EMCORE Corp (EMKR) 2005 Q3 法說會逐字稿

Good morning and welcome to the EMCORE third quarter fiscal 2005 earnings conference call. [OPERATOR INSTRUCTIONS] It is now my pleasure to turn the floor over to your host, Victor Allgeier with the TTC Group. Sir, you may begin.

Thank you and good morning, everyone. Yesterday after the close of markets EMCORE released its fiscal 2005 third quarter and nine month results. By now you should have received a copy of the press release. If you have not received a release, please call our office at 212-227-0997.

With us today from EMCORE are Reuben F. Richards, Jr., President and CEO, and Tom Werthan, VP and CFO. Tom will review the financial results and Reuben will discuss business highlights before we open the call up to your questions.

Before we begin, we would like to remind you that some of the comments made during the conference call and some of the responses to your questions by management may contain forward-looking statements that are subject to risks and uncertainties, as described in EMCORE's earnings press release and filings with the SEC.

I will now turn the call over to Tom.

Thanks, Vic, and good morning to everyone. Today we are reviewing our third fiscal quarter of 2005 and I'll start with a review of our operating results for the quarter.

Revenues for the quarter totaled $33.2 million and this represents a 57% year-over-year increase and a 9% sequential increase. Revenues increased in all 3 of our operating segments year-over-year and in fiber and photovoltaic sequentially. Electronic materials and devices decreased by $250,000 sequentially.

Let me review revenues by product line. Electronic materials and devices was up 30% year-over-year but down 7% or $250,000 sequentially. However, last quarter included a last-time buy from General Motors for magneto resistor sensors which contributed approximately $1.2 million of revenues. So revenues from our continuing products actually increased about 37% quarter-over-quarter and this was led by new high-powered gallium nitride products. We are also expecting a modest increase in revenues for this quarter.

In our fiber optic division, which includes both 10 gig product line as well as the CATV product line, revenues were $21.1 million, a 77% year-over-year increase and an 11% quarter-over-quarter increase. 10 gig products continue to drive the increase and we expect FTTx to begin late this quarter, which Reuben will elaborate on. For the September quarter, we expect revenues to increase by about 10%.

Finally, in our photovoltaic solar power division, revenues were $8.8 million, a 30% year-over-year increase and a 9% quarter-over-quarter increase. Revenues for this division are expected to decrease modestly in the coming quarter.

So our expectations for the fourth quarter are for revenues to come in around $35 million.

Gross margins for the quarter were 20% and this is an increase of 2 percentage points sequentially but were up 16 percentage points since the beginning of our fiscal year. Again, higher revenues, continued progress on yields and improvements in bill of material costs all contributed to the increase.

Operating expenses, excluding $2.4 million of restructuring and severance, which I will discuss in a moment, totaled $10.1 million. This is a decrease of $2.2 million or 18% from the same period last year. Sequentially operating expenses increased approximately $1 million.

R&D decreased slightly while SG&A accounted for the entire increase. Several line items contributed to the increase, including JDS Uniphase acquisition costs, increased Sarbanes-Oxley compliance costs, a sales and use tax audit and some bonuses paid out during the quarter. However, SG&A should decrease next quarter. For the nine month period, excluding severance and restructuring, both SG&A and R&D decreased over the same period a year ago, SG&A by $0.5 million or 3% and R&D by $5 million or 27%.

As I mentioned a moment ago, including-- included in operating expenses were $2.4 million of restructuring and severance charges and most of these charges related to the announcement during the quarter that we will be closing our City of Industry, California, photovoltaics operation and relocating it to New Mexico. The charges incurred this quarter relate to the write-down of some fixed assets that will not be needed in New Mexico, accounting for the facility lease on the City of Industry property and idle facility charges incurred during the move.

We are estimating additional charges of approximately $1.3 million over the next 2 quarters until the move is completed. Annual cost savings after the consolidation will be approximately $3 million.

Below the line, interest expense was flat. Our portion of the GELcore loss was approximately $800,000. The loss is a result of the GELcore announcement that they were closing their Canadian manufacturing operation and relocating that to Mexico. So included in their results are charges of $1.6 million related to the transfer of work to Mexico. Excluding the transfer of work charges, GELcore would have been profitable.

The move also resulted in a capital contribution from both GE and EMCORE in the amount of $3 million. Our portion, or $1.5 million, was paid during the quarter, as was GE's.

From an operational viewpoint, GELcore maintains their $90 million revenue projection for calendar year '05 and a return to profitability this quarter now that the move is behind them.

Our net loss, excluding severance and restructuring charges, was $5.1 million or $0.11 per share. This compares to a net loss of $12.5 million or $0.27 per share one year ago. Sequentially, the net loss was flat after backing out the $12.5 million gain recorded last quarter from the receipt of our earn-out on the sale of our equipment business in November of '03.

Income before interest, taxes, depreciation, amortization, severance and restructuring charges or adjusted EBITDA was $541,000, an improvement of $230,000 sequentially.

Our backlog at June 30-- June 30th was $34.4 million. That's an increase of about $1 million since March and $6 million since the beginning of the fiscal year.

Cash at June 30th was $36.5 million, a decrease of $8 million since March and virtually all of the decrease is attributable to non-operational transactions and let me review those. We had our semi-annual interest payment on our convertible debt of $2.4 million. Fixed asset purchases were $1.2 million. The investment in GELcore, as I previously mentioned, was $1.5 million. We purchased JDS Uniphase's CATV operation during the quarter. That was $1.5 million. And the cash portion of our restructuring and severance charges was $750,000, so our subtotal there totaled $7.3 million. So use in ongoing operations was less than $700,000.

Let me spend a moment on earnings per share before I turn the call over to Reuben. We did report a loss of $0.16 per share. However, if you back out the impact of the severance and restructuring, that accounts for $0.05 per share and GELcore's loss, which is entirely the result of their transfer of work to Mexico -- and, as I mentioned, they would have been profitable without that -- accounted for about $0.02 per share and this will bring you down to the $0.09 EPS, which agrees with consensus estimates.

So to summarize, we were very pleased with the quarter. The trends are good. Revenues are increasing. We are projecting further increases. Gross margins improved again this quarter to 20% and cash burn from operations decreased.

The restructuring charges will be behind us by December and then we expect approximately $3 million in annual savings by consolidating our photovoltaics operation. GELcore, with their manufacturing move behind them, is expected to return to profitability this quarter and selling, general and administrative expenses, while higher than expected this quarter, will decrease next quarter.

And with that, let me turn the call over to Reuben for an operational and product update.

Reuben F. Richards, Jr.: Thank you, Tom, and good morning, everybody. I will begin with some general comments on the financial, operational and strategic aspects of the June quarter and move to a product line and market trend analysis and close with some comments on fiscal Q4, as well as some outlook on fiscal 2006, which begins in October.

Revenues, as Tom cited, for the quarter were $33.2 million, representing a 57 increase year-over-year and a 9% sequential improvement over the prior quarter. Revenues came in significantly above the guidance of $30 to $32 million for the quarter. Revenues were up substantially in fiber optics and satcom and down moderately in RF materials.

Gross margins improved to 20% from 18% the prior quarter on improved profitability in fiber optics, where gross margins improved from 16% to 23%. Margin improvement was due to increased volumes, better overhead absorption and lower material cost.

Based on improved gross margins and net of the restructuring and severance costs, EBITDA improved to $540,000, more than 2 times the prior quarter.

EMCORE's operating management continues to do a terrific job in executing against the operating plan and during the quarter we took the necessary steps in reducing the operating structure of both the satcom and GELcore business units. Taking-- as Tom pointed out, taking out the one-time charges and restructuring and transfer of work in these 2 business units, the company hit its EPS target of a $0.09 loss per share.

Backlog as of June 30th was slightly ahead of the prior quarter, as Tom pointed out, however bookings in July, particularly in fiber optics and sat com, are well ahead of plan and are 90% booked for the quarter.

Revenue guidance for fiscal Q4 is being increased to $35 million. Operating targets for Q4 are continued margin improvement through lower cost of goods, which is going to be achieved by more products being transferred to contract manufacturers. This reduces our labor cost basis in these products. These improvements should also result in continued improvement in EBITDA in Q4.

In our product line discussion, in fiber optics revenues on a consolidated basis improved 11% quarter-over-quarter and 77% year-over-year and represented 65% of the company's total revenues. Gross margins improved to 23% from 16% the prior quarter and a loss the year ago.

On the digital side of the business in the 10-gigabit Ethernet and datacom markets, revenues were up sequentially and EMCORE continues to be the sole supplier to Cisco on the 10-gigabit Ethernet LX4.

With regard to LX4, we have visibility on unit volumes through December from Cisco. We are seeing significant unit volume increases, both this quarter and next, and we have purchase orders that take us through October, slightly above the forecast that Cisco had originally given us.

Non-Cisco customers, such as Extreme, 3Com, Huawei are expected to be qualified and commercial shipments commenced by the end of the current quarter.

Last quarter we finished the three-phase transfer of the manufacturing processes to Fabernet (ph), EMCORE's contract manufacturer in Asia, and Cisco is expected to approve the final PCNs, process change notices, this quarter. This approval will substantially increase unit capacity of LX4 and subsequently reduce cost of goods.

In our telecom market, revenues for the quarter were slightly ahead of plan. Cisco, Sycamore, IBM and Tellabs were driving demand during the quarter.

At a component level, this is in storage area networks, revenues were substantially above plan, driven by 4-gigabit and 10-gigabit applications where Intel, Agilent, JDSU and Finisar were the major customers in our shortwave 815 and under market.

On the analog side of the business -- this is the cable television and fiber to the home markets -- significant developments during the quarter were the acquisition of the JDSU CATV and fiber to the home product lines, which achieved 3 corporate objectives. First, it consolidated the cable television industry where EMCORE has a dominant market share. It expands EMCORE's product line in both CATV and fiber to the home and gives EMCORE best-of-breed in each product segment. And finally, it allows EMCORE a number of operational efficiencies through the elimination of some R&D projects because the acquired assets contained those product lines, profitability improvements through eliminating redundant staffing and elimination of some 2005 and 2006 CapEx requirements because of the equipment set required. We expect that the acquisition will add approximately $10 to $15 million in 2006 revenues.

In fiber to the home, EMCORE has completed product and manufacturing qualifications with Tellabs/Verizon on its PON transceiver and will begin shipping against the first PO in approximately 2 weeks. The initial purchase order is approximately $7 million covering deliveries through the end of the calendar year quarter. We are working closely with the customer on unit volume requirements for the balance of fiscal year 2006.

In the RF product line, revenues for the quarter were down slightly from the prior quarter, as Tom pointed out, but 30% year-over-year. Gross margins declined as a result of lower revenues. Product mix was unfavorable, given the fact that there was a last-time buy by General Motors in [inaudible] sensors last quarter, however $1.73 million of the revenues or 53% of the total were gallium nitride-based materials with gross margins in excess of the corporate average versus the legacy gallium arsenide products.

We continue to see a transition from the company's business-- in the company's business from a legacy gallium arsenide transistor product line to a business dominated by gallium nitride technology as a replacement for silicon LDMOS in high-power, high-frequency applications.

Further, EMCORE has expanded its customer base to companies developing combinational transistor structures to achieve smaller devices and better power control in RF amplifiers. The revenue for the-- the revenue outlook for RF continues to be stable, as Tom pointed out, at between $3 and $4 million.

In satcom, in photovoltaics, revenues increased 12% to $8.8 million. Operationally it was an outstanding quarter for yield and productivity and fab yields continue to trend above plan. Market demand continues to be strong with orders from General Dynamics, Northrop Grumman, Loral and Lockheed Martin.

During fiscal Q3 the company took a $2.4 million charge related to the shutdown of its City of Industry facility and transfer to Albuquerque of its [inaudible] panel operations, which will save the company $3 million annually.

Further, EMCORE continues to see interest in its terrestrial photovoltaic products and is currently engaged with customers in both Japan and Spain regarding the deployment of this product technology. We expect commercial revenues to begin after January of '06.

On GELcore, as Tom pointed out, during the second and third quarters GELcore transferred manufacturing operations from Canada to Mexico. The transfer costs are reflected in this quarter's financials and it is what caused the net loss for Q3. Absent those one-time transfer-of-work costs, we expect that GELcore would have been profitable in Q3. The move to Mexico will save approximately 30% on labor costs, which are a significant portion of our cost of goods and we expect GELcore to return to profitability this quarter and revenues are on plan for the year.

In closing, I would summarize Q4 as the company exceeded its revenue targets. The company exceeded its gross margins expectations and, when we net out the restructuring charges at both satcom and GELcore, we met our EPS target for the quarter.

We expect to finish the fiscal year with approximately $125 million in revenues, up 34% year-over-year and above the guidance that was given at the beginning of fiscal year 2005.

With regard to 2006, we will give the same guidance of revenue expansion of between 20% and 30%, year-over-year, and this revenue growth is based entirely on existing products and markets. We expect quarter-over-quarter improvements in EBITDA. We expect to hit EBIT positive mid-2006 and EPS positive by year end of 2006.

And with that, I will turn it over to questions and answers.

[OPERATOR INSTRUCTIONS] John Lau, Jefferies & Company.

I was wondering-- you mentioned a couple things about the 10-gigabit per second Ethernet business. You said that Cisco is coming in above plan and you also mentioned that others are being qualified-- have been qualified and you're going to start shipping. Can you tell us how-- how tight your capacity is and how you're going to be able to support that business going forward?

Reuben F. Richards, Jr.: Yes, let me just review my comments for a second, John. We have been given unit volume forecasts for this quarter and next quarter, so-- and generally what Cisco does is every 30 days release another PO. So where we are-- on the last call we had been booked through -- I can't remember -- July or August. They have continued-- the forecast that they gave us at that time, the purchase orders have been coming in slightly higher than what the forecasts have been to date.

So we are looking at, I would-- a substantial increase in unit volume in September versus the June quarter and another increase in the December quarter versus the June quarter. So there is a consistent ramp there and the POs are- we're now booked through October.

The transfer and the non-Cisco customers, the Extremes, the 3Com, Huaweis, we-- our exclusivity restrictions with Cisco expired on June 30th, at the end of last quarter. The first week of July we had shipped qualification parts to these customers. It is a standardized part so that the board layout and performance are pretty well in line.

We expect that the transfer of the manufacturing process-- processes to Fabernet (ph) and their approval -- and this was a 3-phase transfer. The first phase was approved and that accounted for some of the gross margin improvement in the June quarter. The second phase has been approved. We're waiting on the third phase and on the third phase, we expect capacity to move from the approximate 600-unit a week capacity that we have manufacturing internally to approximately 1200 units a week and that will accommodate not only the step-up in Cisco volumes, but the new customers, as well.

And you mentioned that those qualifications have been going on and you're getting ready to ship that?

Reuben F. Richards, Jr.: We expect to finish qual and to start commercial shipment by the end of this quarter.

And just as a final question, on the Verizon business you had mentioned that you're planning to start shipment of those units to Tellabs this quarter?

Reuben F. Richards, Jr.: Yes.

Is that ahead of plan due to the Verizon pull-in on the CapEx? Is that what you're seeing?:

Reuben F. Richards, Jr.: We're-- the numbers that we're seeing from Verizon-- well, from Tellabs for Verizon is, I think, higher than we had anticipated and we are starting-- as I said, we will begin shipments this month. We-- so it's a little bit of a pull-in. The initial purchase order was higher than we expected and we're very pleased by that and we will be able to meet deliveries on time.

Ramesh Misra, C.E. Unterberg.

First, just to follow up on that question from John, you said you had some of the gross margin improvement this quarter due to Fabernet (ph). Could you explain that a little better? I mean, obviously you're not-- commercial shipments of products from Fabernet (ph), apparently, have not been approved by Cisco, so where is the gross margin improvement coming from? Is that-- do some of the parts or a subset of the LX4 manufactured over there? Is that where the gross margin improvement came from?

Reuben F. Richards, Jr.: Yes, Ramesh, when we transfer the manufacturing process to Fabernet (ph) it's a 3-phase project. The initial phase is that we shipped them the-- what I'll call the sub-components. They do the packaging, the pig-tailing and so on and that was approved by Cisco during the June quarter, early in the June quarter. That was the first process we transferred. So with that-- with that approved that reduced our costs on that-- on the manufacturing of that sub-component.

The next phase is the sub-assembly integration and manufacturing and the final is the test. So we were able to achieve the full economic benefit of the packaging side during the June quarter, some of the component integration and sub-assembly cost benefits, not a significant portion, and then we expect the full-on module to be manufactured out of Fabernet (ph) this quarter.

And just let me clarify, Ramesh, that the percentage increase in gross margins was really a combination of a number of factors that I mentioned. It was higher revenues, good progress on yields and improvements in bill of material costs, as well as the outsourcing.

Got it. OK. And, Tom, in regards to your SG&A expense, now on a quarterly basis that, of course, was up fairly significantly from about $5 million to $6 million. You alluded to the fact that this is due to Sarbanes-Oxley and some other--

There were really 4 issues there, Ramesh, that hit us in the June quarter. Our Sarbanes-Oxley compliances costs are-- have increased. We do need to be compliant by our year-end, which is September 30th. We're on track for that.

We also had some SG&A added because of the JDS Uniphase acquisition. It wasn't that much, maybe about $130,000 or so.

We had a sales and use tax audit here in New Jersey, so we had to accrue for that. We are fighting that, but with the budget deficits in New Jersey they're looking everywhere for revenues.

And also, we did pay out some bonuses during the quarter, which hit SG&A.

OK. So next quarter would it be safe to assume that that would probably go back to somewhere close to the March quarter levels?

I don't think it'll hit $5 million, but it'll definitely decrease from the $6 million. I would say probably around $5.4, $5.5.

OK. Now I'm sorry for bouncing back again to the 10-gig side. Reuben, you said that margins over there went up to 23%. With-- with Fabernet (ph) coming-- coming fully online, where do you see that margin going to, say, in the next 1 or 2 quarters after that full approval.

Let me just clarify. The 23% is the entire fiber division, which includes the 10-gig as well as the CATV product line. So we don't break out gross margins specifically by product.

OK.

Reuben F. Richards, Jr.: But clearly we will be-- by having it 100% manufactured by Fabernet (ph) as opposed to 30% or 60% manufactured by Fabernet (ph) as it was the last quarter, we expect further cost reductions in the labor components. So margin improvement, anyway, sequentially.

OK. And in terms of your internal capacity, you said running at around 600 units per week right now. Due to efficiencies or any other factors, do you see that going up by year end, calendar year end?

Reuben F. Richards, Jr.: No, our capacity? No, I don't think so.

No, we don't want to spend any more money on our capacity because we're so close to outsourcing it.

Reuben F. Richards, Jr.: Yep.

Macon Rudisill Keane Capital Management.

Two questions. In the-- in the 20% to 30% year-over-year revenue guidance off of a base of $125 million, you said that doesn't assume-- that's existing business. Given that you've gotten the PO from Verizon that hasn't shipped yet, is Verizon now considered existing business for next year or will that be incremental business?

Reuben F. Richards, Jr.: Macon, in the context of the 20% to 30% increase in revenues, Verizon's considered an existing customer. And remember, we sell through Tellabs. We don't sell directly to Verizon.

OK. And is that run rate for the $7 million on that business, is that as far out as you can see, will that likely stay the same or what's your capacity for more there on a quarterly run rate basis in '06?

Reuben F. Richards, Jr.: We-- on a quarterly run rate basis, we're going to be ramping-- the ramp will occur roughly August through October and run at rate for the next couple of months at the November rate. We probably have a 30%, maybe a 40% increased capacity capability beyond that.

OK. And the other question is just on the GELcore monetization, any more direction there, one way or the other, what you'd like to do, what the interest level is, et cetera, et cetera?

Reuben F. Richards, Jr.: Macon, I think we've been pretty explicit about-- about our feelings regarding GELcore. It's a terrific asset. Beyond the comments we've made historically I don't-- there's not much more to add.

[OPERATOR INSTRUCTIONS] Joia Macurtee (ph), State of Wisconsin.

I was wondering if I could get a sense of where gross margins can go, longer term?

Sure. We were at 20% this quarter. That's up from 18% last quarter. As I said previously, we think by the end of this calendar year we can get to the 23% to 25% range. Some of that is dependent on product mix. With the results trending upwards we're pretty confident that we can get there.

Do you think that's pretty much where the longer term-- where gross margins can be sustained or do you think you can get them higher from there?

We could probably get higher. A lot of that will have to do with the revenue growth. Once we get up to about $39 million a quarter, your contribution margin really starts kicking in and we should be able to approach about 30% by mid-'06.

OK.

Reuben F. Richards, Jr.: Also-- it also depends on product mix, quarter-over-quarter. There are-- there are quarters where clearly we can exceed those expectations and there are-- but there are quarters that we may fall short. So--

Sure. Would you also describe the industry environment in the satcom area?

Reuben F. Richards, Jr.: Sure. I think what we have said on previous calls are-- is that basically we come-- the environment today is probably 75% maybe 80% government-related. That's not necessarily just the U.S. government. It's the government of India. It's the government of Japan. It's the EC governments and their programs as opposed to the commercial market. And we continue to see that.

The dynamics of the government market versus commercial are really kind of power-specific, meaning in their-- in a government satellite configuration it really-- they run the gamut from launching geosynchronous satellites, which are large revenue projects for us to the low-earth-orbit satellites which are smaller in scope. They-- the pricing tends to be on a cost-plus basis. Now that's not necessarily a bad thing. Cost-plus is frequently a gross margin in excess of 30% on that business, but it's still-- it's a very stable and long-lead-time kind of environment, but it's also populated by some very big programs which run 2 to 3 years, which EMCORE has been competing on.

The commercial market is dominated by, at this point, companies with the business models like XM Satellite Radio and DirecTV and something with sort of a consumer base and their business-- business models have been succeeding and hopefully, at some point, that will result in the commercial satellite market becoming a more attractive venue for equity investors.

So, again, just to recap, it's 75% to 80% government-related. It is characterized by longer-term projects. It is-- the commercial market is smaller, more reliable from the standpoint of timelines because government programs get pulled in and pushed out with some degree of frequency. So the commercial launch dates are pretty well fixed. So it's-- but are more competitive on a pricing basis.

So I think-- hopefully, that answers your question.

It does.

[OPERATOR INSTRUCTIONS] John Lau, Jefferies & Company.

A quick followup. You mentioned something that was-- that I wanted to catch up on. You mentioned for the solar cell EPV division you mentioned some terrestrial applications. You have a strong base over in the satellite. Can you tell us what are the different opportunities for the terrestrial-based? Thank you.

Reuben F. Richards, Jr.: Sure. Right now -- and this is largely be driven at the moment outside the United States, but there are a number of government subsidies. Germany is very aggressive in that. Spain is going to be a fast follower. Japan has always-- has a sort of an open edict that they want all residences to have a 4-kilowatt passive capability.

The-- so there's a fair amount of government funding. The silicon photovoltaic guys are capacity-constrained, not only from a manufacturing standpoint but from a silicon perspective. And the economics of gallium arsenide in terrestrial applications become compelling when you utilize a concentrator technology, which allows you to connect-- creates enough power output to connect directly to the grid. So in population-dense areas or on solar farms it's a very cost-effective approach in generating renewable energy.

With regard to this, in the Japanese market we are currently engaged with Sharp, who probably has, I don't know, a good 60% of the entire photovoltaic market and probably almost all of Japan's with regard to deploying that. And in Spain, we are currently working with a company called Isophoton, who has a number of utility contracts to develop. I've forgotten the-- it's, I think, 125 kilowatt capability on this initial pass-through with-- in Spain.

So as I said, we are finalizing, sort of, the product entry. It's going to be different. Sharp we would sell just cells to. Isophoton we would probably manufacture something that's more highly integrated, a module, probably. And there seems to be a lot of market pull, particularly from government entities in supporting this product technology in those markets.

It would be-- result, probably, in, I would say, commercial-scale volumes after the first of the calendar year.

Thank you. There appear to be no further questions at this time. I would like to turn the floor back over to Mr. Richards for any closing remarks.

Reuben F. Richards, Jr.: Thank you, operator. And just in closing we-- we felt that the June quarter was pretty good. Obviously, we exceeded revenue targets. We exceeded gross margin expectations. We met EPS targets, net of restructuring. We have guided up in revenues. We feel pretty good about our visibility now for both this quarter and the December quarter and we look forward to continued operational improvements as we go forward. Thank you very much.

Thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.