EMCORE Corporation
Q1 2012 Earnings Call Transcript

Published: 15 Feb 2012

[Operator:]

Good day, ladies and gentlemen, and welcome to the EMCORE Corporation First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Mr. Victor Allgeier. Go ahead, please.

[Victor Allgeier:]

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 financial trends affecting the financial condition of our business. Such forward-looking statements include, in particular, projections about our future results, statements about our plans, strategies, business prospects, changes in trends in our business and the markets in which we operate. Management cautions that these forward-looking statements relate to future events or our 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 our business or our industry to be materially different from those expressed or implied by any forward-looking statements. Neither management nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We caution you not to rely on these statements without also considering the risks and uncertainties associated with these statements and our business that are addressed in our 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 our annual report on Form 10-K and our quarterly reports on Form 10-Q. We assume no obligation to update any forward-looking statements to conform such statements to actual results, or to changes in our expectations, except as required by applicable law or regulation. With us today from EMCORE are Dr. Hong Hou, President and Chief Executive Officer; and Mark Weinswig, Chief Financial Officer. Mark will review the financial results and Hong will discuss business highlights before we open the call up to questions. I'll now turn the call over to Mark.

[Mark B. Weinswig:]

Thank you, Vic, and good afternoon, everyone. Today, I'm going to focus my discussion on our first fiscal quarter operating results and our balance sheet. Please note that the effect of the flooding of our contract manufacturer's facility in Thailand is reflected in our Q1 results. I will discuss the rebuild plan and our expectations later in the call. Consolidated revenue for our first fiscal quarter totaled $37.5 million, which is a decrease of $14.7 million, primarily due to the decline in our Fiber Optics revenue impacted by the flood. Our revenue was in line with our prior guidance of $36 million to $38 million. On a segment basis, our Photovoltaics business accounted for $19.1 million or 51% of the company's total revenue. This represents a decline of $2 million from the revenue for the segment in the prior quarter. We believe that the Space Solar business will continue to experience year-over-year growth, although our revenues in any given quarter may be a bit lumpy, as illustrated with our last couple of quarter results. The Fiber Optics segment accounted for $18.4 million or 49% of the company's total revenue. This represents a decrease of roughly $12.6 million from the prior quarter with the decrease primarily due to the impact of the flood in Thailand. Despite the challenges, we met key accomplishments in the quarter including strong revenue growth in our active optical cables product. In fact, revenues for those product lines not affected by the flood, increased by more than 25% sequentially. I will discuss the prospects for the Fiber Optics business later. Consolidated gross margin was 9% with a decline primarily attributable to the flood impact. On a segment basis, Photovoltaic gross margin increased 1.7 percentage points to 22.7%. We continue to focus on meeting our gross margin targets of 30% for this segment. Fiber Optics gross margin loss was 4.8%, a significant decrease in the prior quarter, primarily due to the impact of the flood. During the quarter, the company recognized expenses of approximately $1.5 million due additional excess and obsolete charges from the reduction in our forecast. In addition, we recognized $0.9 million in losses on outstanding purchase commitments relating to legacy product lines that will not be rebuilt. These charges were classified in our cost of goods sold and reduced gross margins by almost 13 percentage points for our Fiber Optics segment. We expect our gross margins to improve in future quarters after we rebuild the manufacturing lines damaged by the flood. Operating expenses, excluding the flood loss and insurance settlements and impairments of other items, decreased $1.9 million from the prior quarter to $14.5 million, primarily due to cost reduction activities put in place after the flood, including temporary salary reductions and rotating furloughs. At the end of the January, we removed those compensation-related reductions. In addition, the company is in the process of implementing a single ERP system to improve its reporting capabilities. As a result, our R&D and SG&A expenses should increase in the March quarter to approximately pre-flood levels. We recorded a flood loss of $5.7 million in the quarter, related to our Fiber Optics segment. This is primarily from $3.9 million due to destroyed inventory and $1.8 million of fixed assets. These amounts are based on estimates from our detailed review of the equipment and inventory. During the quarter, we record $5 million of insurance gains from proceeds for our business interruption insurance policy, which we recognized upon receipt. Any future receipts of proceeds will be accounted for as a gain. For our Solar CPV joint venture, Suncore, we recognize an operating loss of $1 million for Q1. We expect those losses to decrease over time as Suncore begins producing product in volume. Hong will discuss the Suncore strategy and opportunity in more detail. In addition, we realized a $1.6 million tax expense associated with the capital distribution from Suncore. There was no net cash impact for EMCORE from these activities with our joint venture. On a GAAP basis, the consolidated net loss for the first quarter was $14.2 million, flat with the prior quarter. Our GAAP net loss per share was $0.15. Our non-GAAP adjusted operating loss after excluding certain adjustments, all of which are set forth in the non-GAAP tables including today's release, was a loss of $5.1 million versus a $1.4 million loss in the prior quarter. Please note that we have included additional information regarding depreciation, amortization, stock comp and other items in today's release to provide further clarity on our result. We expect our results to improve throughout this year as we ramp up our product lines. Now on to order backlog, which we define as purchase orders or supply agreements accepted by the company with expected product delivery and/or services to be performed within the next 12 months. At December 31, the company had a Solar order backlog of approximately $51.7 million, a significant increase from $43.5 million in the prior quarter. The increase was driven by a large order for Terrestrial Cells from Suncore. The company is reviewing its manufacturing capacity and customer commitments on the Fiber Optics business and therefore is not disclosing backlog for this segment at this time. Moving onto the balance sheet. At the end of September 31, the company's cash and cash equivalents and restricted cash balance was $24 million. Our net cash increased by $19 million from the prior quarter, primarily due to customer prepayments and lower working capital requirements for accounts receivable. With these cash levels, we do not have any immediate needs for any equity financing. Finally, on January 27, we recently announced a reverse split. We believe the reverse split will increase our ability to market to larger institutions and expand our research coverage. In addition, there are certain expense reductions from reducing the shares outstanding. The stock will begin trading with the effect of the stock split on March 16. As we discussed in December, the company has moved quickly over the past 3 months to improve its position, including implementing various costs reduction and spending cuts, receiving prepayments from customers, amending our line of credit with Wells Fargo to increase our borrowing capacity, submitting and receiving insurance claims and negotiating special payment terms with our key suppliers. Regarding the insurance recovery for the flood damage, EMCORE has received $5 million through its own carrier. In addition, our contract manufacturer has insurance coverage related to the confined inventory and equipment. We are working with them to finalize the claim and begin receiving proceeds. While the amounts and timing of those receipts are uncertain, we are working to maximize our recoveries. We believe that these measures significantly improve our financial position and we are confident that the strength in cash levels will enable us to purchase new equipment, replenish the inventory pipeline and invest in working capital to drive our business forward. Overall, we will recover from this crisis caused by the flooding in Thailand with regained business focus and in a good financial position. With that, I would turn the call over to Hong, who will discuss the impact of the flood, the company's strategic and operating initiatives and provide revenue guidance for the second quarter.

[Hong Q. Hou:]

Thanks, Mark. Good afternoon, everyone. As Mark discussed in detail, we achieved a consolidated revenue of $37.5 million in the December quarter, within the guided range. This represents a 28% sequential decline due primarily to the reduced of revenue from our Fiber Optics business. Our revenue in the Fiber Optics segment for the December quarter was $18.4 million, representing a 40% sequential decline compared to the September quarter. This was due to the fact that we lost a significant amount of our manufacturing capabilities due to the flooding and our contract manufacturing in Thailand. The revenue in the Solar Photovoltaics segment for the December quarter was $19.1 million, which represents a 10% sequential decrease compared to the immediate preceding quarter. The consolidated gross margins for the Solar segment were 22.7%, which represents an increase from the 21% reported in the September quarter. The improvement of gross margin continues as the more profitable Space Photovoltaics business takes up a vast majority of the solar product mix. Now let me discuss the market dynamics and our position in each of our major business areas

[Operator:]

[Operator Instructions] Your first question is from Alex Henderson of Miller Tabak.

[Alex B. Henderson:]

So first question. Can you give us the non-GAAP optical and Solar gross margin number since we don't have a break out on that on a non-GAAP basis?

[Mark B. Weinswig:]

If we exclude the $0.9 million of purchase loss commitments for the fiber loss associated with the lines of an [ph] operating back up and if we also take out the additional $1.5 million of additional expenses that we had for excess and obsolete inventory, mainly for excess as a result of the reduction in our forecast. In addition to those figures, we also have some additional stock compensation charges that we exclude for these purposes. Our gross margins would've been greater by more than 15 percentage points. So we ended up with about a loss of negative 5%, we would've come in close to about 10% positive gross margins on the Fiber Optics side.

[Alex B. Henderson:]

Can you tell us what the number would've been on a non-GAAP basis, just the optics gross margins and I assume the solar gross margin, we can calibrate off of the stock comp adjustment, what [ph] portion of the stock comp between the 2?

[Hong Q. Hou:]

Mark is looking at that number right now.

[Alex B. Henderson:]

So while you're looking that up, second question, you sound like you're running ahead of target on getting some of these lines up. First off, am I right in reading that? And then second, within the context of getting these lines up, can you remind us a little bit about how you're seeing the requalification process, specifically on the Tunable XFPs, the ITLAs and in any other products that are of substance, for instance, cable? Are there anything where you've got an extended qualification period once you get the production up and running? Or is that going to be eminent production and then you ramp production and people take it immediately?

[Hong Q. Hou:]

So, Alex, we are basically rebuilding 3 production lines. One is for ITLA for 40 and 100 gig, the second is Tunable XFP, the third is the cable TV lasers and transmitters. In all of this 3 lines, I would say that ITLA was running ahead of the schedule slightly, so we're very happy about that. The other 2 product lines are largely unscheduled. As for the qualification requirement, we could have taken a task to get a product of the line recovered quicker. But after working with the customers very, very closely, we chose the copy-exact strategy. Basically, we rebuild the line with the same design, same component, same machine processes and so in that scenario, the product qualification cycle will be greatly reduced. We still have to optimize a process for each work station to inform -- to ensure the product process capability, or CPKs, we still have some samples for some accelerated qualification test, but this is not going to be 5,000 hour [indiscernible] because the designs are identical to our product we have been shipping in volume pre-flood. So most of the product, we work with the customers, they require about 500 hours qualification and our strategy is after all the processes are finalized and optimized, we're going to be doing the risk production while we are doing the qualification waiting for 500 hours. And because we are pretty confident that this process, copy exact strategy, will work for that purpose. So I think, we wanted to ship to customers after 500 hours, but some of the customers may take the same strategy, mainly taking our products, start integrating into their systems and waiting for a high sign of the qualification result after 500 hours.

[Alex B. Henderson:]

So just to summarize what was a fairly lengthy answer, is there a window of time that we should be anticipating across those 3 lines for how long it takes to qualify? If they're up to, say by, just to choose a date, May 1, is it 30 days to qualify or 60 days to qualify on ITLAs, Tunable XFPs and cable production? That's the length.

[Hong Q. Hou:]

Right, so for cable production, the qualification time is 2 weeks after we delivered the process [indiscernible] samples. For telecom, it's going to be 3 weeks roughly, that's 500 hours.

[Alex B. Henderson:]

That's a very, very short period then. So you can do that relatively quickly. So you would be, at the end of June, fully back to existing or previous production rates, cleaned out all of the old obsolete and older technologies and fully qualified, no issues, and therefore able to run at your prior production rate?

[Hong Q. Hou:]

Yes. So by the end of June, we would be in a position to get all the process and production lines set up, ready for ramp. Some customers may require a little high, longer hours of qualifications, but again, as I said, we're going to be producing full throttle. So we may not be shipping the product to you, some of the qualification hours accumulated. Yes, so the structure, the production infrastructure will be completed for recovery and rebuilt by the end of June, but the ramp is going to be in that September quarter.

[Alex B. Henderson:]

So just one last question on the same subject. If there's a lot of production to get the line up initially, I assume that you'll have some product that will come off those lines that won't be up to snuff as you're debugging the lines. Can you give us an estimate of how large a nut that might be in terms of incremental costs that really ought to be just onetime in nature, but they are associated with production, so it can't be eliminated?

[Hong Q. Hou:]

Yes. So I think the material for engineering and testing and setting up the line and optimizing the line it's -- you're right, it's going to be onetime in nature and I think there's going to be cost for that in the range of about $500,000 to $750,000 range. So that's in the June quarter.

[Alex B. Henderson:]

Right. Great. So do you have those numbers, Mark?

[Mark B. Weinswig:]

Yes, so for the fiber and solar gross margins, respectively, it was just over 10% and 24% for the, what we'll call, the gross margins excluding these onetime items we discussed and also the stock compensation charges.

[Operator:]

[Operator Instructions] Our next question is from Edward Zabitsky of ACI Research.

[Edward A. Zabitsky:]

I have a few questions of course. First one is on TXFP product line, you said you shipped over $1 million, and you expect more than double it in the March quarter? So I think you had said your internal capacity was about $3 million per quarter, is that still roughly correct?

[Hong Q. Hou:]

Yes, so that's when we run full, round the clock, we'll be about a $3 million capacity in the Bay Area. Clearly, we like to have our full production capacity and capability established at the Fabrinet as quickly as possible.

[Edward A. Zabitsky:]

Absolutely. Understanding that, do you expect to have good gross margins on the products that you're manufacturing internally? The TXFP modules?

[Hong Q. Hou:]

The TXFP modules in the Bay Area have a pretty respectable margin. Between the manufacturing in the Bay Area and running round the clock, it's primarily for meeting the customer demand in the short-term whether the margin is expected to improve dramatically when we are finally running at full production in Thailand. Although, right now, it's respectable, but in the future, we expect the margin to be north of the 30%.

[Edward A. Zabitsky:]

Well north of 30% or just a little north?

[Hong Q. Hou:]

Well north.

[Edward A. Zabitsky:]

Okay, without tipping off your competitors, just wanted a direction on that. Design wins, you mentioned 10 design wins in TXFP and qualified with 3 new customers. Is that 10 products or 10 customers? Ten different corporations that are buying your TXFP?

[Hong Q. Hou:]

Ten different corporations. And some of them, they probably use for 2, 3 different product lines but we count 10 different companies.

[Edward A. Zabitsky:]

That's great. Can you give us a sense as to where you're competing well in the market? Obviously, you have a top-tier of competitors that are pushing into the TXFP market, so maybe not that 25 to 30 we had before, but maybe 4 or 5. What's the competition like? Where are you seeing the best demand for your TXFPs?

[Hong Q. Hou:]

Currently, our design really shines for the more demanding applications; namely, 300-pin transponder replacements. I think out of that 10 customers, our service is, 1 or 2 of them are doing the application to replace 300-pin, but the majority of the demand at this point is for us to replace the fixed-wavelength DWDM XFPs. We are one of the few suppliers out there and I think it's certainly our product has a performance advantage, but good enough is good enough. So in that area, we are one of the suppliers. In fact, we're really looking forward to the industries migrating to 300-pin replacements and there again, our product will show a significant performance advantage.

[Edward A. Zabitsky:]

Right, I was assuming so. When do you expect the 300-pin replacement market to start to take off?

[Hong Q. Hou:]

I think the industry concern is this is a little bit slow, but it's going to be happening in the second half of this year, more significant ways than the last year.

[Edward A. Zabitsky:]

So just moving on, the gross, one of your larger competitors mentioned that there was some heavier than normal pricing pressure with the annual price negotiations. Just from your own perspective, what's happening to pricing across your product lines? You had mentioned last quarter, you thought you would get some better gross margins with the ITLAs going forward. How do you see these -- how did these price negotiations go for you in general?

[Hong Q. Hou:]

So far, so good. I have to say, we have not experienced similar problems. Our problem right now is more capacity limited and we have to work with our customers very closely to allocate our capacity to meet their most urgent demands. I'm sure, the price pressure and the discussion [ph] but long-term pricing is going to become later, but at this point, that has not been a problem for us.

[Edward A. Zabitsky:]

Okay, that's good. I was a little confused on the ramp up of CATV manufacturing capacity. You said last quarter, you met 1/3 of the capacity from your own facility in China and you expect to have -- did you say a full ramp, full production in March? Or start full production at your contract manufacturer in March?

[Hong Q. Hou:]

So we will be getting our equipment tuned up, qualified by the end of March for the full capacity. But, the ramp up really is for delivery, is going to be in the June quarter.

[Edward A. Zabitsky:]

Right, so you expect to have the same sort of revenue from the CATV product line this quarter as in the last quarter, the December quarter?

[Hong Q. Hou:]

Yes. We give the guidance of the revenue in the range of $38 million to $40 million. The increase is all from Fiber Optics area. So we expect a pretty significant improvement in revenue from the Fiber Optics segments from the December quarter to the March quarter. But it's still the production capacity limited. We have more orders than we really can produce and we are pushing our suppliers as hard as possible to get the equipment delivered. But for most of it, the 3 production lines, we got pretty much all the critical pieces--equipments delivered and right now, we're in the process of fine-tuning for process capability and integrations. We'll be producing samples for qualification, as I talk to Alex. We wanted to get our setup ready to go for high-capacity, high-volume manufacturing by the end of March. But clearly, we will not be benefiting the full capacity of the rebuild in the March quarter.

[Edward A. Zabitsky:]

Right, now on the solar side of the house. I just had one question. It seems like your Gen 3 process is going pretty well with the gross margins rising. What kind of yields are you getting in at this point? Are they rising? Or do you expect them to continue to improve from here?

[Hong Q. Hou:]

Yes, the Solar Space Photovoltaics side, we reported, a couple of quarters ago, we introduced a whole range of new products and product mix on the floor, it's its record high. So have been working through this, you see [ph] the manufacturing yield has been improving and that is the reason that we have experienced increased the gross margins but we have more room to improve and the trends will continue.

[Operator:]

Our next question is from Stephen Koffler [ph] with Combrero[ph] .

[Unknown Analyst:]

Could you help me just reconcile a few comments. It really sounds like on the demand side of things, things are looking pretty good. The backlog and Photovoltaics increased nicely and all the commentary and qualitative commentary you gave on optics was very constructive. And it also sounds like supply is coming on and will be coming on all through the quarter in the Thailand situation. So I'm a little perplexed at the guidance that it's -- I mean it's great that you're going to show growth, but it sounds like it's only, it's sort of constrained to a flattish $1 million or $2 million kind of absolute dollar [ph] growth number. I'm wondering, is there any part of the business, maybe TV, that's got some seasonality and the revenues that nets out to that kind of guidance?

[Mark B. Weinswig:]

This is Mark. Regarding our guidance for the quarter, as Hong mentioned, we're going to have the cable TV line up and running by the end of March and then basically going into full production thereafter. So the March quarter will be similar, in some sense, of what December was, in that we will not have actually our lines up and running at full capacity at that time. But going into the June quarter, that's where you should start to see more of a ramp up in our Fiber Optics revenues at that point going forward, as we start to have our other lines up and running. One important thing we mentioned on the call is that for the lines not impacted, the optical components lines not impacted by the flood, they were up more than 25% quarter-to-quarter. So we are seeing pretty good demand in some of the other product lines; in fact, that's actually where most of the growth will come from this quarter.

[Hong Q. Hou:]

I think the clear differentiation, Stephen, is by March, the end of March, we'll be getting pretty much out of new lines set ready to go. But during this quarter, we spent a lot of times rebuilding the line, devote tremendous engineering and operation resources in tuning the line. So there's no weakness in business, but it's really lack of a capability and the capacity. So we wanted to focus on building the long-term capability and capacities rather than struggle for the short-term revenue that will still prolong the rebuild of the manufacturing infrastructure. So that's the course we have to take. I think that sequentially from December quarter to March, the Fiber Optics revenue is going to improve, but it's not back to the pre-flood level. But I hope by the end of June quarter, we'll be at that level.

[Stephen Copper:]

Okay, but I would think that the manufacturing capacity in March versus December quarters should be substantially higher in Fiber Optics, isn't that correct?

[Hong Q. Hou:]

Yes. But the thing is, the December quarter, we had a half month of 3 weeks, normal production, and we also had some inventories, we rescued from -- before the floods get in. So that was the finished [indiscernible] inventory that kept us going in the December quarter. And the March quarter, our revenue had to be from the new product and from -- there is no finished goods inventory we could sell [ph] anymore.

[Stephen Copper:]

I understand. That makes perfect sense.

[Operator:]

Our next question is from Alex Henderson of Miller Tabak.

[Alex B. Henderson:]

I just want to dig down a little bit more into the Cable business. There's been some volatility in that business in the last couple of quarters. Some of it had to do with availability, some of it had to do with mix. Can you talk a little bit about what's going on in the mix of that business and the margins of it?

[Hong Q. Hou:]

Yes, the Cable business, Alex, it's hit pretty hard by the flood. So you're right. In the September quarter, we experienced a little bit softness compared to the June quarter, but the demand, actually, the backlog, we exit the September quarter very strong and then we lost taking [ph] higher manufacturing capability, especially the lasers, it required a new unique custom-made laser welders to make. So fortunately, we had some capacity and capability in our facility in LA, but capacity wise, it's only about 20% compared to the pre-flood capacity. So we have been really running round the clock in pretty much hand-to-mouth for this launch, then the new laser welders just got in to our channel facility. So get back to your original question, is the business outlook robust? Yes. Because we have been watching the MSOs, their CapEx spending very closely. Just as recently as last week, Time Warner Cable, they announced that their CapEx spending in the scalable infrastructure and operated area will increase by about 10% sequentially. So I think, when we get the capacity back, we should be able to grow that business back to the pre-flood level and expand from there for revenue from the new products.

[Alex B. Henderson:]

If I recall correctly, coming out of the June quarter and into the September quarter, there was a mix shift that hurt your gross margins in that business. Are we seeing a mix shift back as we get into the March and then into the June quarters with some of that video-related products or is this more of the basic stuff which comes at a lower margin?

[Hong Q. Hou:]

Yes, the shift is going to be back. That Cable TV-Broadband business has been traditionally running about 35% of gross margin, plus or minus, and in the September quarter, because of the product mix, it dropped about 10 percentage points. So I would expect, when our production capacity ramps back up, our gross margin should get back to the 35% range again.

[Alex B. Henderson:]

That would be not in the June quarter, though, but probably by the September quarter?

[Hong Q. Hou:]

I would say by the September quarter, it has fully recovered.

[Operator:]

I am showing no additional questions at this time. I would now like to turn it back over to management for any further remarks.

[Mark B. Weinswig:]

Great. On one front [ph] note, to clarify my prepared statement before, the reverse stock split will become effective on February 16. And with that, I'll turn over to Hong for any last final comments.

[Hong Q. Hou:]

Thank you very much for dialing in today. We'll be attending the Optical Fiber Conference at LA Convention Center in a couple of weeks. We look forward to seeing you there, talking to you soon. Thank you very much.

[Operator:]

Ladies and gentlemen, thank you for your participation. That concludes the presentation. You may disconnect and have a wonderful day.