Erica Mannion - Sapphire IR Jeffrey Rittichier - President & CEO Jikun Kim - CFO.

Timothy Savageaux - Northland Capital Markets Jaeson Schmidt - Lake Street Capital Markets Joseph Maxa - Dougherty & Company Lee Krowl - B. Riley & Company.

Ladies and gentlemen, thank you for standing by, and welcome to the EMCORE Corporation Fiscal Second Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, today's call is being recorded. At this time, I'd like to turn the call over to Erica Mannion of Sapphire Investor Relations. Please go ahead..

Thank you, and good morning, everyone. Before we begin, we would like to remind you that the information provided herein may include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act of 1934.

These forward-looking statements are largely based on our current expectations and projections about future events and trends affecting our business.

Such forward-looking statements include, in particular, projections about future results, statements about plans, strategies, business prospects, changes in trends in the business and the markets in which we operate.

Management cautions that these forward-looking statements relate to future events or our future financial performance and are subject to business, economic and other risks and uncertainties, both known and unknown, that may cause actual results, level of activity, performance or achievements of the business or our industry to be materially different from those expressed or implied in any forward-looking statements.

We caution you not to rely on these statements and to also consider the risks and uncertainties associated with these statements and the business that are included in the company's filings with the U.S.

Securities and Exchange Commission that are available on the SEC's website located at www.sec.gov, including the sections entitled Risk Factors in the company's Annual Report on Form 10-K and quarterly reports on Form 10-Q.

The company assumes no obligation to update any forward-looking statement to conform such statements to actual results or to changes in our expectations, except as required by applicable law or regulation. With me today from EMCORE are Jeff Rittichier, President and Chief Executive Officer; and Jikun Kim, Chief Financial Officer.

Jikun will review the financial results, and Jeff will discuss business highlights and fiscal third quarter guidance before we open the call up to questions. Now, I will turn the call over to Jikun..

Thank you, Erica. Today, I will provide the details of our Q2 FY17 financial performance. Please note that consistent with prior quarters, these results include the effects of classifying what remains of EMCORE's Telecom and Photovoltaic businesses as discontinued operations.

Consolidated revenue for the quarter totaled $32.6 million, which is 8% higher than the prior quarter and above the high end of the revenue guidance of $29 million to $31 million. Cable-TV market continues to drive revenues for both our DOCSIS 3.1 and RF over Glass products.

DOCSIS 3.1 product revenues held steady relative to Q1 in what has been historically a seasonally low quarter. RF over Glass product revenues increased significantly from a small base relative to the prior quarter. Our merchant ship products also showed the strongest performance over the past 4 quarters with solid gross margins.

We also recognized nominal growth for our Satcom video product line. The Fiber Optic Gyro came in lower than prior quarter driven by the timing of customer orders. GAAP gross profit in Q2 was $11 million, which is 10% higher than the prior quarter. Gross margin in the quarter was 33.9%, up from 33.3% in the prior quarter.

As we discussed on our last call, the combination of higher RF over Glass revenue mix and spending related to our Beijing facility transition efforts created incremental headwinds during the quarter. Beijing relocation expenses in the quarter were approximately $340,000, similar to the prior quarters spend levels.

On the non-GAAP basis, which takes into consideration adding back FAS 123R expenses as well as asset retirement obligations, our non-GAAP gross margins came in at 34.4%. The total GAAP operating expenses for R&D and SG&A were $9.3 million, approximately $1.5 million higher than the prior quarter. SG&A increased by $0.6 million.

The increase was driven by a $0.5 million in PPNE impairments, impairment charges related to the Beijing facility transition and $0.5 million in severance charges related to the same. These increases were offset by lower litigation expenses and audit-related activities.

R&D increased by $0.9 million, driven by higher Fiber Optic Gyro R&D activities, higher payroll and related taxes and accruals. For further details, please see the GAAP to non-GAAP reconciliation tables in the press release.

On a GAAP basis, operating income for the second quarter was $1.7 million, reflecting a decrease of $0.5 million over the prior quarter. On a non-GAAP basis, operating income was $3.7 million or 11.4% of revenue compared to $3.5 million or 11.5% of revenue in the prior quarter.

Making further adjustments for Beijing facility transition expenses, non-GAAP operating income in the quarter would have been closer to $4 million or 12.4% of revenues, very close to the Q4 FY17 operating profit margin objectives of 12.5% that we identified during our prior calls.

Our GAAP pretax income from continuing operations was $1.8 million in Q2 or flat relative to the prior quarter.

Our non-GAAP pretax income after taking into consideration certain adjustments, all of which are set forth in the non GAAP tables included in today's press release, was $3.7 million or $0.14 per diluted share compared to $3.5 million or $0.13 per diluted share in the same quarter -- in the prior quarter.

Please note that we've included additional information regarding unique transactions, litigation-related expenditures, impairments, severance, stock compensation, amortization and other items in today's press release to provide further clarity of our results. Moving on to the balance sheet and cash flow statement.

At the end of Q2 FY17, the company's cash and cash equivalents were approximately $68.6 million, an increase of $6.4 million over the prior quarter. Regarding our working capital metrics, DSOs were at 57 days, showing significant improvement from the prior quarter DSOs of 77 days.

This performance was driven by an even loaded revenue profile in the quarter as well as solid collection efforts. Net inventory turns including noncurrent inventory was at 2.6X, holding steady compared to 2.7X in the prior quarter. Absolute value of net inventory declined $2 million quarter-over-quarter.

In Q2 FY17, we invested $1.3 million in capital expenditures and recognized approximately $0.9 million in depreciation. Capital expenditures declined from Q1 as we moved towards the completion of our Beijing facility transition. Overall, the company generated strong free cash flow of $5.2 million in the quarter.

In summary, we continued to make solid operational and financial progress towards our Q4 FY17 operational and financial objectives. With that, I will turn the call over to Jeff..

Thanks, Jikun, and good morning, everyone. As Jikun highlighted, we continued our momentum into the second fiscal quarter delivering sequential revenue growth of 8% in what is normally our seasonally softest quarter, and year-over-year growth of 51% coming in above the high end of our guidance.

More importantly, during the quarter, we again demonstrated our improving manufacturing efficiency and operating leverage by growing non-GAAP operating income sequentially by about 7%, coming in at the high end of the 9.5% to 11.5% guidance.

Despite the unfavorable mix of our far higher expenses caused by the relocation of our China-based manufacturing operation and heavy R&D investment. With that said, I'd like to provide you with some additional color on the trends we're seeing in each of our served markets as well as the operations of our business.

Within the cable television market, in the second quarter we continued to see strong sequential growth, as our business grew roughly 9% from the first quarter and was up 100% -- 107% over the prior year.

As we discussed on our last call, larger than planned RFoG shipments offset the typical seasonal softness we experience in our cable business in the second quarter. Additionally, in Q2, we saw a heavier one-time mix towards the low end of our RFoG product family, marking the end of a model changeover.

Going forward, RFoG shipments will primarily consist of more sophisticated, higher-margin products which incorporate OBI mitigation technologies.

While Q2's RFoG heavy mix created an incremental headwind to the gross margins, we kept our operating expenses for those products below the corporate average, allowing them to contribute to operating profit and margin in the quarter.

Looking into Q3 and beyond, we continue to see strength in the infrastructure side of cable television, with DOCSIS 3.1 product growth resuming in the June quarter. MSO's remain committed to deploying Fiber networks. In our most recent earnings call, Comcast stated that they expect capital intensity to remain flat year-over-year.

However, they also stated that in the first calendar -- their first calendar quarter was about $150 million lighter than planned, and CPE spending would decrease going forward. This implies that the remainder of 2017 infrastructure spend should be stronger than planned.

A few weeks ago, Charter announced a $25 billion infrastructure investment pledge over the next four years. After backing out the estimated standard Charter and TWC annual CapEx spend, the $25 billion figure implies an increase of almost $1 billion a year.

We believe we're still in the early innings of the network buildout and are poised to benefit from our new products such as our any LEML-based solutions, which are being integrated across our product lines. Moving on to the chip market.

Revenues grew 51% sequentially quarter-over-quarter and early indications from our customers remain very positive for our 10G parts while we continue product development work on parts to address data center markets.

With our OST announcements, we marked the availability of 6.5 gigahertz 5G wireless devices, and expect to continue the development of those products. We also received additional customer orders in the GPON market, which we can fill from stock, in Q3 and Q4.

At a high-level, we expect our penetration into these markets will drive a higher blended margin for both our chip business and for the company overall. Within the Satcom and video market, EMCORE started restructuring its product line over a year ago and is starting to see the benefits from those actions.

We just completed the discontinuation of our video products, which carries excessive engineering costs and cut out over 60% of the product options for our Satcom product line as well.

With the introduction of new low-cost L-Band links, technologies for 5G are -- 5G radio over Fiber DAS and are focused upon larger Satcom systems, we expect profits to grow faster than revenue in these product areas. With all that final testing transitioned to our EMS partners in the U.S.

complete, we believe we are in a good position to realize incremental operating leverage in these product lines. Within the Fiber Gyro market -- let's start with the production side of the Gyro business. Within the last week, we received notification that we were awarded Raytheon's Premier Supplier Excellence Award.

Only the highest achieving Raytheon suppliers are awarded this distinction. I'm extremely proud of the work that our navigation team has done to earn this award for EMCORE. Our strong performance on the MTS-B program has opened up larger, new programs for EMCORE, which we are actively pursuing through product development.

In our previous calls, I indicated that we have important shipment milestones to meet this summer. As of today, we do expect to meet those delivery commitments, paving the way for production of these new products in FY18.

These new products are developed to industry standard and will be sampled to several other customers during the summer and early fall. These are the largest navigation market opportunities that we pursue today, and we're very excited about our position in this business.

We previously announced that we are negotiating a multiyear agreement which could eventually encompass our entire navigation product family. It goes without saying that this is a lengthy process, involving complex government contracting regulation.

Consequently, these negotiations have been time-consuming, and will affect short-term Gyro shipments over the next quarter or two. The most probable impact is some amount of delay in shipment volume, making it unlikely that we will hit the goal of our navigation business being 10% of revenue in Q4.

Any movement in shipments should not represent a loss of business, only a delay. Typically, that is just the way the defense business works. Shifting gears to the operations side of the business. All of our captive cable television manufacturing has been shifted to EMCORE Asia, our new automated facility inside the 5th Ring in Beijing.

With this project complete, we've significantly transformed the operations of EMCORE from where they were nearly two years ago. Over the next three months or so, additional automation equipment will be installed to bring our direct headcount down from about 370 at peak last December to about 100.

This may cause us to incur some additional transition cost in the quarter, potentially at about half the level they were in Q2. Even as our Chinese facilities are being transformed, our U.S. operations shifted postcode simulation test and sort operations as well as Chip-On-Block assembly to EMS providers as well.

When combined with the changes in our Satcom manufacturing strategy, these actions will result in our breakeven point declining by about $1 million to $1.5 million per quarter. We should see some impact from these changes in our numbers this quarter, but will fully realize the benefits in Q4.

It's important to understand that this manufacturing transformation is not really the end point for EMCORE. Our cable television transmitter manufacturing strategy is a terrific example of this.

Over the past year, two of our Six Sigma Green Belt projects have given us the ability to automatically tune CATV transmitters with high accuracy and minimal touch time. The deep learning project was particularly insightful in raising our understanding of profit dynamics.

When combined with new automation techniques, we've achieved 90-plus-percent reduction in touch time per unit. This is now complete. We are going to move transmitter tuning to the EMS providers to eliminate transportation, inventory, carrying cost and to further improve cycle time.

Over the next year, we expect to devote a majority of our Six Sigma Green and Black belt projects to wafer fab operations, where we will not only improve our standard process controls but build the process nodes that will launch new generations of chip products for both captive and emerging markets.

We see the fab as a key area for investments in both in terms of capital and the world-class technologist we need as we work to improve our ability to both execute and invent. In our August call, we'll update you all on the result of our 2016 Six Sigma project, just as we did last year with our 2015 actual result.

Turning now to the outlook for the business. In the third fiscal quarter, given the continued strength we're seeing in the cable TV business, we expect to see revenue in the $29 million to $31 million range, with non-GAAP operating margins about 11% to 13% This guidance eliminates over $3 million in low-end RFoG units that was a one-time event in Q2.

Margins should also start to improve in Q3, depending on the final mix in the quarter. Now, I'll turn the call over to the operator to open up the line for questions.

Operator?.

[Operator Instructions] And our first question comes from Tim Savageaux with Northland Capital. Your line is open..

Hi, good morning.

Can you hear me?.

Yes. Good morning, Tim..

Okay, great. Sorry, the weather seems muted or not [ph]. Couple of questions. First, congratulations on a real strong -- on March quarter. I did not quite catch what the drivers of upside on the chip side were? Wonder if you might mind running back through that? And also, I think the commentary was, business was as strong as it's been in a while.

I don't know if you care to give any more detailed metrics about how much the merchant chip business represented for your business in fiscal Q2?.

On the product mix side, was 10G APDs that we shipped out in larger numbers.

Jikun, you want to cover the second part of the question?.

Sure. So in general, I think, we talked about the chip business being increasing 51% quarter-over-quarter. So that's -- in terms of revenue mix for the Corporation, cable TV was about 80% to 85% of the business, Chips were 5% to 10% of the business, Satcom was 5% to 10% percent, and FOG was about 2.5%..

That is very helpful. And from a margin perspective, kind of came in right in line with where we thought despite a heavier RFoG mix.

I gather, perhaps, you saw some offset from the chips strength in terms of overall margin levels, and as you look forward, I certainly understand the kind of one-time nature of the RFoG and not just Comcast based on your comments from ARRIS last night.

I think it's fair to expect the current kind of DOCSIS cable TV infrastructure market to continue to grow for the year. But as you look into next quarter you expect continued growth in the chip side as well.

And what sort of -- seems like you have a lot of the margin levers moving in the right direction as you head into Q3?.

Yes. I would that's right, Tim. We're just trying to be conservative until all the moving parts are settled on the final set of automation. Installations over at EA, but yes, we're -- I think, we're looking at a stronger quarter in terms of chips. Can't break it down any further than that for you.

Cable TV, I think, ARRIS said they came in with a book-to-bill of something about 1.13 or something like that. So you know, overall, the signals look quite good. And we'll be at Angus in a couple of weeks, over in Europe, when we'll have a chance to see what Liberty Global's up to, more specifically.

But right now, cable TV is still looking quite strong..

Good. And maybe 1 final question on the chip side. I don't know if you've made any comments on kind of the Datacom data center type opportunity. We've had other players in the market there, may come in particular.

Kind of very nearly kind of shift the entire strategy of the corporation toward opportunities for 25 gig lasers in the data center talking about sort of multimillion unit type volume opportunities. We know you've been doing some developing work in that direction.

I don't know if that's translating into any revenue yet, but I'd love to hear an update on what's happening on the data com side of the merchant chip business?.

Don't have much more to say. I would say, if anything, our detector projects are ahead of the laser projects. We're still moving forward with a number of customers and we'll comment further when we actually have something to announce..

Okay. Well, congrats once again on a good quarter. And I'll pass it on..

Thank you, Tim..

And our next question comes from Jaeson Schmidt with Lake Street Capital. Your line is open..

Hey guys, thanks for taking my question. Just following up on one of the previous questions.

Jeff, wondering if you could talk about how your visibility might have improved over the last 30 months? Or kind of where your overall visibility is at this point?.

With respect to cable television or other products?.

Yes, CATV..

Okay. Well, it's -- in cable television, typically by the time we announced the previous quarter's results and we are providing guidance going forward. We really have the bulk of the cable television orders in place, and there is really very minimal amounts of movement that are allowed based on the supply agreements we have in place.

Almost nothing in 30 days, and then sort of depends from there out. And we try to accommodate customers wherever we can. But inside the 60 days, things are pretty firm. Beyond that, we look into the forecasting systems of our customers and we've got techniques for eliminating double counting and things like that.

So it's really the combination of that information and indications about infrastructure spend in the MSOs that give us the insights beyond 90 days out, okay? So not much has really changed as far as the way that we look at the information, I think with the most recent announcements from Comcast, Charter, you look at what ARRIS is now saying publicly, things look pretty good, in the second half of the year.

But cable TV compared to say -- again, we commented about having a multiyear supply agreement.

We're negotiating -- those 2 visibility situations are very different, right?.

No, that makes sense, and is very helpful. Just a clarification on the Beijing facility transition. Those costs will be concluded by the end of the June quarter.

Is that correct?.

Yes. So essentially what we did is we moved everything from one facility into the other. The majority of it has have the automation installed. There are a couple of places where automation is being put in place, literally as we speak. Should be largely complete, end of May, beginning of June. So we'll see a little bit of transition costs.

We expect it to be down quite a bit from where we've seen it..

Okay. And given the strong margin performance you just posted, I assume that 12.5% pro forma operating margin exiting this year and 15% exiting '18.

If those targets are still on track?.

Yes. We feel real good about that period..

Okay. Perfect. And then just the last one for me and I'll jump back in the queue.

Any change as far as how you're thinking about CapEx this year?.

Yes -- go ahead, Jeff..

Go ahead, Jikun..

Yes, so I think we discussed $6 million to $7 million in CapEx at the beginning of the year. Q1 was high. Q2, you can see, it came down quite a bit from Q1. I think we're still on track and, obviously, many of our capital investment decisions are predicated on return on investment.

So if we have opportunities where the payback is 12 to 18 months, we'll go ahead and invest..

The other thing to understand about CapEx is some of these, especially when you start talking about fab equipment, you're looking at lead times per equipment that could be nine months or more, right? So the date that we make commitments versus the dates they come in and get commissioned often times there is a called a phase lag..

Okay, thank you..

And our next question comes from Jo Maxa from Daughtry & Company. Your line is open..

Thank you. I just wanted to touch base on the gyroscope business. You did mentioned a delay in some shipments in the second half of the year. I wanted to just to walk through that again. It sounded like it had a lot to do with the government contracts.

Just maybe give us a little more color on what you're seeing and when you would expect those to start shipping?.

Sure. I'd like to -- I'm going to defer to Jikun, because he's been involved with the contract negotiations, and I will say it's great to have a former Raytheon CFO as your CFO in these sorts of situations. So Jikun, if you wouldn't mind providing in some color on this..

Sure. So it's a multiyear agreement. It's a five-year agreement that we're negotiating, and given the size of the opportunity and the contract, there's extra government compliance regulations required, and as an organization, this is probably our first foray into a multiyear government contract.

And so we're being very methodical and careful about how we understand the requirements and our ability to perform to the requirements.

It's not necessarily the product qualifications or product quality requirements but it's all the terms and conditions that come along with taking a very large government contract, and that's just taking a little time..

In that type of contract, how do you see that unfold? Is it more of a grow through the five years? I mean, may be the first year is the start, but is it more kind of a win here as, once you get up to a certain run rate?.

No. The projections look like it's increasing over time, but the concern would be, the future is more certain in the next six months than five years out, right? so you've got to kind of discount some of the further out volumes that people project, and there's some business backing and involved in making that kind of a judgment call..

Okay, that's helpful. On the chips business, your commentary about initial orders coming from the second half of the GPON market.

Are you -- did you indicate that you expect the chip business to grow from Q2 levels in the back half?.

Sure..

Yes. I think we will..

Sorry Jeff, go ahead..

Yes. I think, it will. Again, the point that we -- had been made -- we had made in the past about GPON was that we really are only going to supply customers that are, let's call it, multigenerational with 2.5G product, and not for -- we're jumping back into it. It's just that we have some inventory, and so we'll continue to supply that.

Maybe we'll make a little bit more for them. But it's really the 10G targets that are going to get 2.5G attention from us when and if they need it. Just to make it easier for them to do business with us..

So in the quarter, was it the 10G product that drove the business or was it more of the 2.5G?.

It was a combination of telecom parts, the 10G parts. 2.5G, we've got orders, Joe, that will build in Q3 and Q4..

Okay, I see. And then, I wanted to ask on the SG&A line. Last year you had a big step up. And I'm wondering if you would expect to see something like that this June quarter? I think last year you said something about a large trade show..

Jikun?.

Yes, the seasonally high trade show quarter was this past quarter. OFC is the big trade show. So we're past that. ANGA is a relatively smaller trade show. So we would anticipate, on a non-GAAP basis, SG&A line to be steady..

Got it. Okay. Thank you very much..

[Operator Instructions] Our next question comes from Lee Krowl with B. Riley and Company. Your line is open..

Hey guys, thanks for taking my questions. I think most of them have actually been covered but one question on the defense opportunity.

In there -- is that contract does win, just given kind of the duration and magnitude of it, is that an incremental step up in CapEx when that, if and when that is announced?.

Jeff, do you want to take that one or....

Yes, sure. I wasn't sure if you meant backward or not. The CapEx necessary for that particular project is pretty much in place.

We are going to be putting in addition CapEx for other Gyro products that can certainly be used in this contract, but we've been building these particular gyros for that customer for the better part of two years at about these sorts of rate. So it's not a big jolt to the system over on manufacturing CapEx..

Okay.

And then just kind of as that flows through, is that -- is the margin structure of the larger contract like that comparable? Or do you have to concede to the fact that it's just a larger contract win? So there is some concessions there?.

Yes....

Well, you know -- go ahead, Jikun..

All right. In general, when customers provide assured, longer and higher volumes, there's expectations there are concession on prices, right? So -- but I think we should be able to hold around here..

Yes, and the short version is, the margin would be above corporate average..

Okay. I was just -- the reason I was thinking it was, trying to think if guys got this big project online, if that changes the timing of the -- kind of the outlook on the overall operating margin targets. But I guess....

No. It really -- it won't. It won't, except in a positive way. It just might push some revenue around more than we would like. But the long-term feature on these products is excellent, and so we're really excited about where we are here..

Okay.

And then on the GPON market, is that a function of kind of renewed CapEx? Or is there kind of incremental activity in the GPON market just because inventories have kind of been worked down and now are at more at a normalized level?.

It's really more the latter than the former. And again, we're only going to supply major customers that are going to buy next-generation product from us. We're not going to be running around in China selling small amounts of this and that..

Got it, got it. Fair enough. And then, just on the last part.

On these large CapEx projects from Charter -- I guess, the question is that, if these guys come in to you with a large order and kind of comes back to the margin standpoint, are these larger billion dollar run rate kind of CapEx budgets, do they require pricing concessions at all just because of the consolidation of customers?.

Well, it's a very competitive market. And you've always got pricing pressure. I wouldn't say that the uptick is triggering unusual activity..

Got it. Fair enough. Alright….

I mean, it's a competitive world as it is over in telecom..

Right. Well, you've definitely covered my questions. Congrats on a great quarter and I'll get back in line..

And I'm showing no further courses. At this time, I'd like to turn the call over to Jeff, the CEO, for any closing remarks..

Thank you. In closing, I just want to thank the team here at EMCORE for the hard work they put in every day. I believe I speak for everyone when I say how proud we are of the business we've built, the opportunity that lies ahead. And thank you all for your time today, especially those guys from the west Coast who have woken up early.

Thanks, again, and we look forward to talking to you soon..

Thank you for participating in today's conference. This does conclude the program, you may all disconnect. Everyone, have a great day..