EMCORE Corporation (EMKR) CEO Jeff Rittichier on Q1 2019 Results - Earnings Call Transcript

EMCORE Corporation (NASDAQ:EMKR) Q1 2019 Earnings Conference Call February 6, 2019 4:30 PM ET

Company Participants

Erica Mannion - Sapphire Investor Relations

Jeff Rittichier - President & Chief Executive Officer

Mark Gordon - Interim Principal Financial & Accounting Officer

Conference Call Participants

Jaeson Schmidt - Lake Street Capital Markets.

Lee Krowl - B.Riley FBR

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the EMCORE Corporation Fiscal First Quarter 2019 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, 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 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 in trends in the business and the markets, in which we operate.

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

We caution you not to rely on these statements and to also consider the risks and uncertainties associated with these statements and the business that are included in the company’s filings with the U.S. US Securities and Exchange Commission that are available on the SEC’s website located at www.sec.gov, including the sections entitled Risk Factors in the company’s Annual Report on Form 10-K and quarterly reports on Form 10-Q.

The company assumes no obligation to update any forward-looking statement to conform such statements to actual results or to changes in our expectations, except as required by applicable law or regulation.

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

With me today from EMCORE are Jeff Rittichier, President and Chief Executive Officer; and Mark Gordon, Interim Principal Financial and Accounting Officer. Mark, will review the financial results and Jeff will discuss business highlights and fiscal second quarter guidance before we open the call up for questions.

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

Mark Gordon

Thank you, Erica, and good afternoon, everyone. Today I will focus my discussion on EMCORE's FY 2019 Q1 financial results ending December 31, 2018. Consolidated revenue for the quarter came in at $24.0 million with broadband revenue, representing 72% of total company revenue, down from 80% in the prior quarter as the Cable TV market returned to a more normalized demand environment, following the large L-EML order we received in Q4.

Chips represented 18% of revenue as compared to 10% in the prior quarter, driven by growth in both GPON and non-GPON related products. While navigation remained at 10% roughly flat on both a dollar basis and as a percentage of total revenue with the prior quarter. Overall CATV was 62% of revenue for the quarter.

GAAP gross profits in Q1 were approximately $5.8 million or 24.2% of revenue, up from 17.5% in the prior quarter. The sequential increase in gross margin was largely driven by the absence of the one-time events in the fourth quarter, which did not repeat themselves in the first quarter. This was partially offset by absorption and additional E&O charges due to the accelerating adoption of our L-EML product and incremental long-term inventory impairments.

Taken together, these expenses totaled approximately $1.8 million, or approximately 8% of sales. Pro forma for these expenses, our gross margin would have been 31.7% in the quarter and within our expectations. While it's important to note that we see these charges coming down throughout the rest of the year. In the second quarter, we will experience larger manufacturing loading in CATV due to the seasonally softer cable TV market during winter months as well as the impact of Chinese New Year.

Looking beyond Q2, we do expect to see improvement in gross margin, as we continue to increase chip contribution and see the production cost of our L-EML-based transmitters decline. As is typical of new products when first introduced, our L-EML transmitters are working down the manufacturing cost experience curve as projected, leading to stronger gross margins on this product line in the quarters ahead.

Total GAAP operating expenses for R&D and SG&A were $11.6 million, $1.6 million higher than the prior quarter and $2.9 million higher than the prior year. In Q1, our R&D investment in navigation products decreased slightly due to the timing of project material expenses, while SG&A increased quarter-over-quarter due to an increase in consulting and litigation-related expenses.

With the arbitration proceedings completed in early January, we will be entering the post-hearing phase in the current quarter. Consequently, we expect to incur similar levels of litigation expense in the current quarter, but expect to see this decline significantly in Q3.

On a GAAP basis, the consolidated operating loss for the first quarter was $5.8 million. Our non-GAAP operating loss after excluding certain adjustments, all of which are set forth in the non-GAAP tables included in today's press release was $2.6 million, a $0.9 million increase compared to the prior quarter, principally driven by improved gross margin performance.

As a percent of revenues, in Q1 FY 2019 non-GAAP operating income was a negative 11%. Our non-GAAP pre-tax loss from operations was $2.4 million.

Moving on to the balance sheet and cash flow statement. At the end of Q1 FY 2019, the company's cash and cash equivalents including restricted cash were approximately $57.3 million, or a decrease of $5.9 million quarter-over-quarter. This decrease was primarily a result of the current quarter loss from operations, our investment in capital expenditures and the timing of working capital that decreased the cash payable balance from the prior quarter end. The overall decline in cash was in line with our expectations for the quarter, as we continue to invest in our fab and modernize our campus.

Regarding our working capital metrics, DSOs were at 78 days down compared to 82 days in the prior quarter. Net inventory turns including non-current inventory were 2.9 times. Capital expenditures in the quarter were $2.8 million and depreciation in the quarter was $1.6 million.

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

Jeff Rittichier

Thank you, Mark, and good afternoon everyone. As Mark highlighted, revenue was in the middle of our expected range in the first quarter with each of our end markets performing as expected. Margins improved due to stronger factory loading and a favorable product mix. While there's still work to be done to improve gross margins overall, our progress in this area is on track.

Within the cable TV market, we saw a resumption of normalized ordering patterns, albeit; sequentially down off a very strong fourth quarter which included a sizable L-EML order.

Demand for our cable TV products was split between our legacy and L-EML products as expected. This was a natural consequence of returning to normalized inventory levels of our legacy products in the fourth quarter resulting in normal production splits between laser modules and L-EML transmitters in Q1.

Demand for our new L-EML products continued to be strong. As we stated on our last call, our L-EML product line continues to perform beyond expectation including production shipments of the design wins that were previously announced.

Outside of cable TV, our other broadband products remained steady quarter-over-quarter with Satcom nominally up. We continue to make progress on our new product initiatives within the DAS market with production revenue likely a late fiscal 2019 to 2020 event when 5G deployments move beyond trial phases.

Moving on to the chip market, in the first quarter, we saw a sequential growth driven by increased demand in both our 2.5 GPON products within China and our non-GPON-related products as well.

Our new product initiatives remain on track with various phases of sampling occurring with a variety of 25G parts for the data center and more advanced components for the telecom markets.

Finally, within the navigation market, we continued to make progress on both production contracts as well as product development initiatives for new programs.

As we discussed on our last call, we entered the year with a record backlog of production orders and we expect our visibility to improve later in the year as the development process leads us to understand what the production schedules are going to look like for these new products.

Operationally, as we discussed on our last call, we're making substantial improvements to our U.S. operations to improve the capacity and efficiency of our navigation product assembly facilities. We expect to continue the modernization of our wafer fab equipment and physical plant to improve our ability to build 25G and beyond products as well as chip-level products across multiple material systems.

We embarked on a general campus upgrade that was long overdue and we'll complete this in phases over the next two years or so. This will allow us to recover significant amounts of space which was poorly organized in the original buildout of the Alhambra facility. This will also enable us to produce more products in Alhambra and will significantly improve manufacturing asset utilization.

It's also worth noting that we are continuing to optimize the geographic footprint of our EMS supply chain to increase the leverage that we have with suppliers and to minimize any tariff impacts.

As you all know the tariff situation is fluid, but given what we know today, we don't expect a material impact from changes in the short-term and feel that we have a solid strategy for staying ahead of the issue.

I would also like to add a bit of color regarding the inputs to gross margin that have affected profitability over the last few quarters. From an industry and pricing standpoint, dynamics have remained favorable over the last few quarters. If anything, our market share has also improved since the launch of our L-EML products. However, this transition to L-EML has generated near-term costs in three areas: production immaturity; the secondary impact of L-EML products on E&O; and improvements in standard cost, which drive balance sheet changes that ultimately affect the P&L.

As we explained in the December call, we've been executing on our margin improvement plan for nearly two quarters and are seeing the results that we were expecting. Costs are coming down, as planned, and we expect to see the benefits of this after the current inventories are turned over in the coming months.

Secondly, the rapid acceptance of the L-EML has caused us to have to take unplanned impairment charges for the internally competitive technologies such as externally modulated transmitters and DFB lasers. We see those charges coming down in the current quarter, but will see those improvements moderated somewhat due to under-absorption caused by the traditional soft Cable TV cyclicality in the winter and Chinese New Year.

Finally, the improvements that we've made in standard cost caused capitalized variances in inventory over the past few quarters that are now rapidly declining. As a result, we expect to see continual improvement in gross margin throughout the second half of fiscal 2019, as costs associated with these three areas return to normal levels.

Now turning to the outlook for the business. Taking into account the traditional weather-related seasonal softness we experienced in Cable TV demand in this quarter, coupled with the impacts of Chinese New Year, we expect revenues to be in the range of $21 million to $23 million. Essentially, we're expecting growth in our non-Cable TV products to help offset the softness we typically see within the Cable TV market in our current fiscal quarter.

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

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] We'll take our first question from Jaeson Schmidt with Lake Street Capital Markets.

Jaeson Schmidt

Hi, guys. Thanks for taking my questions. Just want to start with the navigation business. I know, Jeff, you mentioned entering this year with a very strong backlog. I was just curious, if visibility to when that pipeline and backlog flows to the P&L has improved over the past three months.

Jeff Rittichier

Hi, Jaeson. Yes. Actually, what we've got in terms of current revenue is a combination of production products and new programs that are at least somewhat consists of non-recurring engineering, as well as -- we do sell the prototypes or preproduction units. And so those are well underway.

And the combination of NRE and production product toward the latter part of the fiscal year will give way to a greater mix toward production product. Okay? So I think by the time we get into the third quarter, we'll have a pretty good feeling for the actual volumes associated with that change and we'll be able to comment on that more intelligently.

Jaeson Schmidt

Okay. That makes sense. And looking at gross margin, I know you laid out -- you expect an improvement in the second half of this fiscal year. How steep of a snapback could we potentially see starting in that June quarter though?

Jeff Rittichier

It can be pretty significant. Again, what we're not seeing Jaeson is pricing weakness that is usually the thing everybody looks at when they see a gross margin line that isn't -- doesn't look good. This is all about the rest of the transition in the balance sheet and we're getting very close to seeing that go away. And as soon as we do, yes, you'll see a pretty significant snapback.

What really will drive that is the actual production mix. And so that's what moves the dates around a little bit. And this early in the quarter, especially in the winter, it's very hard to get a picture that's accurate about product mix. So that's why we're being a little bit careful with our comments there. But it could be a significant snapback, yes.

Jaeson Schmidt

Okay. That's fair. And the final one for me and I'll jump back in the queue. With the changing product mix within the CATV business, with the continued and expected ramp of navigation, how should we think about your sort of new quarterly revenue run rate breakeven level?

Jeff Rittichier

Wow, that's a hard question to answer directly. So let me try to at least give you some directional vectors on this. I think what we're saying here is that the L-EML transmitters are going to be approaching sort of the historical margin level for DFBs. But at some point in the third quarter which has the net effect of raising margins as the product mix in navigation improves that also would be accretive to margins. And the chip products, the newer ones that are just being sampled now, we have to get them through qualification. But once they are, those will also help the gross margin picture as well.

So you got all the arrows pointing in the same direction. The challenge is just on the timing side, answering exactly when all of these forces start to hit and when all of them hit at once. And so again, if you -- it's a bit of a complicated answer just because it's so mix and timing specific at this point.

Jaeson Schmidt

Okay. That makes sense. Thanks a lot guys.

Operator

[Operator Instructions] We'll take our next question from Dave Kang of B. Riley FBR.

Lee Krowl

Hey, guys. This is actually Lee Krowl filling in for Dave Kang. Thanks for taking my questions.

Jeff Rittichier

Sure.

Lee Krowl

Just real quick on the guidance. You kind of mentioned that cable TV is going to go through its typical seasonality and that's offset by non-cable TV. Could you maybe just give a little more detail on the drivers? Do you expect kind of positive contribution from all non-cable TV? Or are there specifics perhaps maybe continued strength in PON?

Jeff Rittichier

It's pretty much uniformly strong across everything that isn't specifically cable TV. So Satcom is good this quarter. Chips are looking positive. NAV is looking positive. So it's really just the usual seasonal softness in cable.

And in particular when new capital budgets are released in January for the MSOs, it takes a little while for those guys to sort out what they want to buy and when they want to. So you see poor visibility in January, but by the time March rolls around, people are scrambling to get things in. So if you hear conservatism in our voices, it's just because we're practically speaking at the end of January.

Q – Lee Krowl

Great got it. And then just on R&D, as it relates to navigation, I know it's kind of a moving target just because the opportunities are quickly evolving. But kind of just curious in R&D if that's -- the expense is leverageable or if it's project specific. So just kind of if you spend it today, are you able to use it on future platforms? Or is it specific to each project you win?

A – Jeff Rittichier

Yes. So that's actually a very good question. And the answer is, projects are -- or the R&D is project specific in a certain sense, but the majority of the R&D effort inside those projects actually is common to all products. So for example, the development of technology -- new technologies for our transceivers, our IOCs, the IOCs are lithium-niobate components used in closed-loop FOGs. Those things are 100% in common -- themselves can be quite different, okay? So there's a lot of leverage. That's the simple answer.

Q – Lee Krowl

Okay, got it. And then last one for me. I know it's probably no comment, but you kind of talked in the last call that you were going to have conversations with ARRIS post the deal and it was fairly fluid since it was announced about the same week as the last call. But any update on ARRIS and whether you've talked to them since the announcement?

A – Jeff Rittichier

Yes, we speak with the ARRIS team constantly, and we've got a great relationship going all the way up to Bruce if we need to talk to him. I think the non-answer from us is just that things have -- we haven't turned up anything in the discussion that would give us pause for concern. It's a little bit early I think for even some of those guys to know exactly how the integration's going to go. I think we're still looking at a May-June close for that transaction. But there's certainly nothing negative to report and we're encouraged by the things that they're going to do over on the wireless side which actually dovetail I think with our work very well.

Q – Lee Krowl

Got it.

A – Jeff Rittichier

So no news is good news.

Q – Lee Krowl

Okay, got it. Thanks for taking my questions.

Operator

Thank you. This concludes our questions for today. I'd like to turn it back to Jeff Rittichier for closing remarks.

Jeff Rittichier

Thank you. In closing, I'd just like to thank you all for your time this afternoon and your interest in EMCORE. Also like to acknowledge our employees and thank our team for their hard work and commitment and the drive to make this company as successful as it could be. Thank you.

Operator

Thank you ladies and gentleman, this concludes today's conference. You may now disconnect.