Q2 2019 Earnings Call

Good day, ladies and gentlemen, and welcome to the I'm quite technology second quarter 2018, I mean its conference call.

My name is Blair and I will be a conference facilitator today at this time, all participants I know listen only mode. After the speakers remarks, we will conduct a question and actually session. As a reminder, this conference is being recorded I would now like to turn the call over to Vincent Keenan, Vice President Investor Relations Mr. <unk>. Please go ahead.

Thank you Laura good afternoon, everyone and thank you for joining us for EMCOR second quarter 2019 earnings Conference call.

Joining me today are Steve Kelly, our Chief Executive Officer, and Megan Faust, Our Chief Financial Officer.

Our earnings press release was filed with the FCC. This afternoon and is available on our website.

During this conference call, we will use non-GAAP financial measures and you can find a reconciliation to the U.S. GAAP equivalent on our web site.

We will also make forward looking statements about our expectations for Emcores future performance based on the environment as we currently see it.

Of course actual results could be different.

Please refer to our press release and other SEC filings for information on risk factors, uncertainties and exceptions that could cause our actual results to differ materially from these expectations.

Please note that the financial results discussed today are preliminary and final data will be included in our Form 10-Q .

And now I would like to turn the call over to Steve.

Good afternoon, thanks for joining the call.

Today, I'll review, our second quarter performance and our third quarter outlook.

Well, there's good well discuss market conditions.

And provides additional color.

In our automotive business.

Our second quarter revenue was just above midpoint guidance.

And flat to the first quarter.

Our profitability was at the high end of guidance.

Due primarily to the impact of our cost control efforts.

In the general market, which we define as everything but mobile communications.

Second quarter revenue was flat to first quarter as expected.

We believe that the general market has stabilized and is poised for growth.

In the third quarter.

We expect revenue in the general market to increase approximately 10% sequentially.

Driven mainly by the ramp of advanced S&P in the consumer space.

The remainder of the general market should grow sequentially at a low single digit rate.

In the mobile communications market.

Second quarter revenue was also flat to first quarter as forecasted.

We expect third quarter mobile revenue to be up almost 25% sequentially.

Due to production ramps flagship smartphones.

Our overall revenue is expected to grow above 15% sequentially in the third quarter.

We also have a positive view of the fourth quarter.

Which leads us to believe that the worst of the recent slowdown is behind us.

We have taken advantage of open capacity in our factories to speed, new product and technology qualifications.

Accelerate quality improvement initiatives.

And improved manufacturing efficiency.

These efforts have helped us secure new design wins, which are expected to drive growth in the second half of this year.

It into 2020.

As a technology leader.

Amcor has all of the key enabling technologies our customers need.

Most of these technologies were originally developed to meet the demanding requirements of mobile communications and high performance computing customers.

No.

Many of these same technologies are being deployed in other markets, including automotive.

In general.

Automotive customers are highly sensitive to performance and reliability.

So our proven flip chip technology is a perfect fit.

For high pin count I season.

Found in Adas and other data intensive automotive applications.

Our advanced wafer level fan out technology.

Is a popular choice for automotive radar applications.

Allowing our customers to eliminate substrates and improved performance.

Finally, our advanced S&P technology is a great fit for high end automotive infotainment systems, where performance is paramount.

We believe that we are the leading outsourced assembly partner for many of the top companies that design and build a das image processor automotive radar.

High end infotainment.

And other automotive subsystems.

And with our strong technology platforms.

We are well positioned to capture future growth opportunities.

Technology is very important for automotive customers, but there's only one of many factors critical to success.

Equally important.

Or an automotive quality culture.

And a track record of continuous improvement.

Due to the extended lifecycles of automotive products.

Long term supply stability is an important issue.

Suppliers must demonstrate a long term commitment to operate and invest in key factories.

We believe that EMCORE checks all the boxes for automotive customers performance.

Quality and reliability.

Best in class technology.

Stability.

And a long term commitment to the business.

And were familiar face we've been building automotive grade icees for more than 40 years.

We are encouraged by recent trends in our automotive business.

In the first half of 2019.

Advanced packaging revenue in the automotive and industrial market was up more than 50% year on year.

Increased electronic content.

And our strong competitive position, where the key factors that drove that growth.

In the third quarter.

We expect automotive and industrial revenues to grow mid single digits sequentially.

Both advanced and mainstream revenues are forecasted to grow.

The growth in mainstream revenue is encouraging and may indicate that downstream inventory issues are abating.

In closing I'd like to note that the Capex controls we've put in place last year.

I have not impacted our momentum in areas important to our future growth.

Such as the development of new capabilities.

The expansion of capacity in key growth areas, such as advanced as IP and flip chip.

And our continuous quality improvement initiative.

Megan will now provide a more detailed financial information.

Thank you, Steve and good afternoon, everyone.

Today, I will review, our second quarter results and provide some comments about our third quarter outlook.

Our second quarter 2019 revenue of $895 million came in as expected flat with the first quarter.

Similar to the first quarter, our factories are focused on cost control, resulting in gross margin at the high end of our guidance range.

Operating expenses were lower than expected, primarily due to reduced discretionary spending.

In addition, we had a modest gain in Q2, a $3 million on the sale of real estate and Japan.

The combination of better gross margin and lower operating expenses drove operating income margin up 100 basis points sequentially to 2.5%.

Our second quarter loss per share of four cents includes a charge of three cents per share related to the early redemption of our $525 million senior notes due 2022.

As a reminder, we refinance these notes last quarter pushing out the maturity five years to 2027.

We ended the quarter with over $550 million of cash on hand.

And total liquidity of over $700 million.

Our strong balance sheet and liquidity allows us to continue to invest in new growth initiatives across our end markets.

Before I turn to guidance I would like to note that we have begun a three year project to rationalize our wirebond manufacturing footprint in Japan.

The project will require some modest incremental expense over time.

Which we see as a prudent investment in the business.

Future growth with our Japanese customers will largely come from advanced products, which are built in factories outside of Japan, where we have scale.

Moving on to the third quarter outlook, we expect the 15% sequential increase in revenue that Steve mentioned earlier, Kevin a positive impact on the operating margin net income and EPS.

Third quarter gross margin is expected to be in the range of 12% to 16%.

Gross margin expansion will be constrained by changes in product mix and midyear cost increases.

Operating expenses are expected to be consistent with Q2 adjusted for the 3 million dollar gain on the sale of real estate.

Generally our effective tax rate is around 25% subject to a minimum level of tax is not dependent on our income.

We expect the bottom line to be in the range of a net loss of $7 million or three cents per share to net income of $41 million or 17 cents per share.

We remain focused on Capex discipline, which includes continued allocation of capital to key growth opportunities.

We are holding our target for 2019, capex payments unchanged at $475 million.

We have a goal of generating positive free cash flow in 2019, which would represent our fifth consecutive year for this key metric.

We reacted quickly to the industry slowdown and demonstrated the resiliency of our business model.

Our focus on cost control and Capex discipline together with our positive view of the second half should enable us to meet our free cash flow goal.

With that we will now open the call up for your questions.

Operator, you may begin the polling now.

Thank you ladies and gentlemen, if you have a question at this time. Please press Star then the number one key on your Touchtone telephone. If your question has been answered or you wish to remove yourself from the queue. Please press the pound key.

We have your first question from Sidney Ho with Deutsche Bank.

Hi, This is Jeff on for said congratulations on a good quarter managing expenses.

Going forward, how much more room is there to manage opex or gross margins without impacting the business.

Hi, Jeff So with respect to operating expenses.

We have done a fairly good job this year, reducing those.

I would say for the rest of the year. If you were to look at that we still anticipate about a mid single digit reduction in opex.

As it relates to cost of goods sold and given that we're expecting an increase in demand for the second half we would expect some of those costs to come back with volume.

Great and then five GE has been kind of a popular topic through earnings can you guys, just talk about that opportunity and kind of where.

Where you see where the biggest opportunity is that on the infrastructure side now or kind of when you get to the fiveg assets in a few years.

Hi, Jeff.

I think a fiveg in three basic areas one is handsets of course.

One is the infrastructure no one is in automotive.

And so we're working in all three of those areas.

To gain share.

So essentially that some of the individual products, we're working on today.

Include things like processors modems.

There's quite a bit of activity in RF front end.

Which includes a intent in package modules.

Transceivers.

Even power management. So as you look at the handset, which is the single biggest opportunity.

There is some incremental gain for gross adds a particularly in the front end module space in the power management space.

Great. Thank you.

Thank you we have your next question.

From Randy Abrams credit Steve.

I wanted to maybe the first one just follow up on the gross margins and the Opex for the gross margins I guess the guidance.

It was also flat, but you are into the seasonal strong period and guiding a good sequential increase.

Maybe go through because you mentioned in the prepared remarks, just some mix changes, but just some of the factors impacting the margins this year, where you're not getting the leverage you sometimes too.

And on the Opex I guess, maybe if you can clarify I think you mentioned mid single digit.

Opex savings so you've brought it down to 100 million, but then had the real estate gains so I guess in terms of.

Absolutely just to clarify the number like if you're expecting mid single digit off the 100 million X or maybe if you could just clarify.

What your outlook in Opex dollars would be towards second.

Sure why don't I take that one first LNG easier the mid single digit was referencing what we would expect for full year opex.

Reduction.

Okay. We think we're on track to meet meet that goal for the year.

Okay as it relates to gross margin expansion and what we're experiencing for Q3 and as Weve shared before with the high fixed cost structure and the leverage and generally we would see 40% to 50% drop through.

And if you look year over year from Q3 18 to Q3 19, that's we're right in that range that we would expect a 40% to 50%.

So sequentially there is a different story and as that drop through is much lower.

On an increase of over $100 million and revenue and that's really driven by two reasons. The first reason we mentioned about two thirds of that is related to a change in product mix.

So historically youll see that its very common in the second half of our year given the seasonal build to have an increase.

In material content, and that's what we're experiencing and seeing here in Q3.

That's also part of the advanced as IP product that we're ramping that Steve mentioned in the consumer market.

The second item is.

That relates is about one third of the reason and that's due to some normal mid year.

Labor and other costs.

Increases that we expect labor, we tend to have the merit and promotions happen midyear starts a structural expense increase.

And then there's some other okada that are more seasonal like electricity rates et cetera that increase.

In the middle of it here.

And last there's some one time expenses in there as well.

Some modest expenses for the Japan rationalization project, we mentioned.

So that's what's contributing to the drop through.

Okay, if I could follow up on the Japan rationalization, because you mentioned, there's some expense there will be a little bit of expense increase but could you go through that project is it is this intended to be a upgrade of the <unk> like the cost will be to upgrade the capacity.

Or is it more restructure shut down scale the capacity and then eventually the cost structure would have a change. So maybe if you could talk a bit more what you're doing and in the Japan facilities.

Sure.

Yes, Randy why don't just say a few words and then I'll turn it over to to Megan.

But basically in Japan, we are trying to reduce your factory footprint.

The Japan factories are all a wire bonder mainstream factories.

In the demand for mainstream products is steadily declining over time, so our job in Japan basically is to consolidate to reduce the footprint.

So we can maintain reasonable margins.

The focus in Japan for US is really growing with our Japanese customers in advanced packaging.

So what we're seeing is a most of the new.

Our products are ramping in factories outside Japan.

Okay, Great and then the other question I just wanted to ask on the outlook for the third quarter in mobile that 25% actually seems even a bit stronger than normal.

Got it and I think separately you mentioned, new design wins coming through second half. This year into 2020, if you could talk maybe that the factors on above seasonal and if it's just a function like we came off a low base started the year, if thats part of it or you're seeing actually a change where it somewhat market share related or where customers expecting a better second half.

Because I think in that you're also expecting.

Strength already into fourth quarter. So maybe if you can talk a bit more into design wins and also the.

The second half like the driver of that strength for the sequential pickup.

Yeah, Yeah, Randy Ah. That's good question, So I think you're right most of the.

The increase is coming off a low base. So the first half was pretty difficult I think as you recall, we went through a pretty significant inventory correction.

[noise] in many different smartphone markets.

And then we're also in a.

Down cycle in the general market.

So when you compare first half to second half you didn't get quite an increase.

In Q3, specifically.

You know, we're seeing the smartphone sign up almost 25% there were getting help from the consumer side where weve.

Good some new S&P based products are ramping in consumer.

As we move into Q4.

The reason, we're optimistic as we see both.

Oh, the big opportunity is continuing into Q4, whether it's a smartphone.

Built.

Where the consumer I see ramp.

But we also see the general market starting to recover you know we have a small.

Low single digit increase outside consumer.

In Q3.

And if you know if we look at the historical patterns, we should see continued recovery in the general market in the coming quarters. So that's why we're optimistic on Q4, and and Oh, sorry for missing about 2020.

Okay, if I could fit with just one last question just with all the there's a lot of moving parts with trade work, but to the extent its kind of two factors you've been expanding that China business overtime, I guess, how the that shifts in the supply chain if it.

Changing your your projections.

Working in an expanding into China customers were serving the international customers how to the Shanghai facility and if you could also comment if you saw anything on the fly away impact whether it's it slowed down and then picking back up or.

There's maybe a.

A more.

More of a disruption continuing on that segment until they are back to normal.

Okay.

So.

Let me just make sure I have your question one is.

Better.

The competitive position in China Visa Vitrano sense second is in fact and walk away and third as international customers in Shanghai.

Yeah, and I think competitive position in China, it's how how that ramp of the greater China business is progressing.

Oh sure.

Okay. So why don't we start with the China Oceanwide question.

Our strategy in China has always been very well defined we only compete in the advanced packaging area.

Because our philosophy is.

If we can't do it better than the Chinese those ads, then we're probably not going to win in mainland China.

And so that really hasn't changed too much over the past year clearly if there are local.

Competitors, who could do everything we could do provide the same bundles of goods and services, then we're probably going to lose.

So our growth in China has really been built on the fact of.

We have a technology leadership.

We execute well in our factory in China in factories outside China.

And we keep or or mainland China customers happy.

So, let's try just not going to change.

If I look back to when we started this program back in 2013.

Our revenues were up around you know sevenfold.

In greater China.

Well our revenues as a company are only up about 55%. So we've been gaining share in China faster than we have in the rest of the world.

As I look at walk away.

Again, we don't have much direct exposure there because.

We don't do business with high Silicon we never.

Really had high silicon as an account so there's there's not much to lose there for us.

We do feel the impact.

Some of the things happening, we walk away through our other customers so any of our customers who supply into our way into the infrastructure or the phone groups. Obviously, if they have an impact we feel it.

But we don't think its a.

That material for our results overall.

As far as international Yeah, Yeah. The last question go ahead.

Yeah, the international customers in Shanghai.

You know at this point, none of our international customers and in Shanghai have expressed an interest in moving that business to other locations, but if they do you know that's one of the benefits of our factory strategy.

Is that we have advanced factories in a number of different locations outside China, which duplicate our capabilities in China.

Okay, great. Thanks, a lot I appreciate the color seemed I guess.

Sure.

Thank you again, ladies and gentlemen, if you have a question at this time. Please press the star and then the number one key touchstone telephone. If your question has been answered or you wish to remove yourself from the queue. Please press the pound key.

[noise].

Thank you Laura this ends the question and answer portion of our call I will now turn the call back to see Steve for his closing remarks.

Okay, I would like to recap our key messages.

First second quarter revenue met our expectations profitability was better than expected.

Second third quarter revenue should be up about 15% sequentially driven by production ramps for flagship phones.

And strength in advanced S&P for the consumer market.

And finally, we are positive about the fourth quarter and believe that the worst of the slowdown is behind us.

Thank you for joining the call today.

Thank you everyone for participating this concludes today's conference you may now disconnect.