Emcore’s quarterly revenue falls by 20.8% due to soft CATV demand and Huawei-impacted chip sales

For its fiscal third-quarter 2019 (to end-June), 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 $17.2m, down 20.8% on $21.7m last quarter and 2.8% on $17.7m a year ago. This is within 11 July’s revised guidance range of $17-17.5m but below its original guidance of $20-22m.

Broadband products fell from 65% of total revenue last quarter 57%, as spending by MSOs (multi-service operators) remained unusually soft in the cable TV sector (which fell from 49% to 40% of total revenue) despite their prior indications that spending would pick up from the seasonally soft fiscal Q2. “Low capital spending by the CATV service providers, coupled with the China trade dispute, created significant headwinds for Emcore in Q3 which will continue into Q4,” says president & CEO Jeffrey Rittichier.

Chip product sales fell from 16% of revenue last quarter to 11%. “The ongoing trade disputes with China are having a material impact on the demand for our chip products, most notably for GPON and those products sold into the Huawei supply chain,” notes Rittichier.

Navigation products jumped from 19% of revenue to 33%. “Emcore’s Aerospace & Defense [fiber-optic gyroscope-based] products performed well over the quarter,” says Rittichier. Within the SatCom product line (now part of Aerospace & Defense), revenue more than doubled year-on-year. “These high-frequency communication products are almost exclusively purchased by the same tier-1 Aerospace & Defense customers that purchase our inertial navigation systems,” notes Rittichier. “Applications for these products have moved substantially beyond their roots in satellite ground stations and are now used in Navy ships, radar systems and similar applications, significantly expanding the market opportunities that we see,” he adds. “We received the first half of an estimated $6m project to modernize FAA air-traffic control towers and should start shipping these products in fiscal Q1/2020.”

“Emcore has been working on its transition from CATV to Aerospace & Defense for several years now. While our Q3 results reflected strong headwinds to our CATV and chip products, our Aerospace & Defense offerings performed extremely well, showing 100% year-over-year growth,” Rittichier notes. “Raytheon is now Emcore’s largest customer, and Aerospace & Defense will be our largest product family in Q4 and beyond.”

Also, on 19 June Emcore announced the acquisition of Systron Donner Inertial (SDI) of Concord, CA, USA – which designs and makes quartz MEMS gyroscopes and accelerometers for customers such as Raytheon, Lockheed Martin, Rockwell Collins and other tier-1 contractors – for $22.8m in cash plus about 811,000 shares of stock. “These navigation products complement Emcore’s fiber-optic navigation products and will increase our serviceable market by at least $500m,” reckons Rittichier.

On a non-GAAP basis, gross margin was 22.3%, up from just 7.3% a year ago but down from 27.3% last quarter. However, this was due largely to $3.3m of under-absorption in manufacturing facilities related to the softer-than-expected demand from cable TV and chip products. Otherwise, gross margin would have risen to about 35%.

Operating expenses were $9.3m, $1m higher than last quarter due to additional investment in Aerospace & Defense and the inclusion of SDI operating expenses for the last three weeks of the quarter.

Operating loss was $5.1m (operating margin of -29.7%), an improvement on $6.9m (-39.1% margin) a year ago but worsening from $2.2m (-10.1% margin) last quarter due mainly to the lower gross margin, combined with the partial period inclusion of SDI’s results.

Pre-tax loss was $5m ($0.18 per diluted share), worsening from $2m ($0.07 per diluted share) last quarter but an improvement from $6.7m ($0.26 per diluted share) a year ago.

Capital expenditure (CapEx) was $3m (cut from $3.6m last quarter). Depreciation was steady at $1.8m. During the quarter, cash, cash equivalents and restricted cash hence fell by $30.1m, from $50.7m to $20.6m. The largest contributor to this decline was the purchase of Systron Donner Inertial for $22.8m on 19 June, plus a combination of lower-than-expected volumes and continued investment in Emcore’s fab and modernization of its campus.

“Where aerospace and defense was just an R&D initiative a few years ago, it’s become our largest opportunity. What started out as organic growth of our fiber-optic gyro products has been accelerated by the purchase of SDI and strengthened by a redesigned SatCom product line,” says Rittichier. “We’re adjusting our cable TV strategy to maximize profits as quickly as possible while our chip business is being redesigned to be strategically congruent with our Aerospace & Defense product line.”

For fiscal fourth-quarter 2019 (to end-September), Emcore expects revenue to rise to $22-24m, reflecting strong growth in navigation products (to more than half of total revenue, including a full quarter’s worth of contribution from SDI), offset by continuing softness in cable TV and chip markets.

“[For the chip business], an anti-American stance has been taken for many new design-ins in China, threatening to limit future opportunities to only those products that cannot be sourced from China, Taiwan, Korea or Japan,” comments Rittichier. “Given the ongoing uncertainty around mid- to long-term demand within this market, we’ve chosen to exit many of the lower-margin segments earlier than planned and focused our efforts on a smaller subset of higher-margin products,” he adds. “This trade dispute will not end anytime soon. Consequently, we are also working to change our supply chain strategy to minimize the impact of additional tariffs.”

“While both [major publicly traded] MSOs indicated that capital expenditures will increase in the second half of the calendar year, we remain skeptical that this will occur and have factored out any improvement in the current quarter,” says Rittichier. “Infrastructure demand has hit an eight-year low, which is consistent with the historical bottom of cable TV cycles. We expect the demand to improve from these levels, consistent with the comments from the MSOs, but don't believe that this will occur before calendar Q4. Consequently, we are going to take aggressive actions to create a smaller, more profitable cable TV business going forward,” he adds.

“The current Emcore business (excluding contributions from SDI) is running with a breakeven point of about $24m,” notes Rittichier. “Pricing has not changed in the cable TV market nor has the competitive situation. This dictates that we need to match the breakeven point of Emcore’s legacy business to the new market realities. I’m committed to making an impact on this in the current quarter,” he adds.

“To achieve this, we’re taking four major actions to reduce our breakeven point for legacy Alhambra products. First, we’re moving to an EMS [electronic manufacturing services] model for manufacturing, which will eliminate the under-absorption from the EA facility within three quarters. Secondly, we’re reducing the wafer fab operations to a single shift to reduce fab under-absorption as we emphasize our higher-margin chip products. Third, we’re going to adjust the size of the organization. Fourth, we’re working to accelerate the synergies between our two facilities in California [Alhambra and now Concord] to maximize cost savings and our opportunities,” says Rittichier.

“The combination of the trade dispute and cyclical cable TV weakness demands that we speed up our timetable to resize and move to an EMS manufacturing model for cable television while retooling our chip business,” Rittichier explains. “In 2015, we began to automate our assembly & test processes in China and completed that work in 2017, making it possible now to move to a true variable-cost EMS model for cable TV manufacturing within approximately 9 months from now, with testing and qualification taking up the majority of the time line. During this period, we expect to see a gradual improvement in absorption as the EA facility shrinks its role. Beyond our move to EMS, we also plan to make additional changes in our staff to align expenses with revenue,” he adds. “In addition, we are in the midst of working on alternatives to monetize our Concord, California facility. While we will ultimately consolidate certain functions between our two California facilities, Concord has very important strategic value for Emcore.”

“When complete, the sum total of the various actions we’re taking should gain us $15-20m in cash,” says Rittichier. “This should provide us with a steady improvement in gross margin over the next three quarters, culminating in a return to the mid-30s when these initiatives are complete.”

In the December quarter, on the basis of what MSOs have said about capital spending, Emcore expects CATV business to improve, perhaps significantly.

“We continue to forecast that SDI will generate cash and profits in the December quarter, as previously indicated, and generate additional cost synergies with Alhambra,” says Rittichier. “Between these initiatives and a scaled-back CapEx plan, which we are still reformulating, we expect to have the cash that we need to meet the ongoing needs for the business.”

See related items:

Emcore cuts June-quarter revenue guidance from $20-22m to $17-17.5m

Emcore’s quarterly revenue grows 16.7% year-on-year to $21.7m

Emcore’s quarterly revenue falls 4.9% to $24m

Emcore quarterly revenue rebounds by 42.5%, driven by larger-than-expected cable TV orders

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