EMCORE Corp (EMKR) 2018 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the EMCORE Corporation Fiscal 2018 First Quarter Earnings Call. (Operator Instructions) As a reminder, today's call is being recorded.

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

Thank you, and good morning, 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 and 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, level of activities -- 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. 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 statements 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 those 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 press release as Exhibit 99.1 to the Form 8-K we furnished to the SEC. These materials can also be accessed 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 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 the call up for questions.

Now I will turn the call over to Jikun.

Thank you, Erica, and good morning, everyone. Today I will focus my discussion on our FY '18 Q1 financial results ending December 31, 2017. Consolidated revenue for the quarter came in at $24 million, at the low end of our guidance range. This is 20% lower than the prior year Q1 FY '17 revenues and 18% lower than the prior quarter Q4 FY '17 revenues. Our quarter-over-quarter revenue decline was primarily affected by our decision to temporarily exit the RF over Glass market that we had transitioned -- so that we can transition to the LEML RF over Glass products. The rationale and the strategy for this decision was discussed during our last earnings call. In addition, during the quarter we began to see incremental softness in our cable TV products due to an inventory bubble that was created when one of our largest cable TV customer consolidated EMS manufacturing into their own captive facility. This impact was offset by increasing strength in our chip products. Navigation products performed better than anticipated in Q1.

In Q1, our noncable TV revenues were at 28% of revenues. This compares to 21% full year FY '17. Jeff will discuss these dynamics further in a moment. GAAP gross profits in Q1 were approximately $7.9 million or 32.9% of revenue, a decrease of 350 basis points quarter-over-quarter. Gross margin performance in Q1 was driven by lower volumes, which negatively impacted our manufacturing overhead absorption. This was primarily offset by a favorable mix shift of highly profitable cable TV products that we began shipping last quarter. On a year-over-year basis, GAAP gross margins was down 40 basis points, which is worth noting as despite a 20% year-over-year decrease in revenues, our gross margin was only nominally affected. This demonstrates the effectiveness of both our cost-reduction efforts and the operational improvements we have made over the last several years.

Total GAAP operating expenses for R&D and SG&A were $8.7 million, $0.2 million lower than the prior quarter and $0.9 million higher than the same period last year. We continue to invest in R&D to accelerate delivery of new products across all 3 of our major product families. In the quarter we invested aggressively in new navigation, chips and cable TV products. The benefits of these investments are expected to meaningfully contribute to our revenues and gross margin percentage line in the future quarters. On a GAAP basis, the consolidated operating loss for the quarter was $0.8 million. Our non-GAAP operating income from continuing operations after excluding certain adjustments, all of which are set forth in the non-GAAP tables included in today's press release, was a positive 0.4 -- $0.6 million, a $2.7 million decline compared to the prior quarter. As a percent of revenues, Q1 FY '18 non-GAAP operating income percentage was 2.5%. Our non-GAAP pretax income from continuing operations was $0.7 million.

Moving on to the balance sheet and cash flow statement. At the end of Q1 FY '18, company's cash and cash equivalents were approximately $64.2 million or a decrease of $4.5 million quarter-over-quarter. Regarding our working capital metrics, DSOs were at 70 days, up from 66 days in the prior quarter and down from 77 days in the prior year. Net inventory turns including noncurrent inventory was 2.7x. Capital expenditures in the quarter was $2 million and depreciation in the quarter was $1.2 million.

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

Thanks, Jikun, and good morning, everyone. In the first quarter, EMCORE made solid progress, with increasing momentum in our end market diversification strategy, offsetting a portion of the sequential CATV softness we experienced in the quarter. As we've discussed on prior calls, EMCORE is taking important steps to be more than a cable TV business. The operational and technical foundations that we built in the chip and navigation markets are ready to support rapid growth, and we've got the team that's necessary to build these businesses.

One of our most important objectives this year revolves around building revenue diversity and this past quarter represented important evidence of our progress towards this goal. With that, let me take a few minutes to discuss the first quarter trends in each of our end markets in more detail.

Starting with the broadband market, and specifically, CATV as we discussed in our December call, in the fourth quarter, we made a decision to exit the RF over Glass Micronode market while we await qualification of our third-generation LEML RFoG Micronodes. As reflected in our guidance, this action drove approximately a $4 million sequential decline in our cable TV product revenue in the first quarter, which we expect to continue through the second fiscal quarter. Outside of the RFoG Micronode market, at the very end of the quarter, we also experienced delivery pushouts for some of our products at one of our large customers. Since that time, we've learned that this situation resulted from a transition at one of our customers from EMS to in-house manufacturing. Significant transmitter buffer stock we've built to mitigate the risks of moving the factory and several months’ worth of laser inventory were also consolidated, resulting in a large overall inventory level. After spending significant time reviewing the issue, we believe at current demand levels, it will take about 2 quarters for our customer to work through the inventory on hand. This will create a sequentially larger impact in the fiscal second quarter than the first, followed by shipments returning to normalized levels at some point during the fiscal third quarter.

In an effort to prompt the question in Q&A, no part of this has anything to do with Remote PHY, which I will address more directly in a few minutes. Independent of these 2 near-term headwinds in cable TV, end market dynamics remain robust, with strong demand for transmission projects, as cable operators continue the deployment of DOCSIS 3.1 architectures, including transmitters, modules and receivers.

Within the remaining broadband markets, we saw steady demand in our Setcom products in the quarter with a good funnel behind that. Setcom can be a lumpy business but overall, we're getting what we expected here. In the wireless market, the level of dialogue around 5G rollouts remains encouraging, with many of the top equipment suppliers evaluating our radio-over-fiber solutions. Going to a radio-over-fiber link has significant advantages over all digital systems. First of all, a lot of redundant equipment is eliminated from the tower because digital hardware is not needed. Secondly, radio-over-fiber connection to the antenna eliminate about 1/3 of the weight, volume and power from the equipment up in the tower.

For these reasons, EMCORE products are already installed in venues like Levi Stadium and the new Mercedes Stadium in Atlanta. While it's still too early to gauge the exact timing of material revenue contribution from this product line on the 5G side, we see a growing revenue stream from these products in the 4G world today.

Moving on to the chip market. In the first quarter, we saw an acceleration of demand for 2.5G and 10G chip products within China, which we expect to continue into the second quarter. Our chip product revenue was above planned in the quarter, with a projected return of certain telecom chips materializing as expected, collectively driving fab utilization and contributing favorably to overall corporate gross margin. We fully expect the chips will be ahead of plan in the current quarter. [Thin film] activity has also picked up, with several different chips outside of the PON market and several new development projects are moving forward for data center products with strong expressions of interest from customers.

The heart of the EMCORE's business has always been optical semiconductor chips, and we are committed to driving growth in this business to make meaningful contribution to the business overall this year.

Finally, within the navigation market, production levels for our products remain on plan with a growing backlog of programs. With our signed 1-year sole-source agreement for the MTS-B program, we have excellent visibility for the rest of the year on that product, while we work through the details of the 4-year contract. Please keep in mind that the sole-source contract have a lot of paperwork associated with them and the reviews of that paperwork are very time-consuming. For many months now, there has been no items of contention in the discussions that stand in the way of finishing the agreement. On the business development side of navigation, we're seeing very strong leading indicators of future growth. We just announced the availability of our EG-120 and EG-200 products and are on track to ship production quantities of this to a Tier 1 defense prime this quarter. The EG-120 is especially important because it is the world's smallest closed-loop gyro and offers 2 to 5x the performance in the most important specifications when compared to open-loop gyros. The EG-120 will be the critical element in the new generation of IMUs, which address larger volume applications.

Additionally, we've been negotiating a contract award to deliver the first prototypes of an advanced airborne IMU platform, which we will deliver in the current fiscal year. This should ultimately become the multi-year 8-figure program I spoke of last quarter. Over the next few months, you should expect to see several additional announcements for advanced navigation products. Keep in mind that we don't develop a new navigation product unless we've got a lead customer and a purchase order. Our strong performance with leaders in the defense industry continues to open up larger, new opportunities for EMCORE over the long term. I would also remind you that given the long design, qualification and product lifetimes in this business, it is useful to think of each program as a layer over a technical foundation. Each new program adds revenue over many years compared to their commercial counterparts. EMCORE is now building multiple layers on its technical and production foundation, enabling navigation to be at least as large as the current broadband business over the next few years.

Before I shift the discussion to the second quarter outlook, I'd like to take a moment to discuss a popular topic amongst investors, mainly the impact of DAA or Remote PHY on EMCORE's business. Currently, cable TV networks operate with 3 technologies. One, all digital, meaning ones and zeroes between content providers such as ABC, NBC, other network affiliates; satellite downlinks and headends; radio-over-fiber or linear optical links between the headend and the node; and, three, a radio-over-copper link from the home -- sorry, from the node to the home. At the risk of oversimplifying things, the focus on EMCORE's role in network, Remote PHY is all about replacing the radio-over-fiber optic link from the headend to the node with a ones and zeroes digital link. This moves the transition where the network stops being all digital from the headend, normally located in a commercial office building, to the node located in a neighborhood. Keep in mind that for the connection between the node to the home, Remote PHY requires linear, radio-over-copper connections to the home that are identical to the current systems. There are 3 reasons why Remote PHY is potentially attractive. Number one, it can simplify the equipment in the headend, where space can be difficult to find; two, it can increase the bandwidth from the headend to the node to 10 gigabits per second; and number three, digital optics can offer superior price performance to traditional DFB-based linear optics. Notice that I qualified my statement with traditional DFB laser.

EMCORE believes that over time, all DAA Remote PHY connections to the node will penetrate the current market for linear optics. Clearly, the most important questions for us to answer about EMCORE's business are, when will this cause a material impact to EMCORE's linear optics business? And what will that impact be? For this year, our market checks are telling us not very much. There will certainly be some more extensive deal trials in the year that will generate excitement in press releases but not much else. Major OEMs are addressing the equipment space issues with double and quadruple density transmitters, which minimizes the pressure to transition to Remote PHY when space is limited in the headends.

As we get to 2019, we'll expect to see more Remote PHY installations beyond small field trials. But the actual impact on our cable TV business should also be small. There are 3 major reasons for this: Number one, MSOs have enormous investments in linear optics which won't be quickly obsoleted. The balance sheet of the major MSOs are estimated to have over $700 billion in assets. Most of which are tied to linear fiber optics in some way. The $100 million per year optical component tail does not wag the $700 billion asset dog. Network reliability is often at odds with new technology. MSOs are regulated with significant requirements for reliability, E911, emergency broadcast networks, et cetera. When coupled with customer satisfaction expectations for reliability during major events, such as the Super Bowl, it's clear that the bar for reliability is extremely high, often putting it at odds with the introduction of new technology. I will point out that it took 10 years for the telcos to move from 10 gigabit per second technology to 40-gig in their core networks, and over 5 years to roll out the relatively simple DOCSIS 3.1 upgrade from the time the draft specification was originally released. Reliability requires careful engineering and staged rollouts over time. Number three, linear EML performance continues to make linear optics harder to unseat in the cases where bandwidth is the sole reason for considering Remote PHY. Remember, Remote PHY is a 10 gigabit per second technology, which has superior bandwidth to traditional linear DFBs at around 6 gigabits per second. LEMLs change the game by offering somewhere between 9 and 12 gigabits per second at virtually the same cost as the DFB, radically changing the price performance decision to go Remote PHY. Furthermore, they improved video performance in the network at the same time. So what objective reasons does EMCORE have to be confident about this? Well, quite simply the design wins we've got from major customers. Last year at this time, we were shipping one LEML transmitter to one customer. A second LEML transmitter started shipping in Q4 to a second customer and 2 more will ship in the current quarter. By the end of the fiscal year, we expect there to be a total of 8 to be shipping replacing a large portion of the DFB market. It's also important to note that we see a trajectory for LEMLs to reach over 15 gigabits per second while still operating within the DOCSIS 3.1 spec. I would also point out that simply because we're a key supplier of linear optics technology doesn't mean that we can't compete in the Remote PHY market when it starts to ramp. As the market becomes relevant from a revenue perspective, we will discuss our Remote PHY product strategy in greater detail.

Now turning to our outlook for the business. For the second fiscal quarter, given the continuing RFoG market dynamics, combined with the inventory overhang I highlighted earlier, we expect revenues to be in the range of $21 million to $23 million. While we still remain confident in our abilities to grow cable TV revenue on a sequential basis in Q3 and Q4 of 2018 through a combination of both ASP expansions with LEML products and the resumption of RFoG shipments in the second half, we've got to clear the inventory bubble first.

Consequently, we now expect cable TV revenue, including RFoG, to be down somewhere between $23 million and $27 million on a year-over-year basis.

It's worth reiterating though that the current inventory dynamic is in no way a reflection of the overall health of the cable TV market or the demand for our products. As we discussed on prior calls, near-term demand volatility is a function of several factors: cable TV's high customer concentration; adverse weather, which limits installs in the winter; as well as infrastructure and CPE spending shifts. These factors combine to cause supply chain imbalances like the one we're experiencing now. Over the mid- to long term, however, big picture trends tend to hold, which is the case for DOCSIS 3.1 deployments and the migration to LEML technology, which reflects quite favorably for EMCORE. Outside the cable TV market, we continue to be enthusiastic about our revenue diversification initiatives and expect to see 33% to 37% of revenue contribution from noncable TV products over the whole year, setting the stage for larger, absolute growth in FY '19. We expect to do this while keeping our goal of 15% non-GAAP operating margin on a run rate basis as we exit Q4. Overall, I think that our team is doing an excellent job of executing in the areas that we can control and is working to hold down expenses as we work through the cable TV inventory headwind that I described. With all of that said, I'm encouraged by our progress in navigation and chips, enabling us to build a stronger, larger company over the long term.

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

(Operator Instructions) We will take our first question from David Kang, B. Riley & Co.

This is actually Lee Krowl filling in for Dave Kang. Couple of questions. First, just on cable TV. I know you have a single customer that's got to work through a couple quarters of inventory, but I guess just, if we put that aside and focus on the seasonality and just kind of the demand outside this one single customer. Would you say visibility beyond this inventory is similar or deteriorated year-over-year?

Lee, I'll take this one. No, I wouldn't say it's deteriorated at all. I think the situation is pretty clear, pretty stable with a lot of things on the table, with respect to rollout plans over the year. So other than the inventory bubble that we described and sort of the -- I mean, this is the natural outgrowth of M&A when customers have to consolidate multiple manufacturing sites in EMS. I think the market's not deteriorated a bit. And those -- by the way, those sentiments if you look into the most recent statements from Charter and Comcast are borne out pretty well.

Okay. Fair enough. And then just on the margin side, there's pricing pressure in RFoG, obviously, it seems unreasonably aggressive. But I guess, just is there -- can you just give us some sort of confidence that as you migrate to LEML that a similar pricing dynamic doesn't unfold, maybe not this quarter, next or when you get all customers ramped. But is the landscape, competitively speaking, diminished as you've transitioned? Or is pricing going to remain a risk even as you upgrade to the LEML products at a lot of your customers?

Well, I mean, it's always a competitive world out there. But the real issue with RFoG Micronodes was the original agreement that was put together probably 4 years ago, which led to margin stacking between the manufacturer, EMCORE and then ultimately, the distributor. And it's no secret that it's ADTRAN based on its purchase of the fiber optic business from CommScope about 2 years ago. So the issue is not structural in terms of the equipment. It's structural in terms of the business model. As we take a look at the build material in the LEML and the fact that we control all the chips we manufacture, I think we're pretty comfortable that we can compete there favorably in a competitive world. So think of it more as a business problem -- business model problem that we couldn't unwind because those 3 parties, the manufacturer, us and the distributor each owned a piece of the IP, which is a pretty unusual thing to happen, but 3, 4 years ago that was the way it was done. And you can't stack 30% margins from a manufacturer, the originator of the design, if you will, and the distributor and expect to be competitive.

Got it. That's helpful. And then just the last question. Your discussion about Remote PHY and DAA was very helpful. I just wanted to clarify, you guys said that there might be an opportunity to address that market in the future. I was curious, are you actually investing in Remote PHY technology today, or is that a possibility in the future?

Well, the interesting part is that the investment pattern starts in the fab. And when you take a look at the kinds of chips that we're developing, there is a -- probably, the most substantial portion of our portfolio will be all digital. And that would certainly include the parts that are used in Remote PHY. So if you're going to maintain differentiation, you got to start at the device level and that is what we're doing.

Our next question comes from Jaeson Schmidt from Lake Street Capital Markets.

Wondering quickly if you could give the revenue breakdowns for the December quarter?

Sure, Jaeson. This is Jikun. So for broadband it was 87%, but I think we disclosed that cable TV was 72% of the revenues. So 72% of the 87% is cable TV. Chips is 9%, and navigation was 4%.

Okay. And then just looking at operating expenses this year, how should we think about OpEx ramping throughout the year?

On the R&D side, I would see sustained levels, if not, increasing levels towards Q4. And on the SG&A side, it's probably going to trend a little down from where we are today.

Okay. And then shifting to the Navigation business, can you quantify the customer pipeline or any engagement pipeline you currently have and how we think -- should think about that ramping throughout the year?

Yes. Sure. I'll tackle that one. So the important thing to understand is, this year what you're going to see is a lot more announcements of products, which we have either quickly -- we've either developed or are committed to develop. Sometimes it's with our own money, sometimes it isn't. But the critical point is that we won't develop these nav products without customers and customer POs. And I would describe those, Jaeson, as real strong leading indicators of things that'll move the needle on the revenue side into '19. In the current year, you should expect to see very significant growth as a percentage because we're starting with small numbers. But it's a couple 100%. So it's -- to think of it more as a leading indicator for major growth. But in the current year, it's still substantial on a percentage basis.

Okay. That's helpful. And the last one for me and I'll jump back into queue. Understanding the inventory situation on the CATV side, but looking at the CATV business, do you think you guys have been able to maintain share? Or do you think this issue and stepping back from the RFoG market a bit more has caused you to cede some share to your competitors?

No. I don't believe it has anything to do with share at all.

(Operator Instructions) We will take our next question from Jon Fisher from Dougherty & Company.

Just on LEML, do you remain on track from a qualification standpoint? Or has that product been qualified in? Are you -- how soon would you be in revenue production on LEML?

So we expect to have 4 products that have reached what we call general availability, meaning they're past qual, within the current quarter. The devices themselves, the LEMLs have been qualified several times. The first ones in transmitter form went out over 2 years ago. And so they've got a good track record out in the field. The rest of the transmitter is pretty much a PCBA sort of a problem, circuit board assembly. And so there's no unusual risks there. So at this point, it's the usual sort of incremental blocking and tackling, but there's no surprises that we should expect at this point.

Okay. And then just on navigation and going to the press release what the new product that you have this morning. It sounds like the 8-figure contract that you mentioned last quarter, that remains on track for revenue generation in 2019. And then to the new product, is that being shipped to this Tier 1 customer for test and qualification? Or will there be some actual revenue generation from this new Tier 1 customer in this fiscal year?

Sure. So the large program will ship for revenue within the current fiscal year. So it's not a 2019 sort of a phenomenon. We'll get our first shipments probably end of Q4. As far as the EG-120 and its variants, those are shipping -- expected to ship within the current quarter.

Okay. All right. And then on -- and then my final question would be on the wireless side. On DAS, is given the pickup in conversations as you noted on 5G from telecom customers, is there any opportunity for DAS this fiscal year, or is that, too, a 2019 focus?

So what we're seeing is some increased activity that will produce additional revenue on the 4G LTE, DAS systems in the current year. And 5G, I think is really a 2019 phenomenon. So in the short term, it's going to be 4G LTE. When I say short term, I'm really talking through the end of the fiscal year, and we do expect to see some growth. Bigger numbers on an absolute basis are 2019.

As there are no further questions at this time, I will turn the call back to Mr. Jeffrey Rittichier for concluding remarks. Please go ahead, sir.

In closing, I'd like to thank all of you for your time this morning and your interest in EMCORE and would also like to acknowledge our employees and staff, and thank my team for their hard work and commitment that they have -- exhibit every day. Thanks, again, and we'll talk to you soon.

Ladies and gentlemen, that will conclude today's conference. Thank you for your participation.