Ladies and gentlemen, thank you for standing by and welcome to the EMCORE Corporation Fiscal Third Quarter 2020 Earnings Conference Call. [Operator Instructions]. 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 our business and 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 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 in 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 our company's annual report on Form 10-K.

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, which we believe provide meaningful supplemental information to both management and investors. The non-GAAP measures reflect the company's core ongoing operating performance and facilitates comparisons across reporting periods.

Investors are encouraged to review these non-GAAP measures as well as the explanation and reconciliation of these measures to the most comparable GAAP measures included at the end of our earnings press release, included as Exhibit 99.1 to the Form 8-K we furnished to the SEC today.

These materials can also be obtained in the Investors section of our website at www.emcore.com. With me today from EMCORE are Jeff Rittichier, President and CEO, and Tom Minichiello, CFO. Jeff will begin with a review of the third quarter and business highlights, and Tom will review the financial results before opening the call up for questions.

Now, I'll now turn the call over to Jeffrey Rittichier..

Thank you, Erica, and good morning, everyone. In Q3, EMCORE's aerospace and defense, as well as our broadband businesses, drove a 14% increase in quarter-over-quarter revenue. The combination of top line growth and operational initiatives resulted in a 7 point improvement in gross margin despite facing a full quarter's impact from the COVID pandemic.

Our four manufacturing operations improved their productivity thanks, to the diligent efforts of our supply chain, manufacturing partners and more importantly, because of the commitment of the team at EMCORE. Although we settled into a rhythm to deal with most of the C19 outbreak, new challenges constantly emerge that have to be dealt with.

In Q3, we saw surprise push-outs and cancellations of key component deliveries, which required significant creativity to resolve. In addition to the risks from identifiable areas such as labor, material supplies and logistics services, the pandemic continued to increase the general level of friction in ongoing business activities.

Tasks take longer than they should; customer development schedules continue to be pushed to the right, and we've had to adjust our plans accordingly. Keeping our workforce healthy remains a top priority and we've gone the extra miles to protect our team to the best of our ability.

The transition of our cable TV manufacturing operations at Hytera's Bangkok facility, continues to face a fluid schedule. On the positive side, cable TV's demand is very strong, which is required that we minimize the downtime of a major line move from Beijing to Bangkok to meet critical customer demand.

On the negative side, our manufacturing engineers still can't travel to Thailand to complete the transfer of target yields. Therefore, the best strategy for mitigating the risk and maximizing the revenue is to delay the final transmitter line move to the end of the September quarter and the remaining operations to the end of December.

We've also taken additional steps to build out a stronger Thai manufacturing engineering team to support the schedule, should travel continue to be restricted. This move to variable cost manufacturing is a critically important strategic initiative.

As more operations move from Beijing to Thailand, we will see upward pressure on the gross margins from cable television. Turning to the individual business areas, the Broadband unit performed well in the third quarter, largely driven by cable television.

MSOs continued to invest in their networks to break the bottlenecks created by bandwidth demand from both work-from-home initiatives and stay-at-home entertainment. This has resulted in a full order book for EMCORE's cable TV products through the December quarter.

Beyond this point, we remain cautious of the ultimate duration of the upgrade cycle, and are working to complete our move to variable cost manufacturing while orders are strong.

As we said in the May call, it's clear the MSOs are relying on proven, linear optics technology to meet their current needs, and that architectures such as DAA or Remote PHY are being pushed into the distant future.

We continue to believe next-generation Remote PHY Shelf products, which incorporate linear optics built by EMCORE will gain traction in the market at the expense of legacy DAA. In aerospace and defense, our QMEMS product saw a return to normalized demand levels from the seasonally soft second quarter, and experienced improvements in gross margin.

The QMEMS team did a remarkable job improving their operational performance. The Concord development team is expecting to release some exciting new products over the next few months, expanding the markets for our navigation products into weapons platforms.

Demand for our Defense Optoelectronics products remained strong, with high double-digit growth from the same period last year. Production orders for our Fiber Optic Gyro products similarly remained nominally on plan, as we continue design validation and qualification testing on new products.

While our confidence in the new products remains strong, C19 continues to place constraints on access to testing facilities and our ability to collaborate with customers to complete the necessary qualification work.

As a result, although we fully expect these challenges to be transient in nature, it's difficult to project the timing of testing milestones. Independent of the ongoing uncertainty in the markets around us, we continue to make big steps to optimize our business and create operating leverage as well as reduce costs.

The restructuring actions and ERP implementation in Concord, completed in March and June quarters, resulted in a net decrease in headcount. We've also begun to realize the synergies projected as part of the SCI acquisition by applying Six Sigma discipline to the QMEMS manufacturing process.

We've successfully raised gross margins for these products to be in line with corporate average. Rack rates are lower and we've resolved several legacy process problems, which have impacted deals.

Although the Concord team led the margin improvement program across the company this quarter, they also have significant opportunities for further improvement from here.

Moving on to guidance for the fourth fiscal quarter, we're expecting to see a strong performance from cable television, QMEMS and our Defense Optoelectronic product lines while we work through the challenges caused by the pandemic. Taking this into consideration, we currently expect revenue to be in the range of $29 million to $31 million.

With that, I will turn the call over to Tom..

Thank you, Jeff, and good morning, everyone. Consolidated revenue in the fiscal third quarter was $27.3 million, up 14% compared to $23.8 million in the second quarter, as revenue increased for both business segments.

Aerospace and defense revenue grew 8% to $14 million this quarter, compared to $13 million in the prior quarter, driven predominantly by QMEMS rebounding strongly from its seasonally soft March quarter.

Defense Optoelectronics revenue continued to perform well, staying essentially flat when compared to its high-growth quarter in fiscal 2Q, while FOG revenue decreased due in part to COVID-related new product testing delays.

Broadband revenue was up 22% to $13.3 million this quarter compared to $10.8 million in the quarter before, driven largely by the robust demand for our cable TV transmitters and components. Quarterly revenue also increased sequentially for our chips and sensing products.

Moving on to the rest of the operating results, consolidated non-GAAP gross margin expanded to 34% in fiscal 3Q, a 6% increase when compared to 28% the quarter before.

The sequential upturn was largely due to the 36% gross margin for the aerospace and defense segment, rising from 23% in the prior quarter, as QMEMS margins grew substantially, driven primarily by better production yields and a more favorable mix. We also continued to make progress improving our Defense Optoe margins.

The Broadband segment gross margin at 33% was essentially flat on a sequential quarter basis, as the higher volume was offset by a less favorable mix.

Following two back-to-back fiscal years of non-GAAP gross margins at 23%, our fiscal 2020 year-to-date gross margin has climbed to over 30%, as our consolidated and both segment gross margins were all at 31% through the first 3 quarters of the year. Non-GAAP operating expenses were $10.1 million compared to $10.4 million in the prior quarter.

The lower OpEx was primarily driven by headcount-related reductions, including lower travel expenses, as well as a nonrecurring expense recorded last quarter. These reductions were partly offset by higher insurance expense and increased Broadband R&D.

Expense reduction actions over the past 3 quarters have resulted in lowering quarterly non-GAAP OpEx by $2.3 million or 18%. The non-GAAP operating loss this quarter narrowed to $700,000 compared to $3.8 million in the prior quarter.

Adjusted EBITDA, which adds back depreciation, turned positive again this quarter at $300,000 compared to negative $2.5 million in the quarter before. Turning to the balance sheet, we had cash net of a loan payable of $23.2 million at June 30 compared to $22.1 million at March 31.

The $1.1 million generated during the quarter was attributable to $700,000 in cash from operations and $1.4 million received in connection with cable TV manufacturing equipment sales to Hytera. These cash increases were partly offset by $1 million in capital expenditures. With that, we'd like to now open up the call for your questions..

[Operator Instructions]. Our first question today comes from Jaeson Schmidt from Lake Street. Please go ahead, your line is open..

Jeff, just want to make sure I caught your comment correctly. It sounded like you -- it was a surprise push-out in cancelation in the quarter.

Just curious if you could quantify what sort of impact that had on June?.

Surprise cancelation and push-out, not quite sure -- can you give me a little more detail?.

Okay. I might've just misheard that then. So I guess just moving on to the cable business, it sounds like that remained strong. I think it's fair to characterize this as you're seeing more of a surge than a spike.

Are you at all worried that this is pulling forward from demand though?.

Good question. No, I'm not really too concerned about that. As we talk to the MSOs directly as well as to our customers, what we see is a pretty significant shortfall in network capacity. And the cable operators are scrambling to break those bottlenecks.

And so the CapEx from the MSOs is highly slanted toward node splits, which directly impact the bandwidth available at homes and businesses. So surge is probably a much better term; I don't think it's going away quickly. But we're certainly not going to be driving investment into more equipment or anything.

It's all about completing the move to variable cost manufacturing. That's what's consuming us at this point..

Okay. And then the concerns related to the macro backdrop on the FOG business, are you still building out your engagement pipeline? I understand that in design and qualification, stages have been pushed out.

But do you continue to have pretty good dialogue and traction with customers?.

Yes, absolutely. I wouldn't -- well, let me take a step back. Yes, the conversations continue, testing continues, everything has just slowed down. So I just see it as schedules being pushed to the right, as opposed to opportunities lost..

Okay. And the last one for me and I'll jump back in the queue. Gross margin obviously, very strong, and I think the highest level since September 2017 if I'm looking at that correctly.

How should we think about gross margin going forward with sort of the moving parts in the push-out on moving the lines?.

So we're a lot closer this quarter to where I think you're going to see it in at least the next quarter and beyond. So you can see A&D did a large quarter-to-quarter jump, but if you average it over the couple of quarters, it's just over 30%, like I said.

And we're getting better operationally, which was really the key to the QMEMS portion of that segment, which is a significant amount of the revenue. So I think about that one as we did 36%, it's going to stay pretty close to that going forward. We have a few one-time items this quarter that rose it and spiked it up a little bit more.

But nonetheless, the improvements we're making are sustainable. So look for it to do mid-30s near term and with improvement beyond. And then you're probably going to see a bit of an uptick in the Broadband gross margin in the next quarter and going forward. We continue to get some of the benefits of outsourcing, but not all of them.

That'll happen once it's all complete in a couple of quarters from now, but we've got a good backlog, so we know what a lot of the mix is. So that's going to improve over the quarter, and the volume is up. So when you put it all together, mid-30s, 35 plus a point or two isn't out of the question..

And Jaeson, I just want to give you one other little bit of color on the QMEMS side. When we bought SCI, we got a great price on it. Part of the reason for that was a historical set of challenges on gross margin really meaning scrap rates.

And so we felt we were much better at solving those sorts of problems than the previous ownership and so we've applied that knowledge to the problem. The team has really stepped up and that's why you're seeing the improvement. So this was expected to be a key area of contribution and we've got some pretty strong proof statements now..

Okay. I really appreciate that color. Thanks a lot, guys..

Thank you. We will now take our next question from Tim Savageaux from Northland Capital Markets. Please go ahead, your line is open..

Congrats on the results, especially in this environment..

Thank you..

First, I wanted to ask a question on the broadband and cable TV optics side. Jeff, you referenced a full order book through December. I'd like to try and get a little more color on what that means with regard to maybe capacity, or I think your cable TV optics numbers are also as high as they've been in a while.

But they've certainly been higher in the past. So should we take that full order book commentary to imply, along with Tom's gross margin commentary, that you think cable TV revenues can grow further? And how does that marry up with some of the seasonality you might normally see heading early into your fiscal year? And then I'll follow-up with that..

Yes, so first of all, let's tackle the immediate piece, which is seasonality. We've normally got this sawtooth thing where on a calendar year basis, where the March quarter tends to be the worst and the December quarter tends to be the best.

So from, let's call it, the guidance in the current quarter, if we were to break that out a little bit further and look into Q1 to explain my full order book comment, I'd say the numbers are going to be similar to slightly up, okay? We do have some constraints on production capacity at this point and it's strictly related to the fact that we've got equipment in 2 facilities, right? And as I pointed out, our ability to parashoot a team from Beijing into Thailand to get the production rates up and more importantly, the scrap rates to the point where they should be, is really what's limiting the top line at this point.

By the time we're done, those limits will be gone, but for the short term, we're going to be a little bit cautious about where things are because our hands are tied as far as how quickly we can bring up the Thai group..

Okay, fair enough. And to follow-up on the aerospace and defense side, last quarter, I think you had mentioned at least a potential headwind on the commercial aviation side possibly impacting things heading into the year-end or the second half of the year.

Obviously, it doesn’t appear to be impacting your guidance for the September quarter, but I wonder if we can get an update on your kind of thoughts there?.

Sure. Actually, September guidance would've even been higher, so that's already factored into the couple of push-outs that we're looking at will occur in the September and December quarters, okay, so that's all baked in.

And it's strictly related to the commercial aviation side of the QMEMS business, and one particular customer that supplies the commercial aviation market. And there's that that has to push out and we're a good supplier, so we'll play ball with them.

It's not a cancellation in orders, so our hope is that we can use some of that to offset the seasonally soft March quarter. And we're in negotiation with our customer to do that..

Great. And then the last question for me, you mentioned some growth on the cube side of the business within broadband. We've been hearing a lot of good things about 10-gig PON sort of globally lately. I think you have some exposure there. I know the business is also driven by high-speed telecom.

But give us your thoughts on the PON market these days and the opportunities that might present for EMCORE and just an overall update on chips..

Sure. We do have some exposure to 10G PON and we are getting some business there. As you correctly point out, that market has been stalled for a couple of years. I think generally speaking, the entire cost of the suite of devices necessary to deploy it in production, those problems have been solved.

So I'd expect some continued improvement in chips and better margins out of that group. But part of what we've got going on here is some additional customers that are not buying, let's call it, commodity product, and that is also helping us..

Okay. Thanks very much, and congrats again..

[Operator Instructions]. We will now take our next question from Dave Kang from B. Riley. Please go ahead, your line is open..

Tom, in your prepared remarks, you talked about gross margin there, some kind of like upward pressure. Can you explain that? I think I missed that..

Well, that would be I think in the broadband, we're referring to the broadband segment, largely the cable TV business, which it's been similar response to the question earlier, we're likely to see a move upward there with a better mix quarter-over-quarter, and continued progress on the cost side, as we transition to outsourcing.

And that's pretty much what we were referring to..

And then so you talked about near-term gross margin in the mid-30s.

And then beyond near term, where can gross margin go?.

Well, right now, we're modeling in the mid-30s, but yes, there's room to go north of that into the high-30s. We forecast out for a certain period of time and then but long-term, we're looking to get towards 40 and above. It's going to rely on a whole bunch of different factors, especially growth in aerospace and defense.

But that's how we're looking at it over the next 18 months..

Got it. And then regarding OpEx, obviously, you benefited from federal restrictions and all that.

But then once things normalize, and who knows when that is, but how should we expect OpEx when things normalize?.

Well, I'd say near term next quarter or two perhaps. We're at $10 million. You could see something go lower. The travel isn't going to come back in the fourth quarter or maybe not even in the December quarter. We'll see how that all works out. But we did have some benefit of a couple of restructurings we did over the course of the fiscal year.

And we'll get a little bit more of that benefit in the fourth fiscal quarter. So we're modeling 10, but it's got the potential to be a little bit lower than that..

Got it. And then, Jeff, you talked about next-gen Remote PHY with analog optics.

When should we expect that to materialize?.

Well, I need to be a little careful here because of NDAs with our customers. But these things are actively in the design cycles, right? So cable TV tends to move a little slower than some markets. I think it's entirely possible to see an evolutionary product in 9 to 12 months out there in the market..

Got it. And then, Jeff, during your comments, you noted several issues due to coronavirus.

So can you kind of quantify how much that was, or how much revenue left on the table then? Has that been baked into next quarter's guide?.

If you're talking about the push-out in aerospace and defense on the commercial side -- is that what you mean, David?.

Not only that, but then it looks like you have some supply chain issues and all that.

Maybe that contributed to some revenue impact as well?.

The supply chain issue, we were able to navigate. There's a couple of sole force components that completely went away, and we had to get real creative to come up with alternative solutions getting qualified and approved by customers. It was a lot of work, but it didn't affect us.

On the aerospace and defense side, what I said in the May quarter -- on the May call was it was very low-single-digit millions; call it a million or two. That's already figured into our guidance for the next quarter because that's -- it will be impacting us in the September quarter, December quarter.

So actually, the growth in the rest of the business is stronger than it even might look. But as far as FOG goes, it's just delays in getting stuff that we thought was going to be in production now through the qualification cycle. It all continues to move, it's just moving slower..

Got it. Thank you..

That concludes today's question-and-answer session. Mr. Rittichier, I would now like to turn the conference back to you for any additional closing remarks..

Sure. In closing, I'd just like to thank all of you for your interest in EMCORE. And I'd like to thank the EMCORE team for your commitment and very hard work. It clearly showed improved results. All of you, please stay safe. Thanks again..