Overview
Emcore Corporation is a compound semiconductor manufacturer that serves the telecom, wireless and satellite markets. With major customers like Lucent and JDS Uniphase facing a prolonged period of weakness, its no wonder Emcore has seen its profit turn negative over the past few years. That slump may be coming to an end since the company is well positioned for new growth and margins are improving dramatically.
Strengths/ Opportunities
/Weaknesses/ Threats
EMKR has 4 new products for regional bell companies and Cable multiple system operators. / Cash burn and a weak balance sheet are weighing on the company.Systems revenue comprised 48% of total revenues up from 41% / The Fiber business may grow at a slower rate than previous estimates sue to optical components.
Gross margin increased a whopping 8% in the 3rd quarter. / Break even may a long way off. Some estimate 45-47 million in revenue.
Systems Segment Sold 4th quarter 2003
This is the first quarter EMKR is reporting results after selling its Turbo business in 4th Quarter of 2003. The company’s focus is now on compound semiconductors and systems for broadband and wireless communications.
Products & Services (source: company web site)
EMCORE Corporation offers a versatile portfolio of compound semiconductor products for the broadband, wireless communications and solid-state lighting markets. The Company has two operating segments: the systems-related business and the materials-related business. The systems-related business is the Company's TurboDisc metal organic chemical vapor deposition (MOCVD) product line, which designs, develops and manufactures systems and manufacturing processes. The materials-related business is comprised of the Company's Photovoltaics, Optical Devices and Components and Electronic Materials and Devices product lines.
The Company provides a broad range of compound semiconductor products and services intended to meet its customers' diverse technology requirements. EMCORE developed a complete line of MOCVD production systems and is an integrated commercial supplier of the complete spectrum of compound semiconductor products. The Company combines materials science expertise and process engineering aptitude to provide MOCVD production systems, epitaxial wafers, package-ready devices, packaged vertical cavity surface-emitting laser (VCSELs) and fiber-optic modules to customers worldwide.
In January 2003, EMCORE acquired the optoelectronics operations of Agere Systems. The transaction included assets, products, technology and intellectual property related to Agere's cable television optical components, telecom access and satellite communications operations. The business is operated as Ortel, a division of EMCORE.
Systems-Related Business
The Company develops and manufactures advanced MOCVD production systems and engineers and designs next-generation systems to improve efficiency and lower production costs. EMCORE has developed extensive materials science, process technology and MOCVD production system manufacturing expertise to address its customers' needs. Its proprietary TurboDisc deposition technology makes possible a cost-effective production processes for the commercial volume manufacture of high-performance compound semiconductor materials and devices. The TurboDisc technology, coupled with EMCORE's process expertise, provides the production platform for various types of compound semiconductor materials and devices and enables the Company to address the critical need of manufacturers to cost-effectively get to the market faster with high volumes of new and improved high-performance products.
Customers can take advantage of EMCORE's vertically integrated approach by purchasing custom-designed materials and devices from the Company or they can manufacture their own products in-house using a TurboDisc MOCVD production system configured to their specific needs. EMCORE's MOCVD systems include Pioneer 75, Discovery 180 LDM, Discovery 180 GaNzilla, Enterprise 450 EM and Enterprise 450 LED. During the fiscal year ended in September 2001 (fiscal 2001), EMCORE introduced the E300 GaNzilla, featuring a reactor design with greater source efficiency and larger batch size than the Company's previous gallium nitride (GaN reactors). This product release has been highly successful with 14 reactors sold through the end of the fiscal year ended September 30, 2002 (fiscal 2002) and installed in three continents.
Competitors for MOCVD systems include Aixtron GmbH and Nippon-Sanso K.K. Ltd.
Materials-Related Business
EMCORE manufactures advanced, high-efficiency, multi-junction solar cells, covered interconnect solar cells (CICs) and solar panels. With smaller, more efficient power generation, the Company's photovoltaic products help enable satellite weight reduction, wing area reduction, improved radiation tolerance and higher light-to-power conversion, which increases payload capacity and economic return.
The Company designs and manufactures VCSELs, which provide enhanced performance benefits to market applications such as Internet access, onboard photonics, gigabit ethernet and fiber-optic switching, as well as Fibre Channel and storage area network (SAN) applications. EMCORE also designs, develops and manufactures high-speed optical transmitter modules, receiver modules and transponders. Its line of VCSEL and PIN (P-type, intrinsic and n-type) semiconductor materials, photodiode-based parallel optic modules are designed for high-speed optical networking applications, including VSR OC-192 interconnection and high-speed optical backplanes used in data switching and routing.
Using TurboDisc MOCVD production systems, EMCORE manufactures electronic materials, including pseudomorphic high-electron mobility transistors (pHEMTs) and hetero-junction bipolar transistors (HBTs) for wireless communication instruments, as well as devices such as magnetoresistive (MR) sensors. Materials and devices are produced on a foundry basis in partnership with specific customers according to their requirements and under strict confidentiality.
Joint Venture
In January 1999, General Electric Lighting and the Company formed GELcore (GELcore), a joint venture to develop and market hetero-junction bipolar light-emitting diode (HB-LED) lighting products. HB-LEDs are solid-state compound semiconductor devices that emit light and are used in miniature packages for everyday applications, such as indicator lights on automobiles, traffic lights, computers and other electronic equipment. General Electric Lighting and EMCORE have agreed that this joint venture will be the exclusive vehicle for each party's participation in solid-state lighting. Under the terms of the joint venture agreement, EMCORE has a 49% non-controlling interest in the GELcore venture and accounts for its investment under the equity method of accounting.
The Company maintains a worldwide service and support network responsible for onsite maintenance and process monitoring on either a contractual or time-and-materials basis. Customers may purchase annual service contracts under which EMCORE is required to maintain an inventory of replacement parts and to service the equipment upon the customer's request.
Competition:
EMCORE competes with several companies such as Boeing-Spectrolab, Sharp Electronics, RWE Solar, Hitachi-Cable, Kopin Corporation, IQE, Honeywell, Inc., Avalon Photonics, Agilent, Infineon, Stratos Lightwave, Matsushita Electric Industrial Co. Ltd., Siemens AG Osterreich, Electrotechnik, Asahi Kasei Electronic Co., Ltd., General Electric Lighting, LumiLeds Lighting, Osram GmbH, Nichia Corporation, Toyoda Gosei Co., Ltd., Epistar, Arima and UEC.
Sales
Systems Segment Sold, 1st quarter 2004 Recap.
In its first quarter since selling the Systems business segment, Emcore reported revenue of 23.1 million. The 35% sequential increase was fueled by strong demand for fiber and broadband products.
Watching Cap-ex at Large Service Providers (courtesy of Wachovia Securities)
AT&T Wireless-
2003 Cap-ex- $3.4 B vs. guidance of $3.0 B
2004 Cap-ex Guidance- 20% of sales or $3.2B
Comment- Due to migrating legacy networks AT&T was the only company to reduce Cap-ex. Management vows to keep spending, but it will concentrate on growth areas. Cisco and Nortel are the most likely beneficiaries.
Verizon Wireless-
2003 Cap-ex- 4.59 B (Versus guidance of $4.4-$4.7B)
2004 Cap-ex Guidance- $5.0-$5.5B (up 10%-20%)
Comment- Management indicated that if demand picks up it will increase Cap-ex demand.
SBC-
2003 Cap-ex- $4.59 B (Versus guidance of $4.4-$4.7B)
2004 Cap-ex Guidance- $5.0-$5.5B (up 10%-20%)
Comment- 4th quarter 2003 represented 38% of total spending.
Cingular-
2003 Cap-ex- $3.4 B (Versus guidance of $3.5B)
2004 Cap-ex Guidance- $3.4B (Flat from 2003)
Comment- 4th quarter 2003 represented 31% of total spending.
BLS-
2003 Cap-ex- $3.2 B (inline with guidance)
2004 Cap-ex Guidance- $3.2-$3.4B (Flat to up 6% from 2003)
Comment- 4th quarter 2003 represented 34% of total spending.
Alltel
2003 Cap-ex- $1.2 B (inline with guidance)
2004 Cap-ex Guidance- $3.4B (Flat to up 8% from 2003)
Comment- company expects to spend more on wireless than wireline as they continue to expand their wireless network.
RF Materials
One Analyst (Wachovia) sees revenue of approximately 9-10 million in 2003. Another analyst (Needham) cites that the industry has not shifted to InGaP from AIGaA’s as fast as had been expected. Emcore only deposits InGaP expitaxial layers. Management expects this business to be a steady $2.0-$3.0 million per quarter.
Fiber Optic
Emcore’s fiber business is broken in to two segments. The VCSEL business, and the Ortel acquisition. Ortel’s revenue includes cable TV, Satcom, and telecom access optical components. Several analysts (Needham, Wachovia, Merrill Lynch) believe revenue expansion will be driven by increased volumes of CATV, 10 gigabit applications and the deployment of regional Bell Operating Companies (RBOC) that are in direct competition to the cable providers.
Satellite
Solar Cell accounted for $4.6 million in sales down 7% from last quarter. One analyst (Needham) believes the outlook for this business is steady. Currently 4/5 of the business comes from the government (up from 2/3 of the business last quarter.) with the rest coming from the commercial sector. This business should stay at about 5-6 million per quarter until the commercial market starts to pick up. The commercial market has been shrinking but is expected to rebound by the end of 2003 as a large number of commercial programs are due to be awarded in that time frame.
Gelcore
The joint venture with GE Lighting enjoyed its first profit since inception in 2003. Despite growing 26% year over year (53.0M vs. 45M), revenues were lower compared to expectations for $60-$70 million.
By Market Segment / 2002 / 2001 / 2000Systems Related / 35,858 / 134,141 / 65,788
Materials Related / 23,621 / 20,206 / 18,290
Optical Devices / 9077 / 13,606 / 3,383
Electronic Devices / 19,196 / 19,661 / 17,045
In thousands / 87,772 / 184,614 / 104,506
Margin
Gross margin improved by a whopping 7 percentage points, to 14% from 7.7% last quarter
The increase in margins came as a result of higher revenue, better yields and better product mix.
Management stated during the last quarter’s conference call they plan to reduce cost of goods sold by 20%
2004E Margins
/ Gross Margin / Operating Margin / Net MarginLow Estimate / 18.10% / -21.50% / -9.9%
High Estimate / 19.27% / -21.20% / -6.16%
2005E Margins
/ Gross Margin / Operating Margin / Net MarginLow Estimate / 24.54% / -8.84% / 3.56%
High Estimate / 24.54% / -8.84% / 3.56%
Capital expenditures for the quarter were $500,000 and are expected to stay at those levels going forward.
Earnings Per Share
The consensus has been edging lower in recent weeks since the 1st quarter downside surprise in gross margin.While all the analysts agree that the company is on the road to profitability, none are predicting a profitable quarter by the end of 2004.
FY 2004 / FY 2005Street consensus / $ (0.54)
Company Guidance
Low estimate / $ (0.62) / NE
Med estimate / $ (0.55) / NE
High estimate / $ (0.54) / NE
Long-Term Growth
Emcore is deploying 4 new products for the passive optical network (PON) and CATV markets. Right now there is a battle between the regional bell operating companies (RBOC) and the cable multiple system operators (MSO). One analyst (Merrill Lynch) believes the company is well positioned no matter who wins. This business has the potential to be in the $10-30 million dollar range.
On the Satellite side there is there are 3-4 large commercial programs that are expected to be awarded in the second half of 2003. Emcore is very well positioned for these.
Most analyst’s also see the new Realtemp optical unit as having retrofit potential.
Target Price/Valuation
All of the analysts we researched rate EMKR as a neutral. Margin improvement and strong demand does not over come balance sheet weakness.
Additional Conversation
A Worrisome Balance Sheet
Cash and Cash equivalents increased from to 78 million from 38 million. The increase was a result of the sale of the equipment business for $60.0 million in cash. Several analyst’s (Needham, Merrill Lynch, Wachovia) are concerned with the weak balance sheet, which has a 162 million dollar convertible debt issue due in 2006.
Update 2/19/04
Emcore announced the successful conclusion of its exchange offer. The company will exchange approximately $80.3 million aggregate principal amount of its new 5% convertible senior subordinated notes due May 15, 2011 and approximately 7.7 million shares of common stock for approximately 146.0 aggregate million principal amount of its 5% convertible subordinated notes due May 15th 2006.
The exchange offer will achieve an aggregate debt reduction of approximately $65.7 million and a reduction in annual interest of approximately $3.3 million.
Activity Ratios Improving
Emcore’s days sales outstanding (DSO) dropped from 70 days to 60 days, inventory turns improved to 3.5x from 3.3x, and days inventory fell from 109 days to 105 days.
Upcoming Events
Date / Event / CommentsQ4 03 / Ramp up of new optical product Real Temp for GAN applications / First customers should be implementing in 2H of 2003
Q1 04 / 4 new products for CATV and RBOC / Potential for significant revenue cont.
Individual Analyst Opinions
NEUTRAL RATINGS
Needham- Hold While the analyst sees several positives in Emcore’s future; market leadership in equipment for the compound semiconductor industry, synergies from its vertically integrated business structure, and significant potential growth for systems and materials, a hold rating has been maintained due to the expectation of slow growth in the fiber business and a weak balance sheet.
Wachovia – Market Perform –The analyst released a research report based on Cap-ex tendencies of the large service providers. As of the last quarterly report, the analyst believes Emcore will trade in the $2.50-$3.00 range based on 0.6-0.8x 2004E revenue, and 1.4-1.5x enterprise value.
Friedman Billings Ramsey- The analyst released a convertible note research report, in which it discusses business segments and provides an earnings model. The tone is quite negative although the report refers to the convertible exchange offer that the analyst believed would not go through. It has since been approved.