Q3 2019 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the EMCORE Corporation fiscal third quarter 2019 earnings Conference call.

At this time all participants are in a listen only mode.

Later, we will conduct a question answer session and instructions will be given at that time as a reminder, today's call is being recorded.

At this time I'd like to turn the call over to Erik Media, a Sapphire Investor Relations Ma'am. 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 27 eight of the Securities Act of 933 and section 21 E M. B exchange after 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 future financial performance and are subject to this business.

Economic and other risks and uncertainties, both known and unknown that may cause actual results levels of activity performance or achievements are 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 you also consider the risks and uncertainties associated with these statements [laughter] and the business that are included in the Companys filings with the FCC.

That are available on the I said, she's web site located at Www Dot FCC dotcom.

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 these 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 earnings press release included as exhibit 99.1 inch a form 8-K, we furnished with yes, you see today.

These materials can also be found in the investors section of our web site at Www Dot M Dot com.

With me today from EMCORE, Jeff Literature, President and Chief Executive Officer, and Mark Gordon interim principal financial and accounting officer.

Mark will review the financial results and Jeff will discuss business highlights and fiscal fourth quarter guidance before we open the call for questions.

Now I will turn the call over to Mark.

Thank you Erica and good morning, everyone.

Good day I will focus my discussion on M. courts fiscal year 19, Q3 financial results ending June Thirtyth 2019.

Consolidated revenues for the quarter came in at 17.2 million broadband revenue represented 57% of total company revenue.

Down from 65% in the prior quarter and NFL spending within the cable TV market remained soft during the quarter.

Chips, representing 11% of revenue as compared to 16% in the prior quarter, principally as a result of the continuing trade dispute with China.

Well navigation grew to 33% of revenue from 19% in the prior quarter.

Overall cable TV was 40% of revenue for the quarter.

GAAP gross profits in Q3 were approximately 3.7 million or 21.6 right.

6% of revenue down from 26.7% in the prior quarter.

The sequential decrease in gross margin was largely driven by under absorption in our manufacturing facilities related to the softer than expected demand for cable TV and chip card.

Colombia operating expenses for R&D and that's your name were 13.9 million 2.5 million higher than the prior quarter and 3.8 million higher than the prior year.

non-GAAP basis.

Well this excludes the impact from the Arbitration award, which was accounted for in the third quarter operating expenses were 9.3 million 1 million higher than the prior quarter.

Due to additional investment in aerospace and defense.

And the inclusion of Sci operating expenses for the last three weeks of the quarter.

Well I guess basis, the consolidated operating loss for the third quarter was 10.2 million.

Our non-GAAP operating loss from continuing operations after excluding during a drop there always are set forth in the non-GAAP table included in today's press release.

5.1 million or 2.9 million decrease compared to the prior quarter, primarily due to a lower gross margin level I referenced earlier combined with the partial period inclusion of FBR.

As a percent of revenues in Q3.

Fiscal year 19, non-GAAP operating income was a negative 29.7%.

Our non-GAAP pre tax loss from operations was $5 million.

Moving onto the balance sheet and cash flow statement at the end of Q3 fiscal year 19, the companys cash and cash equivalents, including restricted cash were approximately 20.6 million or a decrease of 30.1 million quarter over quarter. The largest contributor to this decline was the purchase of Ciscura, daughter, inertial for 22.8 million I'm doing 19.

Beyond this expenditure remaining decline in cash was due to a combination of lower than expected volumes in the quarter American theater invested enough, though the monetization of our campus.

Regarding our working capital metrics Dsos were 78 days.

Down compared to 84 days in the prior quarter.

Net inventory turns including non current inventory were 2.8 times.

Capital expenditures in the quarter were 3 million and depreciation in the quarter was 1.8 million.

With that I will turn the call over to Jeff.

Thank you Mark and good morning, everyone.

EMCOR has been working on its transition from cable TV to aerospace and defense for several years now while our Q3 results reflected strong headwinds to our cable TV and ship products, our aerospace and defense offerings performed extremely well showing 100% year over year growth.

Raytheon is now emcores largest customer and aerospace and defense will be our largest product family in Q4 and beyond.

[laughter] in the navigation market demand for fiber optic gyroscope based products remained strong with revenue increasing by 100% year over year, putting this product line on track to double its revenue from F Y 18 to 49.

This year's mission is focused on developing our new generation of inertial measurement units and delivering the prototypes to customers.

To that end, we delivered the first prototype I am you Werent F 18 application as planned.

And expect to deliver the remaining units in Q4, our customers very pleased with the performance of the unit I look forward to moving onto flight testing as soon as possible.

Yes, 300, I am you production units, which are designed to replace Northrop Grumman products have also begun to shift that will start flight testing soon.

We've also been developing chip products for the aerospace and defense business over the past year and have started to ship them to our first customers.

Additionally, on June 19th we announced the acquisition of the Strawn, daughter, inertial a world leading manufacturer of courts Mems navigation products were 22.8 million in cash, but about 11 Hot 811000 shares of stock.

As we mentioned in our prior call Sci designs manufactures and sells high performance courts, Mems gyroscopes accelerometers to leading customers such as Raytheon Lockheed Martin Rockwell Collins and other tier one contractors.

There are only a small handful of merchant course gyroscope vendors in the market today and among them ask do you guys the clear market leader.

These navigation products complement emcores fiber optic navigation products and will increase our serviceable market by at least $500 million.

For example, now that STR is part of the U.S. company. It is free to compete for a far wider range of defense contracts that it could while it was owned by a French parent.

We continue to forecast that STR will generate cash and profits in the December quarter, as previously indicated and generate additional cost synergies with Alhambra.

Beyond the numbers a little over two months into the integration. We're pleased with the progress. The team is making and are more excited about the opportunities for a cocker team than we were when we closed the deal our customers think that this was a great move for both EMCOR in Sci and we've received significant positive feedback on the accommodation from industry leaders.

Within the Satcom product line, which is now part of aerospace and defense demand remained strong with revenue up over 100% year over year. These high frequency communication products are almost exclusively purchase by the same tier one aerospace and defense customers.

Purchase our inertial navigation systems.

Application for these products have moved substantially beyond their roots in satellite ground stations and are now used in Navy ships radar systems and similar applications significantly expanding the market opportunities that we see.

We received the first half of an estimated 6 million dollar project to modernize ebay traffic aircraft control towers and should start shipping. These products in Q1, that's why 20.

Within the cable market M.S., so spending remained unusually soft in the third fiscal quarter. Despite indications from the M.S. those that spending would pick up from the seasonally soft second quarter.

Furthermore, late June relief on the 25% tariffs, which were due to be imposed on China.

Stall ended quarter transmitter orders, causing us to misguide.

With both major publicly traded Misos, releasing earnings and Capex guidance within the past two weeks, we can confirm that the caused the weakness in cable TV orders was yet another drop in M.S., so infrastructure capex spend.

Well, both M.S. those indicated that capital expenditures will increase in the second half of the calendar year. We remain skeptical that this will occur and its factor out any improvement in the current quarter.

The most important take away is that infrastructure demand has hit an eight year low which is consistent with the historical bottom of cable TV cycles.

We expect to demand.

To improve from these levels consistent with the comments from the M.S. those but don't believe that this will occur before calendar Q4.

Consequently, we are going to take aggressive actions to create a smaller more profitable cable TV business going forward.

We continued to make progress in the wireless market with our new product initiatives within the death in five new market segments.

Laser shipments for Fourg LTE E gas market remain steady.

And we shouldn't expect to see early shipments of five key product for several applications beginning in the new year new calendar year.

We're expecting wireless to at least double its revenue would ask why 20 and Oems are evaluating our products for large testing facilities small cells and das systems.

Moving onto the chip market as we highlighted in our Preannouncement on July 11, the ongoing trade disputes with China are having a material impact on the demand for our chip products, most notably for GE PON and those products sold into the wall waste supply chain.

Furthermore.

An anti American stance has been taken for many new design wins in China.

Threatening to limit future opportunities to only those products that cannot be sourced from China, Taiwan Korea or Japan.

Given the ongoing certainly uncertainty around mid to long term demand within this market.

We've chosen to exit many of the lower margin segments earlier than planned and focused our efforts on a smaller subset of higher margin products.

We believe that this trade dispute will not and any time. Soon consequently, we're also working to change our supply chain strategy to minimize the impact of additional tariffs.

The combination of the trade dispute and cyclical cable TV weakness demands that we speed up our timetable to re size and moved to an M.S. manufacturing model for cable television, while retooling our chip business.

In 2015, we began to automate our assembly and test processes in China and completed that work in 2017, making it possible now to move to a true variable cost U.N.S. model for cable TV manufacturing within approximately nine months from now with testing and qualification taking up the majority of the timeline.

During this period, we expect to see a gradual improvement in absorption as the east facility shrinks its role.

Beyond our move to E.M.S., we also plan to make additional changes in our staff to align expenses with revenue.

In addition, we are in the midst of working on alternatives to monetize our Concord, California facility.

Well, we ultimately we will ultimately consolidate certain functions between our two California facilities conquered has very important strategic value for EMCOR and we're looking forward to a bright future there when complete the sum total of the various actions. We're taking should gain is somewhere between 15 and $20 billion in cash.

Between these initiatives and a scaled back Capex plan, which we are still re formulating.

We expect to have the cash that we need to meet the ongoing needs of the business.

Where aerospace and defense was just in R&D initiative, a few years ago.

It's become our largest opportunity what started out as organic growth of our fiber optic gyro products has been accelerated by the purchase of Sci and strengthened by a redesign statcom product line.

Aerospace and defense will be Emcores largest business in the current quarter and going forward.

We're adjusting our cable TV strategy to maximize profits as quickly as possible, while our chip business is being redesigned to be strategically can grew it.

With our aerospace and defense product line.

Well, there's still much work to be done to take advantage of the full benefits of this transaction.

I'm excited about the progress we've made so far.

Turning now to a forward looking view of the business I think it's important to point out that the current EMCORE business. Excluding contributions from STR is running with a breakeven point of about 24 million.

Even though gross margins in Q3 came in at an anemic, 21.6%. The primary cause of this was 3.3 million in factory under absorption.

Correcting for this reveals the gross margins on the current mix of products would have otherwise been around 35% pricing has not changed in the cable TV market nor has the competitive situation.

This dictates that we need to match the breakeven point.

Oh, Im CT legacy business to the new market realities.

I'm committed to making an impact on this in the current quarter.

To achieve this we are taking four major actions to reduce our breakeven point for legacy Alhambra products.

First for moving to an E.M.S. model for manufacturing, which will eliminate the under absorption from EA within three quarters.

Secondly, we're reducing the wafer fab operations to a single shift to reduce that under absorption as we emphasize our higher margin chip products third we're going to adjust the size of the organization.

Fourth we're working to accelerate the synergies between our two facilities in California.

To maximize cost savings and our opportunities.

This should provide us with a steady improvement in gross margin over the next three quarters, culminating in a return to the mid Thirtys. When these initiatives are complete.

Moving onto our outlook for the fourth fiscal quarter, we expect revenue to be in the range of 22 to 24 million, which reflects strong growth in our navigation products with a full quarter's worth of contribution from STR offset by continuing softness in cable television and the chip market.

Now I will turn the call over to the operator and open up for questions operator.

Thank you Sam if you would like to ask a question. Please signal by pressing star one on your telephone keypad, if you're using a speaker phone. Please make sure. Your mute function is turned off to allow your signal to reach our equipment.

Again, Please press star one to ask a question well pause for just a moment to allow everyone the opportunity to signal for questions.

Our first question will come from Tim Savageaux with North I'm, sorry, Northland capital markets.

[noise].

Hi, Good morning morning couple of questions Hi, Hey.

See you had some pretty strong organic growth in the the gyro business in Q3.

I Wonder if you feel like you know those levels are.

Kinda sustainable you can grow from those levels or.

Or whether you know if you look at your guide for fiscal Q4 that essentially reflects the.

The inclusion of Sci it kinda than anticipated the anticipated run rate and sort of flat performance I'm in the organic business.

Yes, so first of all I mean.

On on a sort of a.

He took on an average basis, yeah. We certainly believe that we can grow the fiber optic gyro business from where we are as we're just starting to ship.

I knew I am new units for production.

It's not as simple as that.

The commercial side of the business in that.

Oftentimes when we deliver prototypes, they're pretty expensive.

And the they don't immediately transition into production because theres flight testing.

That has to go on so so there could be periods going forward, where we will see what a what is apparently softness but in fact, it's just the normal sort of structure in the way that.

Our test and qualification occur as more product programs go into qualification. These ripples will tend to smoothed out.

Sci.

We'll continue to grow.

Beyond where it is right now we're real happy with where things are and.

So again the two.

Navigation product lines, we see growing from here and.

You know are by far our largest opportunities centrally.

The long awaited moved to become.

You know far less dependent on cable TV is upon us right now.

Right, so be fair to say that defense and that would be about 50% of revenue contemplated in your guidance for fiscal Q4.

It's going to be bigger than that.

Quite a bit later.

On a percentage basis.

Okay great.

And then given.

You had a little bit higher opex and expected and.

And some higher losses.

Any sense for.

As you include the balance of the S.T.I. operating spending.

What's relative to what you put up in Q3, I don't think you've guided to the bottom line, but given your incorporating the acquisition I Wonder if you can provide any more color as to what that.

You know combined Opex run rate will look like from a baseline and then maybe what you hope to.

Reduce that by from a combination of synergies and what it looks like you know potentially some pretty significant restructuring on the cable TV side.

So first of all.

You know as we as we take a look at the integration of SD Guide.

It's important to understand that you know, it's a bit of an anomaly in Q3, because these guys. Unlike where we were in cable television, we're actually sort of forward loaded in the quarter from a revenue perspective, and you had a pretty linear opex. So.

It may look a little bit strange that there was.

You know call it would appears to be in the surface.

You know a bunch of expenses from Sci when in fact it was just.

Indicative of the way there quarter turned out so we shouldn't see that sort of an impact.

In the current quarter and beyond.

So it was just a little bit of a transition thing right with expenses appearing.

Without the necessary revenue because they'd already made you know the overwhelming majority of their shipments.

So does that clarify things for you Tim.

Sorry.

Pull myself off mute there.

You know a little bit I mean.

So are you are you, saying you might think you talked about three weeks of expenses for first <unk>. So I I assume there's no another.

You know substantial chunk to to be recognized in Q4, but.

Okay, well it sounds like you're saying that you'll have yeah, but you'll have the revenue along with it so essentially since we only owned them for the last three weeks of the quarter all the revenue the ship prior to that date of course, we don't recognize.

Right.

So you just sort of had the stub period in which you have sort of normal expenses.

But you don't have the revenue that goes along with it because those products that already shipped.

Okay and in the classroom and yeah in the current quarter, you'll see the full.

Full quarters worth of revenue and the full quarter's worth of expenses.

And you know, we're not expecting much of an impact at all net net.

In terms of I mean, they're going to be pretty close to.

Breakeven this quarter, but we're projecting that that occurs in the following quarter.

Got it thanks.

Thank you again, if youd like to ask a question. Please press star one at this time our next it next question comes from Jason Smith.

From Lake Street capital.

Hey, guys. Thanks for taking my questions I just look at your September quarter guidance I'm wondering if you could provide what sort of contribution from FDI that assumes and it related Lee your comments that the you are more bullish on the Sci business now compared to close I think at the time, you had expected it sort of a 10% growth rate for the FDI business going forward should we assume that.

Expectations are probably a little better than that now.

Yes, hi, Jason the I think expectations are a little bit better, but you got to temper those by the reality of qualification times.

We've already had integration work done between the sales forces.

We we've uncovered one or two places, where we were selling against each other and Weve deacon vault those.

So I mean, largely I'd say, 95% of the forecast actually looks pretty clean and that they were.

Chasing.

Opportunities that we weren't and vice versa. Okay. So.

Beyond that I think it's going to take a little while for a more accelerated growth.

Two.

To occur its just the nature of aerospace and defense. It takes a long time to get designed in and it takes a longer time, even to get designed out.

In the in the in the next quarter, we're we're not going to break out.

The and going forward, we won't be breaking out FDI separately, but what I would say is that.

The movement or the.

The guidance that we have basically doesn't change too much of what is going to occur out of Alhambra.

Okay.

Okay. That's helpful.

And yes, and no I think it's a lot of moving parts with the restructuring, but looking at your expectation for gross margin to eventually migrate back to the mid 30% range does that assume any significant work or change on ft ice gross margin.

No.

No, we're where we are with FDIC gross margins is there.

They are actually.

Hi, there they are pretty good.

And we've uncovered a few things that are going to allow those to make continued sequential improvements so.

Sci doesn't really need to do anything other than what we're already doing to continue to make improvement, but we're not relying on those factors too.

Pull out the legacy products margin forward.

Again, I'd point you back to.

The point that we made about gross margin, which was a 21.6% looks really bad but the almost the entire reason for that is under absorption right. So as we go to transition.

From EA and transmitters go first and then laser modules.

And then you you know you make the final set of changes downward over in China.

The under absorption from China goes it starts to go away right and some impact will be made even in the current quarter.

On that but it's all about how quickly we can break down headcount.

Because nothing has changed on the pricing side nothing has changed with competition and probably 80, 90% of the reason why margins are depressed is just fine.

Okay and the last one for me I just want to make sure I heard you correctly that you expect the CATV business the bottom in December .

No no, we're saying that we believe right now we're at the bottom and we're not forecasting an improvement in the current quarter, but when you take a look at what BMS those have said about capital spend.

The only conclusion you can reach is that.

Calendar Q4, we'll see some improvement and potentially significant improvement it just depends on.

Orders materializing that we have not seen yet and given that we're five weeks into the quarter were low to project that you know the spigots going to turn back on and we're going to be able to get everything.

Built and shipped.

Before the end of the September quarter.

Okay. Thanks, a lot guys.

Mhm.

Thank you I'm currently showing no questions in the queue I'd now like to turn the call back over to Jeff richer for closing remarks.

[noise] in closing I'd, just like to thank all of you for your time. This morning, and your is your interest in EMCOR and I look forward to our follow up calls and visits over the next week. Thank you very much.

Thank you ladies and gentlemen. This concludes today's teleconference. You may now disconnect.