EMCORE Corporation
Q4 2020 Earnings Call Transcript

Published: 1 Dec 2020

[Operator:]

Good day and welcome to the EMCORE Fourth Quarter 2020 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Tom Minichiello, EMCORE Chief Financial Officer. Sir, please go ahead.

[Tom Minichiello:]

Thank you, Katie. Good morning, everyone, and welcome to our conference call to discuss EMCORE's fiscal 2020 fourth quarter results. The news release we issued yesterday afternoon is posted on our website emcore.com. On this call, Jeff Rittichier, EMCORE's President and Chief Executive Officer, will begin with a discussion of our business highlights. I'll then update you on our financial results for the quarter, and we'll conclude by taking questions. 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 the business. Such forward-looking statements include, in particular, projections about future results, statements about plans, strategies, business prospects and changes in trends in the business and the markets in which we operate.

[Jeff Rittichier:]

Thank you, Tom, and good morning, everyone. In the fourth quarter, EMCORE drove a 23% quarter-over-quarter revenue increase. The combination of top-line growth and operational improvements resulted in a gross margin of 38%, a 4-point improvement over Q3. Operating expenses came down as well, resulting in a GAAP profitable quarter. The entire team at EMCORE really came together to put together a great set of results. From an operational standpoint, the supply chain and operations teams were well ahead of the COVID-19-driven shortages that required a lot of work to overcome in previous quarters. We experienced only a modest number of challenges with our supply chain throughout . Nevertheless, the pandemic continued to increase the general level of friction in ongoing business activities, particularly with customer development schedules and new programs, forcing us to adjust our plans. Our workforce has remained healthy and protecting our manufacturing and engineering teams that must work in our factories remains a top priority. We believe that we've gone the extra mile to protect our people but are mindful of the increase in new cases in our surrounding communities.

[Operator:]

Excuse me, everyone, and please remain on the line as we reconnect with our speakers. Thank you for your patience in holding. We now have our speakers. Jeff, please go ahead.

[Jeff Rittichier:]

Thank you. I'm going to back up just a little bit to make sure that I've covered everything. So if I've said a few of these sentences before, my apologies. Looking forward, the strong Cable TV demand is to continuing to require us to maximize total production output and minimize potential losses to that volume from yield fallout. The good news is that the Thai government is starting to allow foreign workers back into the country after negative COVID tests at a 2-week quarantine. We're beginning the process of getting our EA engineers set up to travel to Thailand for 3-month assignments, which will strengthen our Thai team and allow us to finish the job sometime in early in the June quarter. Our Thai manufacturing engineering team continues to get stronger and improve their effectiveness, but adding the highly experienced EA engineers into the mix will have a positive impact. It's important to note that there is sufficient product demand to justify parallel operation at both facilities, enabling us to hedge the risk of a switchover before we're ready. Our customers expect certainty in their ship dates and a 2 facility operation provides that. As more operations move from Beijing to Thailand, we expect to see upward pressure on gross margins in Cable TV. Turning to our individual business areas, Cable TV demand drove strong performance in the Broadband unit. MSOs continue to invest in their networks to break bottlenecks created by bandwidth demands for work-at-home and stay-at-home entertainment. While we don't know the MSOs’ calendar year '21 spending plans in their entirety until January, EMCORE's Cable TV products had a strong order book well into the June quarter. Although we remain cautious of the ultimate duration of the upgrade cycle, we're confident that we'll complete our move to variable cost manufacturing while orders are strong.

[Tom Minichiello:]

Thank you, Jeff. Consistent with our preliminary results announced in October, consolidated revenue in the fiscal fourth quarter was $33.5 million. This is a $6.2 million or a 23% increase when compared to $27.3 million in the third quarter and is the largest quarterly revenue for EMCORE since December 2014. Aerospace and Defense revenue was $14.5 million this quarter, up 3% when compared to $14 million in the prior quarter, driven by increases in revenue for QMEMs and Defense Optoelectronics. Broadband revenue was $19 million, up 44% when compared to $13.3 million the quarter before, driven by the robust demand for our Cable TV transmitters and components as MSOs continued to expand their networks to meet increased bandwidth demands. On an annualized basis, consolidated revenue for fiscal 2020 was $110.1 million, a 26% increase when compared to $87.3 million for fiscal 2019 with annual revenue increasing in fiscal 2020 for both the A&D and Broadband segments. Moving on to gross margin. Consolidated non-GAAP gross margin grew to 38% in fiscal 4Q, a 4% increase when compared to 34% the quarter before. The higher gross margin was driven by a 42% gross margin for Broadband, up from 33% in the prior quarter, partly offset by a sequential quarter change in A&D's gross margin to 32% in 4Q compared to 36% last quarter. Contributing to the Broadband gross margin performance in 4Q were higher Cable TV revenues, over absorption of production overhead costs and a favorable product mix, while A&D's change was due to non-recurring credits in 3Q and a less favorable product mix. For fiscal year 2020, we significantly expanded our consolidated non-GAAP gross margin to 33% compared to 23% for the two previous fiscal years. While the higher revenue was a factor, the full 10% increase was also driven by cost reductions, improved production yields and better inventory management. Turning to operating expenses. Non-GAAP OpEx improved to $9.7 million and 29% of revenue in 4Q compared to $10.1 million and 37% of revenue in the prior quarter. The reduced OpEx was all attributable to SG&A expenses as R&D was flat on a sequential quarter basis. The lower SG&A was largely a result of ongoing expense management activities. During fiscal 2020, we lowered our quarterly non-GAAP OpEx by $2.7 million or 22% when compared to the $12.4 million in 4Q of fiscal 2019, while improving our OpEx as a percent of revenue from 51% to 29%. Moving to the bottom-line. In 4Q, we generated a non-GAAP operating profit of $2.9 million and an operating margin of 9%. Not only was this our first positive result since the fiscal 2018 first quarter, it was also a $3.6 million or a 12% swing from just the quarter before.

[Operator:]

. Our first question comes from Jaeson Schmidt with Lake Street.

[Jaeson Schmidt:]

Jeff, in your prepared remarks, you mentioned some continued kind of supply chain challenges. Just curious if you could quantify what sort of impact that had on your revenue in the September quarter? And relatedly, I guess, what sort of impact do you think that is having on the December quarter?

[Jeff Rittichier:]

Well, in my prepared comments, what I said was, in previous quarters, we've had a few challenges with supply chain that we had virtually completely beaten back in 4Q. So -- and these are component shortages of custom linear components that were in short supply because of COVID breakouts in packaging operations in Phoenix -- I'm sorry, in Taiwan and in Malaysia, right? And so those things are pretty well resolved itself and we had no trouble getting the components we needed. We've had a few problems, little things just with total production availability with a couple of subcomponent suppliers over in Taiwan. But it was nothing we couldn't get past. So I think there's -- we've established a rhythm in terms of dealing with the problems. I think we've got a pretty good handle on where the concerns are in the component supply chain. And it's not going to hold us back at all that we can see going forward, unless something changes, right? I mean, it's a fluid situation everywhere.

[Jaeson Schmidt:]

Okay. No, that's helpful. And I mean, obviously, demand in the cable business remains robust. Just curious if from your position, do you think this is more of a rising tide? Or if you guys think you're actually taking share as well?

[Jeff Rittichier:]

Well, it's without trying to get our competitors round up, we probably have taken some share. There is certainly, I would call, the majority of it, a rising tide, as more and more MSOs are demanding linear EMLs, which we're the only people in the world that can make. Of course, we're going to get a benefit from that. And linear EMLs are the largest part of our business now of our Cable TV business.

[Jaeson Schmidt:]

Okay. And then just last one for me, and I'll jump back in the queue. I mean, based on your comments on, as the transition to the new facility continues, you would see an uplift in gross margin. I mean, is it fair to assume that gross margin from September should continue to trend higher?

[Jeff Rittichier:]

You mean into 1Q?

[Jaeson Schmidt:]

Correct.

[Jeff Rittichier:]

I'd say the numbers are going to be similar. I don't have a scalpel available to cut things that finally, but it's going to be similar, right? With the guidance range that's similar, there are always mix issues that change quarter-to-quarter, but we'd expect similar sorts of results. There's not a wholesale movement in Q1 of product being built in Thailand. So that effect, which really happens as the primary facility for manufacturing becomes Bangkok, that's when it really manifests itself. And so it's -- transmitters will virtually all be over there in some point in the March quarter and then laser modules early in the June quarter.

[Operator:]

Our next question comes from Dave Kang with B. Riley.

[Dave Kang:]

First of all, my first question is on the OpEx. Can you tell us how we should think about OpEx going forward?

[Operator:]

I do apologize, Dave. This is the conference operator. Please hold while we reconnect with our speakers. Thank you for holding, Dave. We do have our speakers back in conference. Please continue with your question.

[Dave Kang:]

I guess, there was a disruption. But my first question is on the OpEx. How should we think about OpEx as engineers start to travel, how much will OpEx increase going forward?

[Tom Minichiello:]

Hey, Dave, this is Tom. So we're pretty much in a -- I would say, in a run rate of $9.5 million to $10 million on quarterly non-GAAP OpEx. So I think you continue to look at it that way. The fourth calendar quarter, our fiscal 1Q is, if you look at past history, and there's reasons for it, it usually does trend lower than the other quarters for a variety of reasons and way payroll costs cycle around the year. So we think we'll be under $10 million in 4Q. But we're kind of in that $9.5 million to $10 million range on a run rate basis going forward.

[Jeff Rittichier:]

Yes. And Dave, as far as costs involved with the EA travel, it's not something I'd concern yourself with.

[Dave Kang:]

Got it. And then just going back to gross margin. So you said once transition is complete, there could be upward pressure on Broadband gross margin. So you're saying it could be higher than 42% once the transition is complete?

[Jeff Rittichier:]

Yes, it could be. The danger in making that statement is just you don't know what the mix is going to be when we make that final transition and whether or not we'll still have the over absorption, so you got to be a little careful with that. But fundamentally, yes, there's upward pressure on it.

[Tom Minichiello:]

Dave, I would add this that we have some benefit now because of the assets in EA have been put in a held for sale account on the balance sheet. So there's no depreciation expense. We still have other fixed costs in EA or in China, we call EA internally, and those will go away. And when we get into the variable model in full force deep into fiscal '21, the key there is, is that we'll be able to hold a higher-margin regardless of the top-line where we have a variable model. Right now, we're still -- especially in the fourth fiscal quarter, we were still largely an in-house operation.

[Dave Kang:]

Got it. And then on Aerospace and Defense. A&D gross margin went from 36% to 32%, it sounds like you saw mix driven. So is gross margin going forward on A&D basically mix driven? Or do you have any controls to improve the gross margin?

[Jeff Rittichier:]

We do. So there's a little bit of issue also in the way that absorption gets spread around in the U.S. facilities, but mix and just getting the FOG numbers up will make a pretty decent-sized impact. And so we're working really hard to get through qualification flight testing on a couple of these programs and that will start to move the needle, which also will improve margins.

[Dave Kang:]

Got it. My last question is during, actually, fiscal third quarter earnings call, you talked about possibly commercial aerospace projects being pushed out by one to two quarters. Can you give us an update on that?

[Jeff Rittichier:]

Yes. I don't think much has changed. One of the things of note is that we did settle an old set of problems with Collins Aerospace that showed up in the GAAP R&D line, that's sort of a one-time thing. Part of what was negotiated in that agreement was push outs of some commercial aerospace products, and we'll expect those shipments to start coming back in the March quarter. So it doesn't look like it's getting any worse, Dave, and it's just continuing to move it forward.

[Operator:]

Our next question comes from Tim Savageaux with Northland Capital.

[Tim Savageaux:]

I guess my first question is focused on cable optics demand. And last quarter, you had commented about order visibility extending into the March quarter. Now you've moved that to June. And I guess my overall question is sort of what's driving that? Where you don't appear to be capacity constrained in any way, is this visibility and the timing of cable deployments stretching into '21? Are you building backlog? Or -- I wonder if you can give us some more color on that comment about order visibility stretching from the March into the June quarters?

[Jeff Rittichier:]

Sure. The principal use over on the cable operator side is, this is no split driven. It's purely pushing additional capacity into the networks. There's no fancy virtualized CCAP step on top of it that we're aware of, it's driving the spending. It's just about breaking bottlenecks. I would say that we do have some production constraints running across both operations, meaning Bangkok and Beijing. We're managing them and continuing to work through them. And I think customers would always like to have things sooner rather than later. But with the current schedules, again, we've moved the bar from the March quarter into June. And we're not looking at material shortages. It's just making sure that we can build these products with a high loan quality and high yields. The other complicating factor, I didn't really talk about very much, is that customers have pretty rigorous processes for approving product change notices. And so again, this is an example with my comments about general friction in the business. Originally with one of our three major customers, we had an audit scheduled in Bangkok. I want to say it was and it just got completed last week. And it was literally -- it went from being a line audit, which is a whole team of people involved to a virtual audit where we're walking around with cameras in Bangkok and showing all the processes and going through the documentation. And it just took a long time to set up and get through. We're expecting that there are very few findings of any substance, we're expecting to get those PCNs completely signed off for that particular customer for that particular product. And again, it will improve our flexibility to put the capacity where we need it. So it's a sort of a complex thing, but at its heart, Tim, it's still about breaking bottlenecks in the case of the EMSs, a lot of linear EMLs going out into the market.

[Tim Savageaux:]

Got it. And I -- in that context, I wanted to follow-up. I mean you did express, I guess, some caution at the timing or sustainability of this upgrade activity, which, I suppose, is healthy in general. But outside of -- I mean do you have any real kind of substance to support that caution? Or do you feel like, hey, cable optics revenue has accelerated to this elevated level, and it's reasonable to think that that's not sustainable forever, despite increasing order visibility? Or I wonder if you could kind of go a bit further into that commentary around the length or sustainability of the upgrade activity that you're seeing.

[Jeff Rittichier:]

Yes. So we're staying very, very well plugged into the channel. We don't see inventory building up anywhere. It's just very unusual to run with this level of backlog in cable. And so perhaps paranoia is seeing just how quickly things turned from 2017 to 2018, has us a little bit cautious. But if you'll remember, a part of that was driven by a major customer that was just over order. And we don't have any evidence to suggest that that's what's going on now. The other point to note is, every year we get a picture from the MSOs in early January about what their planned spend is, and so that's always a good thing to have. And we haven't had updates other than our informal conversations with those guys, which we do have outside of our normal conversations with our major CATV OEMs. So I would just describe my words of caution as just comments from a guy that's been -- has taken the heavy lessons of volatility in Cable TV to heart. I wouldn't read -- try to read anything into it. We're actually very, very happy with the situation as it is.

[Tim Savageaux:]

That makes sense. I mean, as you mentioned, not being used to running with this level of backlog in cable, are there any metrics you can give us that would describe kind of where you are now from that backlog perspective relative to maybe your normal operating level?

[Jeff Rittichier:]

Yes. I would say we're running maybe -- if you think about what the peak was in 2017 for cable, EMCORE was running at about $25 million a quarter. Of that $25 million, $5 million of it was going into RF over glass. And essentially, that whole effort has lost scheme worldwide, certainly in the U.S. So you take that off the top and you say, okay, for roughly a year, 18 months, we were running at $20 million. And if you take a look at the total number of links, it was -- we were selling a lot more lasers back then than we were selling transmitters. So the number of links that were going out or that we were enabling was probably somewhere between -- and I'm spitballing this a little bit, I would say, 50% to 75% higher than what we're running at now. So this is what gives us just a little bit of comfort that we're not looking at a build it, build it, build it; stop it, stop it, stop it scenario because the actual number of links that are going out is still substantially lower than the links we were enabling in 2017. Does that make sense, Tim?

[Tim Savageaux:]

It does. And I'll pass it on.

[Operator:]

Thank you. That concludes today's Q&A. I will now turn the call back over to Jeff for closing remarks.

[Jeff Rittichier:]

Thank you. And I'd certainly like to thank all of you for your interest in EMCORE and the entire EMCORE team for putting together such a great set of results. Please stay safe, and thank you again. Goodbye.

[Operator:]

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.