Ladies and gentlemen, thank you for standing by and welcome to the EMCORE Corporation Fiscal Second Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-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 Ms. Erica Mannion of Sapphire Investor Relations. Please go ahead, ma'am..

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, levels of activity, performance or achievements of 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 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.

US 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. 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 press release included as Exhibit 99.1 to the Form 8-K we furnished to the SEC today.

These materials can also be found in the Investors section of our website at www.emcore.com. With me today from EMCORE are Jeff Rittichier, 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 second quarter guidance before we open the call up for questions. Now, I'd like to turn the call over to Mark..

Thank you, Erica, and good morning, everyone. Today I will focus my discussion on EMCORE's fiscal year '19 Q2 financial results ending March December 31, 2019.

Consolidated revenue for the quarter came in at $21.7 million with broadband revenue representing 65% of total company revenue, down from 72% in the prior quarter as demand in the Cable TV market exhibited its typical seasonal softness.

Chips represented 16% of revenue as compared to 18% in the prior quarter, driven mainly by production set downs related to Chinese New Year. While navigation grew to 19% of revenue from 10% in the prior quarter. Overall, CATV was 49% of revenue for the quarter.

GAAP gross profits in Q2 were approximately $5.8 million or 26.7% of revenue, up from 24.2% in the prior quarter. The sequential increase in gross margin was largely driven by improvements in our manufacturing cost structure which largely offset to seasonal declines I discussed earlier.

Total GAAP operating expenses for R&D and SG&A were $11.3 million, $0.3 million lower than the prior quarter and $2.4 million higher than the prior year. In Q2, our operating expenses remain roughly in line with the prior quarter as we continue to incur litigation expense at similar levels to Q1.

Having now entered the post-hearing phase with respect to a majority of the claim, we would expect to see this cost decline significantly in Q3. On a GAAP basis, the consolidated operating loss for the first quarter was $5.5 million.

Our non-GAAP operating loss from continuing operations after excluding certain adjustments, all of which are set forth in the non-GAAP tables included in today's press release was $2.2 million, a $0.4 million increase compared to the prior quarter, as improvements in gross profit offset the revenue decline.

As a percent of revenues, in Q2 fiscal year '19, non-GAAP operating income was a negative 10.1%. Our non-GAAP pre-tax loss from operations was $2 million. Moving on to the balance sheet and cash flow statement.

At the end of Q2 fiscal year '19, the company's cash and cash equivalents including restricted cash were approximately $50.6 million, or a decrease of $6.7 million quarter-over-quarter. This decrease is primarily a result of the current quarter loss from operations, and our investment in capital expenditures.

The overall decline in cash was in line with our expectations for the quarter, as we continue to invest in our fab and modernize our campus. Regarding our working capital metrics, days sales outstanding were at 83 days, up compared to 78 days in the prior quarter. Net inventory turns including non-current inventory were 3.1x.

Capital expenditures in the quarter were $3.6 million and depreciation in the quarter was $1.6 million. With that, I will turn the call over to Jeff..

Thanks, Mark, and good morning, everyone. As Mark highlighted, we continue to deliver on our revenue diversification and operating performance initiatives in the second quarter. Within our non-cable TV products, we saw strong sequential growth, driven largely by our navigation product.

On the margin front, GAAP gross margins increased by 240 basis points with cost improvements outpacing the seasonally lower volumes. As we projected in our last call, in Q2 we eliminated the overwhelming majority of costs associated with transitioning to the L-EML technology.

However, decreased volumes did cause under-absorption, which depressed gross margins by 560 basis points below our standard margin. With transition cost behind us, the only thing that prevents us from returning to more historically normalized margin is cable TV volume. Within the cable market, demand came in as expected.

Volume were in line given this impact of typical winter seasonality. Remote PHY remains a distant threat that we believe will not impact our business this year and remains unlikely to have a material impact in the intermediate-term.

L-EML penetration continues to progress with the new standard transmitter designed for smaller customers who need access to this important technology, but who cannot justify the expense of the custom transmitter development.

Overall, the technical capabilities and associated performance benefits from these products continue to capture the attention of both MSOs as well as our direct customers. L-EML technology development is robust and expected to yield next-generation products in the coming months.

Outside of cable TV our other broadband product sales were particularly strong. Satcom products increased 33% quarter-over-quarter and 227% year-over-year and several larger projects were shipped. Satcom backlog remains strong into Q3 and include the program to modernize air traffic control towers with EMCORE technology.

With respect to our wireless products, we continue to make progress on our new product initiatives within the DAS and 5G market segments with production revenue likely a late fiscal 2019 to 2020 event when 5G deployments move beyond trial phases. Moving on to the chip market.

In the second quarter, we saw moderation in demand driven by a combination of a strong preceding quarter and the impact of Chinese new year.

With that said, overall demand in the second quarter remained strong, growing 20% year-over-year driven by a combination of both legacy 2.5 GPON products for the Chinese market as well as non-GPON-related products.

Looking ahead, our new product initiatives remain on track with various phases of sampling occurring on a variety of 25G parts for the data center and more advanced components for the telecom markets.

As these new products are released into the market and begin to generate production volume level, we expect to see an even greater shift in mix to non-GPON products in the quarters ahead, which will have a positive impact on margins.

Finally within the navigation market, we saw a record performance from the navigation team with revenue increasing 66% quarter-over-quarter and 100% year-over-year. Putting this product line on track to double its revenue once again from FY '18 to FY '19.

New customers were added over the quarter that will purchase our lithium niobate IOCs, increasing the volumes through manufacturing to take advantage of the substantial operating leverage that we built into our operations.

Navigations four year pattern of generating substantial growth in percentage terms now seems poised to start generating materially larger absolute dollars as we exit the current fiscal year. The challenge for us is to continue the same growth pattern in navigation revenue into FY '20 and beyond.

To accomplish this we're making heavy investments in engineering talent, manufacturing engineering and capital equipment. Our engineering team continues to make excellent progress on both development contracts for custom products as well as internal product development initiatives for new technologies.

To that end, we're preparing to ship the first of the new generation of custom IMUs to a major defense prime contractor this week. The customer seems very pleased with the performance of the unit and look forward to moving on to low-volume production in the fiscal new year.

On the operations front, we expect to take delivery of the first of the new generation of automated manufacturing tools in the current quarter that will improve across throughput and quality across the entire navigation product family.

Operationally, as we discussed in prior calls, over the past several quarters we faced cost headwinds resulting from faster than expected ramp up in our L-EML product line and its associated accounting impacts. As of the end of the second quarter, we work through these issues and expect gross margins to increase as volume returns.

In addition, as we look out over the next few quarters, we expect to see further improvements in gross margin as we increase profit contribution from new chip products and see significant yield improvements in our manufacturing processes and extended supply chain, which will translate into improvements in final product cost.

In particular, L-EML yields continue to improve across the board and at this point we expect those product cost to achieve their targets. Regarding our campus initiatives -- campus upgrade initiatives, those remain on track and are already helping us become more efficient as we free up space in the cramped Alhambra campus.

These efforts will free up 20,000 square feet of floor space and allow us to finally group our personnel logically. Our upgraded FOG manufacturing space should be completed in the current quarter and new navigation laboratory space build out will start after that. Now turning to the outlook for our business.

As I pointed out earlier in my comments, the only thing that stands in the way of return to profitability is cable TV product volume. CATV is a notoriously cyclical business and the key to developing guidance is understanding the MSOs spending environment, which typically becomes clear right around this time every year.

EMCORE's market share is nearly 70% in the downstream optical component market, so our CATV revenue generally follows the infrastructure CapEx spend of the MSOs. Recent announcements by one of the major MSOs provided some important visibility and show that the Q1 CATV MSO CapEx was at nearly a 5-year low in Q1 calendar '19.

This MSO went on to point out that the expected spending to increase over the year, but that their whole FY '19 infrastructure CapEx would be lower than FY '18. Therefore, we should expect to see an uptick in CATV starting at the tail end of EMCORE's current fiscal quarter progressing through the end of calendar year '19.

Given the two-week cycle for recognizing revenue from shipment into virtual managed inventory, we can't be sure the potential shipments will count for revenue in the current quarter.

Consequently, we expect revenues to be in the range of $21 million to $23 million, which reflects CATV orders returning toward normal late in the quarter along with chip and navigation products roughly steady. Again, we expect navigation to roughly double on the year and chips to have strong double-digit growth over the year.

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

Operator?.

Thank you. [Operator Instructions] And our first question will come from Mr. Jaeson Schmidt with Lake Street..

Hey, guys. Thanks for taking my questions.

Just starting off on the navigation business, curious if you could quantify the number of customers or engagements currently in that navigation pipeline? And any color on how that it's grown over this last quarter?.

Hi, Jaeson. So the navigation pipeline keeps growing and we have a frighteningly large funnel at this point. As you’re aware it's a complex technology, so it's not so much turning, let's call it prospects to orders. It's about our ability to ramp the manufacturing process on this complex product line.

So with that said, it wasn't -- I wouldn’t say that there's been a huge growth in the funnel.

We got customers that are legacy customers that have been taking more, but I would also say that there is been a significant uptick in sampling and we're scrambling to try to make good on those sample request and in the case of some customers qualification product..

Okay. That’s helpful.

And looking at the CATV business, I know you outlined some of the moving parts here in the June quarter, but just curious your confidence in being able to actually grow CATV revenue in fiscal '19?.

When we say grow, I would point out that I said that infrastructure CapEx spend as reported by two of the three major MSOs that are U.S public companies, right? Liberty Global doesn’t report anything because they don't have to, indicates that they’re going to have a softer '19 over '18, but when you take a look at the math what you see is the Q1 was so like for both of them that we will -- we should expect an increase in orders from both of those MSOs through our customers, who are primarily Cisco and Arris as you guys know.

As we go into deep channel checks, if you will, both at Cisco and Arris and as we crosscheck things with our contacts in the MSOs, there's no data points that indicate that orders are going to be increasing.

It's really a very fine timing issue in the current quarter, right? I mean, if we don’t shift to one particular customer with BMI by roughly the middle of the month, we can't be sure it will get through their process and generate invoices that we then use to recognize revenue.

And so I’m being a little cautious on the visibility for the current quarter, but all indications are at every level in the supply chain the cable TV will be moving up, beginning right at the end of the quarter..

Okay. That's helpful. And the last one for me and I'll pass it. I know there's lot of moving parts with the mix shift and then some of the manufacturing changes.

But what's a good ballpark quarterly revenue run rate we should think that is the new breakeven level?.

So, again, it's very mix dependent. If we kept the exact same mix that we're currently at, right, it would -- you probably have to put another 4 ….

$5 million..

… $4 million to $5 on top of it to get to breakeven. If the mix shifts more toward cable or navigation away from chips, then that number becomes smaller..

Okay. That makes sense. Thanks, guys..

Thank you. Our next question comes from Mr. Dave King with B. Riley FBR..

Great. This is Lee Krowl joining in for Dave King. Thanks for taking my questions.

Just a quick question, maybe it's just I flipped my mind, but could you maybe talk about whether there's any cannibalization, I guess, as customers transition to the newer L-EML product and whether that’s a revenue headwind?.

Hi, Lee. The short answer is no. There's no cannibalization. We -- and I'm not quite sure that I understand what you mean, but let me try to answer it two ways.

First of all, at the customer level, there was originally some question about whether the acquisition of Arris by CommScope would cause one level of cannibalization, i.e., there's overlap between the product lines and that is certainly not the case. There is no overlap between CommScope and Arris.

The second thing is in the case of, does one product substitute for another? The answer is yes. So when an MSO puts in a link, you either could sell a DFB laser, a DFB transmitter or an L-EML transmitter, okay? So there's a zero-sum game at the link level, the connection between the head and the neighborhood.

So consequently an increase in L-EML sales does put a decrease in DFB sales.

Does that answer your question?.

Yes, that makes sense..

Okay..

And then, I guess, you guys kind of alluded to investments and would you guys expect this CapEx trend to kind of stay in line or does it increase incrementally as you kind of accelerate some of these development efforts?.

I would say at this point, it's going to tend to remain in line with decrease at some point next year. There's two major sets of things that are going on, arguably a third.

But the two major things are upgrade of the wafer fab, right? So the original reactors here will install 20, 25 years ago and because of that when you go to put new reactors in, all of the building issues, safety systems that were grandfathered now have to be completely upgraded, right? So there's the cost of the equipment and then there's the facilitation expense, okay? So the wafer fab is in the process of being upgraded.

And then the other part is the changeover and upgraded facilities to support increased navigation manufacturing, okay? So as the -- where we’re at with NAV right now, so we take a look at increased volumes next year and potentially beyond there's things like rate tables, they’re used for final checkout and test that have 10 to 12 month availability, like all larger pieces of CapEx.

And those commitments have to be made significantly before they’re actually needed. But overall, I would say that it's going to increase. I would say, there will be some lumpiness, and I would expect to see the trend really start to change at some point next year.

And it's going to depend on the -- when certain equipment arrives and just how much of it that we end up needing in some cases..

Got it. That’s helpful.

And then just real quick on Satcom, maybe I missed it, but do you guys expect a similar run rate, just given how quickly that jumps in terms of a quarterly run rate for Satcom?.

Yes, Satcom is one of these things that can look like an overnight success, but the reality is these programs are put into motion, in some cases, a year or two ahead. So in the current quarter we're expecting to see sort of similar numbers that a Satcom and potentially into Q4. The other thing that is driving Satcom is this FAA control tower upgrade.

And so even if some of the larger projects that we’ve started shipping in this quarter and expect to ship -- I’m sorry, last quarter and this quarter there's additional business which should keep this number pretty much around where it is now for at least the next three or four quarters.

And there's always a little lumpiness, so we have to be careful. There's also a concern in one particular case we’ve got a sole-source component in the middle of it and sometimes, it can be hard to get those. But fundamentally the forces driving that business are solid and expected to move things at the current level..

Got it. That’s helpful. Thanks for the color..

Thank you. [Operator Instructions] Our next question comes from Mr. Tim Savageaux with Northland Capital Markets..

Good morning, Tim..

Good morning. I like to focus on the chip business for a moment. It looks like you mentioned strong double-digit growth for the year, expect it looked like, for the first half you are up about 50% year-on-year, which I would certainly characterize as strong double-digit.

I wonder if you can discuss kind of the drivers of that year-over-year growth, and also -- and I know the fab upgrade serves the whole business.

But sort of related to that, if you can discuss -- or I would just like to follow-up on some details of the cost and the timing of the reactor upgrade or the fab upgrade you kind of where we stay in that process?.

one of them is PON, the other one is -- let's call it, telco non-PON, and then the third is data center. So the things that are responsible for the growth broadening to some degree on the PON product into some places that are a little bit more difficult and are not quite commodity products.

And for example, if you look on the OLT side as opposed to the ONT side of the PON networks, you would find logical places where we would be heading there. Second thing is, I think we're still seeing good steady demand on our telco chips. Historically, that means game chips for SLBs, which are used as primary sources for external cavity lasers.

There are also -- there's some EML activity, not linear EML that I would classify as more telco than PON. And then finally there's strong sampling going on in the initial stages of us moving into 25G components over on the data center.

So, again, as more of these parts hit the market, it's going to take the mix away from GPON, and that an outsized impact on margins because GPON is just tough, right? Nobody really makes money in GPON anymore, okay? So that hopefully answers the question about what’s responsible for the chip growth. As far as the fabrication ….

If I could follow-up briefly. So -- ….

Sure..

… but is GPON albeit not great margin, I may have missed that comment, but is that growing? Is that part of the year-over-year growth story or is it mostly on the telco side?.

It's mostly the other stuff, Tim. So we ….

Okay..

… in some sense, the job of running proportional chip business is to sell the stuff or produce more of the stuff that has the greatest margin.

So if you have the ability to sell parts at greater margin, you just limit the number of parts you'll sell like GPON stuff that really do very little other than just pay overhead bills, right? So we now have a broader product line that’s enabling us to do more of that. And we're expecting that trend to improve going forward.

Does that answer the question?.

Yes. I know you mentioned OLT.

Any impact from 10 gig PON as of yet and could that improve the PON equation for you?.

The short answer is yes. So we've been selling 10G APDs for some time, I want to say better part of two years, we do see an uptick in volume there. And we are sampling 10G DFB sources, which have significantly better margin than the 2.5G stuff.

So, yes, 10G PON is -- there's an uptick, but it's -- I mean, you have the Chinese markets are, it's -- until you get reasonably close to cost parity between a generation of the line speeds, the market doesn't move quickly..

Okay. Thanks. And then, I guess on to the reactor, just I guess the total investment from soup to nuts as well as -- I don’t know, I think we may have discussed this before.

I don’t know if you got one new machine coming in or multiple or -- and what the overall timing of that is?.

Yes. So let me just hit reactors and I will try to give you some overall flavor on the other pieces because we could spend a half an hour going through this. So we have two reactors coming in. One is complete and in checkout, I think the second one is close behind it.

Again, those are $1.6 million a piece, significant amount of that is already been paid as is typical -- typically you get to this stage, you’re at sort of 10% final acceptance payments. And so now what we're doing is the facilities upgrades and the big expense is in stuff like safety systems.

It all has to be redone as you're aware -- there's these require what’s called an H-5 occupancy permit. And so you get significant life safety cost.

And the challenge you run into sometimes being in a place like Southern California is that the permits are slow in coming and the reason why is the municipalities, even the county guys, AQMD, they don’t do enough of this kind of work to have specialists on staff.

So when they don’t have that, they hire consultants and that links into the permitting cycle which links in the total installation cycle, okay? But if you wanted to take a swag, you would say, well, the equipment represents X.

The facilities costs are generally somewhere between 50% and 100% of the cost of the equipment, okay? At least for where we’re at right now.

So there's a significant set of facilitization cost that come along with MOCVD, right? This will probably the last set of upgrades that we do in this particular campus just because it's been so difficult to get permits and make everything happen on schedule. So beyond the reactors you’ve got other very important pieces of equipment.

You’ve got -- you do need operators and sputtering systems, which are used facet coatings, and you’ve got grading, litho upgrades and as well as PECVD. And a lot of those things have been done, but there's still more.

I mean EMCORE's fab was built when it was Nortel in the late '80s and some of the pieces of equipment are still running, it should be at a museum.

So, we are actively trying to move those out as quickly as we can get process engineering work done without being -- and I guess, you could say irresponsible even with the amount of equipment that we can install at one-time. So we are moving as fast as we can, but nevertheless it's a big job..

That’s a great review. Thank you..

Thank you. That concludes our allotted time for Q&A. I will now turn it back to our speakers for closing comments..

Okay. Quite simply in closing, I would like to thank all of you for your time this morning and your interest in EMCORE. And finally I would like to acknowledge the hard work of the entire EMCORE team and their commitment to making this a more successful business. Thank you very much..

Thank you. Ladies and gentlemen, that concludes this morning's presentation. You may disconnect your phone lines, and thank you for joining us this morning..