Emcore (EMKR)… Nothing plus nothing = nothing

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Emcore’s plan to spin out each division leaves investors with 2 bones and no meat.

It has been 6 months since Citron has been covering Emcore (EMKR:NASDAQ). Oil has made its unprecedented round-trip from $100 to $147 a barrel and back.  Mainstream solar stocks have achieved record profits — and record valuations — in the anticipation of $200 oil …but Emcore is yet to book a single commercial size order from a verifiable counterparty. Compounding its credibility problems, management was forced to acknowledge that its largest claimed commercial order to date, PR’d with much ballyhoo, was a total write-down – months after Citron had exposed it as a fraud.

In the intervening six months, the company has burned through $20 million more of investor’s money as receivables and inventories have ballooned, leaving in its wake no tangible business accomplishments, only empty promises and even more “shadow customers” for their solar business.  It is the opinion of Citron that if current management performance continues down this road, Emcore is on the fast track to becoming a penny stock.

What’s Changed?  In our opinion, quite a lot.
  1. Prices for photovoltaic grade silicon have passed their peak, and consensus is they are headed lower as new supply comes on line to meet demand over the next eighteen months, as wide-scale commercial deployment of solar panel projects continue at a brisk pace.
  2. Emcore finally admitted that, as reported months ago by Citron, Green & Gold Energy’s huge orders are being written off the backlog, because the customer cannot pay for them.
  3. Emcore turned another horrendous quarter, losing $11.6m on operations, consistent with its $33.7m loss turned in for 9 months of 2008.  The only thing keeping its “EPS miss” down was, ironically, a huge increase in the share count – up more than 50% in the last year alone.
  4. Analyst Scorecard:  Canaccord, which had defended Emcore doggedly for months, admitted that Emcore’s Korea deals are a fantasy, and downgraded it to hold.
  5. Tobin Smith’s Changewave newsletter endorsed Emcore.
  6. Over this timespan of unprecedented oil prices, Emcore doesn’t have a single multi-megawatt order from a reputable and verifiable counterparty to show for it – only more “shadow customers”, whose ability to execute or pay can’t be verified.

Before we explain why this has happened to Emcore, let us first take a peek at the cash flow statement. 

Follow the Money

The Truth is in the cash flow statement.  Cash flow from operations remains consistently very negative.  Quarterly free cash flow stands at about negative $12 million per quarter, roughly what it was a year ago in spite of spending $85 million on an acquisition and in spite of enjoying the best of times in the solar business.  The accounts receivables portion was the main reason.  Without further explanation from management, it appears to Citron as if Emcore continues to sell to fictitious companies (or at least fictitious orders), find a way to book it as revenue, and then reverse it by saying, as they did in this quarter, that the company in question is being sold so we have to cease the orders we have for them. 

Unbilled revenues spiked from $6.4 million to $12 million quarter over quarter.  That change is equivalent to 30% of the revenue growth quarter over quarter.  Did something change with the way they do business or did management get more aggressive on recognizing revenues for some reason?  And in spite of dealing with companies that seem to come and go such as Green & Gold Energy, EMKR’s allowance for doubtful accounts has dropped to an all-time low of just 0.7% of accounts receivable.

A report of earnings increase accompanied by unrelenting cash flow from operations losses spells trouble.  Investors have to decide between the black and white – and management excuses. 

Management vs Investors.

One question commonly posed to Citron is “why would companies ever commit fraud?”  As an investor in the market, we are able to buy and sell companies as we see fit.  But management doesn’t enjoy such flexibility.  It has to wake up every day and face the enormous pressures of trying to make the best of what it previously sowed.  Once overly optimistic claims cross the line into untruth and are subsequently exposed as falsehoods, loss of credibility becomes a slippery slope.  We’ve seen this pattern over and over.

The Fantasy: Can two losing companies yield one profitable spinoff ?

Emcore still insists it is pursuing the strategy of “spinning off” its solar division into an IPO, somehow creating a profit from turning a dime into two nickels. 

The harsh light of reality
The harsh reality is that Emcore’s terrestrial solar business is in deep trouble, having shown no signs of economic viability.  In the quarter that may well mark the high point of pricing for oil and polysilicon, Emcore’s terrestrial solar division could book only $12 million in revenue.  Emcore has burned $87 million in its solar business in the last six quarters.  What’s more, it is Citron’s opinion after scrutinizing all available information about Emcore’s order announcements that at least 80% of Emcore’s current remaining backlog (even after dropping Green & Gold) will never be realized as revenue.

And the fiber division?  Cliff diving at its finest.

Emcore has generated $38 million in losses in its fiber division since October 2006, averaging a loss of $5 million per quarter.  The division they acquired from Intel was showing year over year revenue declines of 20% and 51% for the December and March quarters, and was unprofitable in June 2008, indicating no reversal of the pattern of declining revenues for the division — even though Intel was still performing the manufacturing and operations.  Emcore will have to take over these activities by September 2008.  Of course, management insists it will be able to run the operation better than Intel.  Its track record, however, leaves little cause for encouragement. 

When you back out Intel’s inventories of $31 million from EMKR’s balance sheet, it appears that inventories are at an all time low ($10 million less than last year’s $28 million inventory balance).  This seems odd for a company that is about to blow the doors off.

The Blind Cheerleaders

Tobin Smith of Changewave investing recently published a glowing piece on Emcore.
http://www.moneyshow.com/investing/articles.asp?aid=tptp082108-15102

In his recommendations he seems to break the law countless times with a multitude of Reg FD violations.

For those of you who do not know Tobin, he is a newsletter writer with a sizeable following of the lowest common denominator of investors.  This is not the first time Citron has encountered Tobin.  He has been equally as bullish on three other stocks we profiled.

  1. The first was Interpharma, (AMEX:IPA) which Citron wrote about when it was $7.  Tobin called it a “legacy buy”. 
    http://citronresearch.com/index.php/2003/09/22/
    The “ legacy” of IPA is 5c per share.   

    Marketwatch wrote the story of Tobin vs. Citron.
    http://www.marketwatch.com/News/Story/Story.aspx?guid=%7BD2D8E0B3-CF81-450F-8AED-96A2E672ADFE%7D&siteid=mktw

  2. Then there was Zeros and Ones  (OTCBB:ZROS).   In 2007, Tobin recommended this company that he claimed was going to revolutionize file transport speeds on the internet.  His subscribers bought the stock up.  Citron reported on ZROS :
    http://citronresearch.com/index.php/2007/03/20/stocklemon-reports-on-zeros-and-ones-otcbbzros/   

    ZROS is now VOYT and the stock now trades at .16 cents.

  3. American Superconductor (NASDAQ:AMSC) In June and July this year, Citron warned about this company, which Tobin went on to recommended just a few weeks ago at $38, with advice to “get more aggressive” at $35.  Just three months later, today you can buy all you want around $21, and you don’t have to get aggressive about it, either.

So now we have our fourth stock to add to the list.  Citron is so convinced of the terminal nature of Emcore’s problems that it makes this prediction:  Not even Tobin Smith’s ego can save this company from its fate of ending up in penny stock land.   Citron Research vs. Tobin Smith is like the Harlem Globetrotters vs The Washington Generals.

Stanford Group

Then Stanford Group published an analyst report more akin to a bulletin board glossy promo mailer than real research.  Shockingly, they tabled each of Emcore’s terrestrial solar “orders”, an impressive list unless you apply even a modicum of critical thought.  Then you see that the orders fall into 3 categories:  unverifiable, proven fraudulent, and nearing completion.

  1. For example, included are ES Systems of Korea, which has announced projects greater in size than the total world implementation of CPV, yet its website hasn’t changed in six months, and research turns up not a shred of tangible evidence that the company has the capability to execute on any projects whatsoever.
  2. Then there’s SunPower a purported California investment group with no track record in solar projects, who claimed their project was dependent on tax credit legislation which was not law at the time of the announcement, and has since not become law.
  3. Then there’s XinAo Group of China, again PR’d as though it was a big deal, but which is in reality a tiny test system of 50KW – estimated order value $17,000 a scant 1/20th of what would be needed for a field-size test.
  4. And of course, Green & Gold Energy, which has already been written off by management’s own admission.

Of course, missing is any mention of Emcore’s cash burn rate or factoring further dilution into its valuation.  Citron believes this is a fine example of analyst malpractice.

The hits just keep on coming.

Conclusion

It is the opinion of Citron Research that the analysts and cheerleaders are ignoring the reality that Emcore is still on a trajectory of running out of cash.  Emcore is comprised of two terminally money-losing divisions, which cannot possibly justify a “spinoff IPO”.   The PIPE investors in its last round have lost 50% of their money in a few short months.  Yet the investment banking firms do what they do best — maneuvering for their next deal.  This stock is headed for another dilutive round of financing, and the inevitable negative consequences for investors.

Cautious investing to all.