11 May 2016

Emcore grows margin and income year-on-year despite seasonal drop in quarterly revenue

For its fiscal second-quarter 2016 (to 31 March), Emcore Corp of Alhambra, CA, USA - which provides indium phosphide (InP)-based optical chips, components, subsystems and systems for the broadband and specialty fiber-optics markets - has reported revenue of $21.5m (towards the low end of the $21-24m guidance), down 4.3% on $22.5m last quarter but up 12.6% on $19.1m a year ago in a typically seasonally weak quarter.

"Similar to last quarter, the results reflect demand in our CATV and components product lines [with cable TV comprising 60-65% of total revenue], despite seeing continuing pressure on our chips product line," says chief financial officer Mark Weinswig.

Revenue for chip-level device products has been relatively flat for the last two quarters, at $4m (19% of total revenue, mostly from GPON applications), as an unseasonal increase in shipments from Q1 to Q2 was counteracted by pricing pressure. Nevertheless, revenue has grown significantly over the prior two years (with first-half fiscal 2016 chip revenue already exceeding the total for full-year fiscal 2015).

The rapid rise in GPON volumes (starting at the end of February) has not only helped to accelerate top-line growth but also significantly improved manufacturing utilization and allowed Emcore to greatly reduce the fixed-cost burden allocated to remaining businesses, including its core CATV business.

On a non-GAAP basis, gross margin was 32.6%, on the low side of the mid-30s target range but down only slightly from 32.9% last quarter despite the $1m drop in revenue.

Total operating expenses were $7.4m (flat on last quarter but down from $8m a year ago), comprising $2.6m in R&D expenses and $4.8m in selling, general & administrative (SG&A) expenses (which included $0.3m from legal activities).

Net income is up from $3m ($0.10 per share) a year ago and $1m ($0.04 per share) last quarter to $4m ($0.15 per share). However, this includes $3.8m ($0.16 per share) of income from discontinued operations related mainly to the Sumitomo Electric Industries (SEI) arbitration ruling in April. Income from continuing operations was $0.6m ($0.02 per share), down from $1.3m ($0.05 per share) last quarter but up from $0.25m ($0.01 per share) a year ago.

Capital expenditure (CapEx) was about $1m (making $2.2m in first-half fiscal 2016 - CapEx is expected to be hit $5m for full-year fiscal 2016, exceeding the target of 5% of revenue).  

During the quarter, cash and cash equivalents fell from $115.5m to $110m, due mainly to an increase in accounts receivable and inventory (but excluding the receipt of cash from the Sumitomo arbitration finding announced in April).

Regarding Emcore's cable television business, the firm has seen an overall backdrop of strength in infrastructure spending along with turbulence over the past two quarters relating to inventory build up in the channel and some consolidation in the market. "We see this turbulent period ending, as we've seen significant strength in new orders as we finish Q2 and in our first month of Q3," notes president & CEO Jeffrey Rittichier. "Going forward, we expect to see a return to growth in cable television. The strength of our most recent orders clearly demonstrates that MSOs are making their planned shift to DOCSIS 3.1 deep fiber deployment. These new architectures allow them to compete more aggressively with telco and satellite products, offering a faster network that can deliver 4K and over-the-top services much more efficiently. Given our leadership position in the market and the significant investments that we've made in cable TV chip technology over the past few years, Emcore is enabling the shift to DOCSIS 3.1," he adds.

"Importantly, the successful conversion of our linear EML [LEML] is a new opportunity for our cable television business over the next few years, as LEMLs have superior cost:performance ratios to the traditional externally modulated transmitter technology that exists in the market today," says Rittichier. "Over the next year, as we roll out new products based on the LEML and its derivatives, we expect that those products will set the standard for both DOCSIS 3.1 and RF-over-glass deployments in the future."

"Despite consolidation at both the MSO and OEM levels, and a strong competitive market overall, Emcore's technical position and strong market share has allowed us to keep pace with and even exceed overall market growth by entering new segments where we have not competed in the past," continues Rittichier. "Given our position in the market, our strong relationship with customers, broad suite of product technology and leadership, we have good reason to be excited about the outlook for cable TV going forward. CapEx spending and network upgrade deployments are healthy and, given our market share leadership and relationships with customers, we have an excellent technical position and a good handle on the dynamics in the market. Consequently, we feel confident in our ability to continue to provide differentiated products over time. Coupled with our manufacturing and operating cost reduction initiatives, cable television remains a very attractive stable foundation upon which to grow into other areas," he adds.

With trends in cable TV continuing to improve, for fiscal third-quarter 2016 (ending 30 June) Emcore expects total revenue to rise to $22-24m.

Rittichier notes that Emcore is implementing its hybrid EMS (electronics manufacturing services) model to reduce cost and convert fixed cost to variable cost. So, commodity processes will no longer be done at Emcore, even in China. Emcore is removing satcom assembly & test from its US facilities to Thailand this quarter, and several commodity processes have already been moved from its Chinese facility to its two primary EMS partners (e.g. TO-can packaging, box builds and turnkey assembly, which can hence be done more efficiently). "We've already started to insert robotics into our Alhambra chip fab operation, and just finished installing new automated processes (which reduced labor by 80%) in our transmitter tune and test processes in China. This produces much better return on assets, improves operating leverage and ultimately reduces cost," says Rittichier.

"While we are implementing new strategies that should improve our operating model in future periods, those activities will lead to some additional cost in the next couple of quarters and take some time to realize," notes Weinswig. Emcore hence expects gross margins to be in the low-to-mid 30s for fiscal Q3/2016.

"Within our chip business, we have a number of process and technology initiatives in the fab, which will help drive down cost, such as migration to 3-inch wafers, outsourcing of commodity epi growth, and automated techniques for coding, simulation, test and sort," elaborates Rittichier. "These steps will enable us to compete more aggressively in the market over the long-term. Automation is especially important to this initiative, as chip fab operations have been labor-intensive. New equipment is being installed to modernize our fab and improve its productivity," he continues. "We have determined that supplying bars to third-party dicing, packaging and sorting vendors provides the right mix of value-added services on Emcore's part versus what could be done more efficiently elsewhere. As these products begin absorption in the market within the next year, we expect that they will drive higher gross margins in our chip products, while marginally reducing ASPs [average selling prices] since the product will not have undergone as many manufacturing steps, and thus will be sold at a lower price from Emcore."

"As we implement these initiatives and others across their business, you should expect to see some inventory build up over the next couple of quarters," says Rittichier. "Additionally, we've been incurring some double costs on the personnel side during the transition of certain manufacturing processes, which will improve as we exit the calendar year," he adds.  

"We're now two quarters into this transformation of our manufacturing operation and are beginning to realize improvements in operating leverage, cycle times, yields and product costs," says Rittichier. "Even last year's revenue dip came with slightly better margins. Once our manufacturing initiatives are complete, we expect to see further upside in the model over time." Emcore's current model is for breakeven on a non-GAAP basis at revenue of about $20m per quarter.

"While the competitive pressure within GPON has increased in the last two quarters, the chip business remains important to us, because it spreads our fixed manufacturing cost over larger numbers of devices while laying the foundation for next-generation applications," says Rittichier. "One can think of our GPON business as really just our initial offering in the merchant chip market, as Emcore intends to become a broad supplier of chip-level products to the entire telecom industry. As the market shifts from 2.5G GPON to the 10G standard, Emcore will be in a far more favorable position given our long history as one of the industry's premier optical semiconductor manufacturers." 

"Although GPON is an important opportunity, we've also been working to ship our chip product," continues Rittichier. "As we exit fiscal year 2016, we expect a third of our chip revenue to come from non-GPON chips. As a result, we will optimize our product mix between captive and merchant use to drive a higher blended margin for both our chip business and the rest of the company's products."

While smaller than cable TV, Emcore enjoys a strong market share in satellite communications and a close relationship with customers. "Unlike the migration from DOCSIS 3.0 to DOCSIS 3.1 in the CATV market, the satcom business has not historically been network-upgrade driven. However, this has the potential to change with the proliferation of distributed antenna solution and ultimately 5G networks in general," says Rittichier. "With the build out of 5G networks on the horizon, DAS (distributed antenna systems) represents an important new opportunity for our existing satcom technology as the sheer number of devices needed in DAS application is an order of magnitude greater than our served market today," he adds. "As wireless networks are upgraded to the new 5G standard, we expect the linear fiber transmission between equipment racks and smaller more densely populated antennas will be critical. Additionally, not having to convert from digital to RF, but the antenna itself, provides significant cost saving," continues Rittichier. "We see Emcore's linear optics technology continuing to reach further into wireless applications going forward and are excited about the partnership that we have with one of the world leaders in DAS technology for their 5G system deployments. While this market remains in its early stages, the progress over the past years have been healthy and we look forward to continuing to work with customers in this space and increase our number of design wins ahead of full scale deployments in the years ahead." 

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