAAP operating margin approximately 9.5% to 11.5%. It's worth noting that Q2 has traditionally been a seasonally soft quarter due to weather limitations. Our roughly flat guidance is significantly better than planned. Finally, we expect to hit the quarter with production almost -- end the quarter with production almost completely shifted over to our new EA facility, a key milestone in the evolution of EMCORE.

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

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question is from the line of Joe Maxa of Dougherty and Company. Your line is open.

Joe Maxa

Thank you, and congrats on a nice quarter and outlook.

Jeff Rittichier

Thank you, Joe.

Joe Maxa

I wanted to ask a little more on your outlook on '17 on the Cable TV side of things. Cable TV is very strong, currently expected for Q2. I mean, from a lot of necessity [ph] with Comcast and others, but what are you seeing as far as perhaps new customers -- not customers, but MSOs building this year versus perhaps next year, and do you expect to see continued growth sequentially through the year?

Jeff Rittichier

Well, getting into the limitations of my crystal ball here, it's hard to say what sequential really means. I mean, Cable could be a little cyclical at times. So with that said, we see a strong backdrop of spending strength. If you look into the documentation that our friends at Charter had to file when they bought Bright House and Time Warner, indicate that in '17 they have to begin to build out additional, what is essentially, high speed capability in the Time Warner and Bright House networks. Charter has been real good about upgrading as well.

So, the net of it is if you look at what Charter is saying it looks like there's additional strength beyond Comcast, as you mentioned. Liberty Global is certainly doing its thing as it rolls up smaller regional MSOs over in Europe, and they have a very strong technology roadmap, so -- and not to -- last but not least, the Japanese are beginning in '17 to do a build-out to bring 8K transmission in for the 2020 Olympics.

So overall, we see strength throughout the industry. I'm sure there will be turbulence from time to time, things switch back and forth between infrastructure and CPE, but all indications are that the major MSOs are spending.

Joe Maxa

That's helpful, and I just want to probe a little more into your operating margins. I mean, you hit your existing fiscal year '17 number pick out [ph] one times on a non-GAAP basis of over 12.5%, guided down in Q2, I know you have some moving parts. Can you walk through again the drivers of that difference of maybe that 9.5% to 11.5% Op margin for Q2?

Jikun Kim

Sure. So, just the pure non-GAAP reconciliation in the back I would refer to in 11.5% Q1 performance, and then obviously the Beijing transition cost would add about $350,000 in costs which would get you up to the 12.7% Op margin. The transition at Beijing is not over. It's just begun. So this is -- we anticipate that cost in Q2 to be the highest. So that's one factor. And then we are going to see a higher mix of the archived products which will definitely impact the operating profit performance a little bit. So I think we're being probably about right at 9.5% to 11.5%. That seems to be a good range and good number, but keep in mind we should come out of that in Q3 relatively stronger.

Joe Maxa

Understood. All right, that's very helpful. Thank you.

Jeff Rittichier

Yes, Joe, the other little piece is that essentially all the processes will be running in EA within another three weeks. So there's redundancy to get stripped out and everything, but this is not something that is way out at the end of our headlights.

Joe Maxa

Just that piece of the business, that transition over in China, once that's complete how do you -- I mean you said $1 million to $1.5 million reduction in breakeven, is that primarily driven by that operations?

Jeff Rittichier

Yes, there's also -- also there will be some changes in the operations here in Alhambra that will contribute. Keep in mind though that what we're talking about is a reduction in breakeven point. So some of the savings essentially go to variable costs which we have to pay third parties to do it, but the good news is that it makes us drought resistant of course if the market ever does slow down.

Joe Maxa

Great, thanks.

Operator

Thank you. And our next question is from Jaeson Schmidt of Lake Street Capital. Your line is open.

Jaeson Schmidt

Hi, guys, thanks for taking my questions. Just a follow-up on one of the previous questions, not looking for specific guidance, but historically you've seen sequential growth in both the June and September quarters, and after a really strong December and March this fiscal year. Is there anything that you currently see that would not allow that trend to continue?

Jeff Rittichier

Well, hi, Jaeson, it's Jeff. So here's the thing. Normally we start to see signs of a slowdown in, let's call it, the winter quarter, our Q2, calendar Q1, a couple of months ahead of schedule or a couple of months ahead of when it actually hits, and we didn't see as much of it. There's been the odd push out here and there which actually ended up pushing the market numbers around just a bit already.

The point of it is that you don't really see indications about where calendar Q2 and calendar Q3 end up until about the middle of March. And that's when it seems like everybody wakes up and starts expediting things. So again, we see a very strong pattern of spend, and there's nothing out there that makes us think that there's an oncoming train headed at us. But you never know really on the slightly longer view until you hit mid-March, and see what quarters look like.

Jaeson Schmidt

Okay, that's helpful. And then just shifting to the Fiber Gyro side, that's obviously a big area of focus for you guys going forward, can you help us understand how you're breaking into that market, what gives you guys confidence that you can see continued traction going forward?

Jeff Rittichier

Sure, great question. So it's funny because the Fiber Gyros we have been working on some of this technology for a very long time. We've now been in production with [indiscernible] MTSD [ph] program for two years, may be a bit more, and we are one of their top supplier, as has been acknowledged through their award system. We are working on other programs for them. And as our success has become clear though the industry we're getting pulled in to bid on things that two years ago, when I joined, people wouldn't have considered us for. So it's a competitive world out there, Jaeson, which is why you haven't seen a ton of press releases. But we like where we are now. The customer relationships that pull us into these programs, which are absolutely critical, we feel that we have, and that we're getting good traction. So not a lot of specifics in that, but we wouldn't be starting to work on expanding our production capacity if we didn't like what we saw going forward.

Jaeson Schmidt

Okay, thanks. I'll jump back into queue.

Operator

Thank you. [Operator Instructions] Not showing any further questions at this time. I'm sorry; it looks like we have an additional question from Joe Maxa of Dougherty and Company. Your line is open.

Joe Maxa

I'd ask for the revenue breakout, like you've given each quarter on your segments.

Jikun Kim

Yes, sure. So, on the Cable TV side we were at 80% to 85% of the revenues. On the chip side we're at 2.5% to 7.5%, in the SatCom Video we're at 5% to 10% and on t [indiscernible] 2.5% to 5%. So, the mix really didn't change very much from last quarter.

Joe Maxa

Great. Okay, that's all I had. Thank you.

Jikun Kim

Sure.

Operator

Thank you. And I'm not showing any additional questions. I'd now like to turn the call back over to Mr. Jeff Rittichier for any further remarks.

Jeff Rittichier

Thank you. In closing, I would like to thank my team for the very hard work they put in everyday, and I believe I speak for everyone when I say how we proud we are of the business we are building and the opportunity that lies ahead. Thank you all for your time today.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone have a great day.

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