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spk02: Good day and welcome to the MCOR third quarter 2022 earnings call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Tom Minichiello, Chief Financial Officer. Please go ahead, sir.
spk03: Thank you, and good afternoon, everyone, and welcome to our conference call to discuss MCOR's fiscal 2022 third quarter results, as well as the acquisition of the inertial navigation business from KVH Industries that we announced today. The news release we issued this This afternoon, covering both our fiscal 3Q results and the acquisition, is posted on our website, MCOR.com. On this call, Jeff Rittcher, MCOR's President and Chief Executive Officer, will begin with a discussion of our business highlights. I will then update you on our financial results, and we'll conclude by taking questions. 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 the business. Such forward-looking statements include, in particular, projections about future results, including those with the acquisition of KVH's inertial navigation business, statements about plans, strategies, business prospects, and changes in trends in the business and the markets in which we operate, as well as the anticipated benefits and costs of MCOR's acquisition of the inertial navigation business acquired from KVH Industries. Management cautions that these forward-looking statements relate to future events or future financial performance and are subject to business, economic, and other risks and uncertainties, both known and unknown, that may cause actual results, levels of activity, performance or achievements of the business or in 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 and the business, which are included in the company's filings available on the SEC's website located at sec.gov, including the sections entitled Risk Factors in the 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 in our news release. I'll now turn the call over to Jeff.
spk01: Thank you, Tom, and good afternoon, everyone. I'm going to begin my comments with a review of our third quarter before discussing our acquisition of KVH's inertial navigation business and how it fits into our growing aerospace and defense focus. MCOR's third quarter fiscal revenue was $23.7 million, slightly below the bottom of our guidance range for revenue, but down about 27% over Q2. Approximately 57% of our revenue came from aerospace and defense, with 43% from broadband. Non-GAAP operating loss was 6.3 million, and adjusted EBITDA was negative 5.1 million. Q3's production, particularly in QMEMS, was affected by a COVID-19 outbreak, as well as the semiconductor and supply chain problems that are well known to everyone. These problems combine to affect our non-GAAP gross margin significantly, bringing it down to 18%. Operating expenses held steady despite the increased headcount from integrating the former L3Harris space and navigation team. On a brighter note, cash on the balance sheet came in a bit higher than expected at approximately 75.1 million. COVID and supply chain production issues aside, the cable TV business became more turbulent with the exit of one of the two largest OEMs in the cable business. Semiconductor availability remained a significant problem in the quarter and costs were up across the board. This is particularly frustrating because you can't ship a product when you only have 99% of the parts. Again, microcontrollers and FPGAs were particularly problematic experiencing substantial price increases. Semiconductors aside, quartz MEMS production continues to be constrained by the availability of certain high-performance hermetic connectors. We expect those problems to ease slightly in the September quarter and continue to improve throughout the end of the calendar year. While availability of some semiconductors is expected to improve somewhat, In the coming quarters, we don't see a catalyst to drive predictability into the supply chain in the short term. Component lead times continued to stretch to levels not seen in many years, triggering efforts to redesign these older parts out. We received the last payment for cable television production equipment that was sold to our EMS supplier, Fast Train, in the quarter, closing the door on MCOR's Chinese manufacturing operations for cable TV. Earlier, I described cable TV as becoming more turbulent. The exit of one of the two largest OEMs from the cable TV equipment business certainly bears that statement out as true. This announcement came in the form of a product obsolescence notice for all of their remote PHY and hybrid fiber coax products leaving one major OEM and a host of smaller players to serve the MSOs. While this permanent alteration of our customer base won't change the demand from the MSOs, a single dominant OEM creates a different set of cable television market dynamics going forward. Increasingly, the direction that the cable TV market is taking is incongruent with our growth strategy. From a tactical perspective, during the quarter, our customers appeared to concentrate more effort on clearing their transmitter inventory problems at the expense of new orders for lasers and other components, damping cable television revenue. We expect the next few quarters in cable TV will be difficult to forecast because of last-time buys, optimization of inventory positions, and competitive dynamics between the OEMs. Beyond cable television, the CHIPS team made their first production shipments as expected. From here, we will ramp up in the September quarter and beyond, constrained only by test capacity because of equipment that is a year late. We are still expecting these products to have significant impact on fab absorption late in the first half of calendar year 23. Beyond that point, they are expected to be margin accretive to the broadband business ultimately contributing tens of millions in revenue by 2025. As I pointed out last quarter, it's important to note the fab utilization from these new products is expected to drive the majority of wafer fab starts, pushing cable TV requirements into the minority, stabilizing costs, and ultimately improving gross margins in the broadband business. We are currently working to close additional chip programs and are excited by the progress that the chip development and production teams are making. Aerospace and defense was the majority of our business in the quarter, driven by our new space and navigation team offsetting the drop in QMEMS production. We are expecting QMEMS revenue to bounce back in the current quarter and continue to grow throughout FY23. Although margins overall were low due to underabsorption in Concord, margins came in better than expected at Bud Lake, while Alhambra's fog products performed at expectation. Defense optoelectronics bounced back nicely in the quarter with shipments up, clearing backlog that was previously supply-constrained. During the quarter, we saw the first high-marge units shipped from the U.S. Army to the Ukraine with additional interest from foreign customers who are anxious to build up their defenses. United Launch Alliance had two successful launches using MCOR-supplied board guidance systems, and the team made good progress on the TAIMU, or TAMU, development for this important end user. In our press release, we announced that we acquired KVH's inertial navigation business today for $55 million. This is being funded from cash on our balance sheet and a new credit facility that Tom will discuss later. We previously told investors that we went out to raise cash in our secondary offering in February of 2021 in order to fund M&A, and we've now funded two acquisitions out of those funds and approximately $20 million in debt. minimizing dilution to our shareholders. It is also important to note that carve-outs take time, and we've now done two of them, space and navigation and KVH. These are opportunities that we started working on as early as 2017. We've also told investors that we have three primary criteria for acquisition. Number one, it's got to fit within our strategic umbrella. Number two, it must be quickly accretive. and three must have additional operating synergies. Space and navigation met all three criteria in the first quarter within MCOR, and we expect that our latest acquisition will perform as well. We think that we've just acquired a great business and an excellent team. We expect the addition of KVH's inertial navigation products located in Tinley Park, Illinois, to generate over $30 million in revenue on an annual basis and be EBITDA positive with cost synergies anticipated to play out in the first two years. Value creation opportunities exist at every level of the P&L in both our existing operations and the Tinley Park operation. MCOR's chips and packaging technologies will ultimately go to Tinley Park, and they will produce coils that will lower our costs. On the demand side, we were impressed with the breadth of the customer base in both commercial and defense applications. In particular, the U.S. Army is an important customer, and the armored multipurpose vehicle, or AMPV, is just about to go into production and should run for a very long time. KBH has opened up some important applications in industrial vehicles and robotics, which should represent strong growth opportunities going forward. Now I will move on to guidance for the fourth fiscal quarter. We will be adding approximately half a quarter's worth of revenue from Tinley Park and are expecting a rebound in QMEM shipments within the quarters. However, within broadband, chips should continue to grow a bit, but cable TV sales should weaken further due to the dynamics that I described earlier. From this point forward, aerospace and defense will be the dominant business at MCORP. For the fourth fiscal quarter, we are expecting revenue in the $24 to $26 million range. The company has reached a critical inflection point with the addition of KVH's inertial navigation products, and coupled with our data center chip business, mCore has an increasingly bright future. With that, I will turn the call back over to Tom. Thank you, Jeff.
spk03: Consolidated revenue for fiscal 3Q? was $23.7 million, with 57% coming from aerospace and defense and 43% from broadband. A&D segment revenue is $13.4 million, a $4.4 million increase when compared to the prior quarter. The sequential quarter A&D revenue growth was largely attributable to the addition of space and navigation revenue of $4.3 million, which was acquired from L3Harris on April 29th. The rest of the A&D segment revenue is up slightly, driven by increased sales of defense optoelectronics products and higher fog revenue. However, this was almost entirely offset by lower sales of QMEMS products, which was affected by multiple supply chain delays and shortages, as well as a COVID outbreak at our Concord facility. Broadband revenue is $10.3 million. a $13.4 million decrease when compared to fiscal 2Q. Sales of our cable TV products continued on a downward slide, decreasing by $14 million, while non-cable TV broadband revenue was up $600,000. Let me now turn to the rest of the operating results, the focus of which will be on a non-GAAP basis. Consolidated gross margin was 18% in fiscal 2Q, compared to 30% the quarter before. The decrease was primarily attributable to underabsorption of fixed overhead across both the A&D and broadband segments. As it relates specifically to the A&D side, where gross margin was 13% compared to 15% in fiscal 2Q, the underabsorption, which was largely due to lower QMEMS volume, was partly offset by improved production yields and a favorable contribution from space and nav and defense optoelectronics. Operating expenses were $10.5 million in fiscal 3Q compared to $10.4 million in the quarter before, due largely to an uptick in travel as well as increased insurance expense in G&A. Moving to the bottom line, the changes to our revenue levels and gross margin in fiscal 3Q resulted in an operating loss of $6.3 million. Adjusted EBITDA was negative $5.1 million. Net loss was $6.3 million or $0.17 per share. Shifting to the GAAP results for a moment, fiscal 3Q net loss was $7.6 million or $0.20 per share. This included costs of $700,000 associated with the space and nav acquisition and a $1.3 million gain on the sale of cable TV equipment to our third-party manufacturer, Fastrains. Note that this was the final shipment of equipment completing our transition of cable TV operations from in-house to fast train. Turning to the balance sheet, we had cash of $75.1 million at June 30th compared to $80.9 million at March 31st. The $5.8 million decrease included $3.5 million used for operating cash, $1.6 in CapEx, and $2.4 million at the closing of the space and nav acquisitions. Partly offsetting these uses of cash during the quarter was $1.7 million in proceeds from the equipment sale. In connection with our all-cash $55 million acquisition of the inertial navigation business from KBH, the deal was paid for with $35 million from cash on hand, with the balance being financed with a new ABL credit facility provided by Wingspire Capital, which at close consisted of a $6 million loan Senior Secured Machinery and Equipment Term Loan, and $14 million drawn down from a revolving line of credit. With that, we are now opening up the call for your questions.
spk02: Thank you. If you'd like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question, and we'll pause for a moment to assemble the roster. And we'll take our first question today from Richard Shannon with Craig Hollam.
spk04: Hi, Jeff and Tom. Thanks for taking my questions here. Let's see, a few questions come to mind here. Let's quickly, Jeff, touch on the cable TV comments you mentioned here. I'm assuming this is your much bigger customer here that's exited the business. Is that accurate?
spk01: Yeah, exactly right. There's really only two large, what I would describe as large OEMs in the business. Um, and those are Comscope and Cisco. Okay.
spk04: Um, would you, would you take a guess as to how you think the, uh, competitive dynamics here, uh, settle out as, uh, as we get past the turbulent times, as you, as you mentioned a couple of times here, I mean, is this a potential for share gain or share loss? Is there any way you can kind of help us think about those in a steady state fashion?
spk01: Yeah, it's, um, I'm afraid the answer is going to take a little longer than I normally like, but I think it's important that it's a complete answer. So there's sort of a strange competitive dynamic in the cable business anyways. The only other supplier that Comscope buys from is Sumitomo, and the only other supplier that Cisco had bought from was AOI. And Cisco's primary business had been with Charter Communications, and since they are 100% linear EML, and all the rest of their DFB business we own 80% share. It's actually a pretty small amount that was with AOI at Cisco and, you know, roughly the same amount with Sumitomo over at Comscope. So it's a little bit of an unusual situation to start, but it's important to, I think, give you that color on things. So, you know, the thing that we had been watching, you know, with Cisco was, you know, after they bought Scientific Atlanta's cable business, they ultimately got rid of the set-top box operation to Technicolor, and it was only a couple years, and then they gradually kept taking down the headcount, and about two to three years ago, they eliminated most of their development engineers. And at that point, you know, I think we started to wonder whether or not they were going to continue at all. And, in fact, it was, you know, and our view was it was just a matter of time. And so, sure enough, you know, some period of time ago, a couple months ago, those end-of-life notices popped up on the website, and it was all of the RemoteFi products and all the HFC products And so the question is what happens from here? So Cisco is sitting on inventory as well as CommScope, so certainly there's going to be efforts to move that. Our understanding is that there are serious conversations going on between the MSOs and Cisco about the abruptness with which things have happened. And there's usually, you know, some sort of a plan that gets put together when those kinds of things happen. So I don't think it will be the straight exit that, you know, the black letter of the content would lead you to believe is going to happen. How long does that take to sort itself out? Probably another quarter or two. And so in the next quarter or two, we're going to expect to see, you know, a combination of last-time buys, and or, you know, jockeying to move inventory between Comscope and Cisco's distributor. And it's really a hard thing to handicap as far as, you know, how exactly that's going to work. But we've modeled in, you know, pretty low numbers in cable. And, you know, we just, you know, got to deal with it. But the crazy thing is, yeah, the crazy thing is that there's no loss of share in any of this. And I want to say, Tom, correct me, you know, in the December quarter, we did like $32 million in cable.
spk03: That's, yeah, right. Yeah, but did $32 million in broadband, just under $30 in cable.
spk01: Yeah, just under $30 in cable. And, you know, you're going to see 80%, 90% of that poof, with no share losses on our side and nothing we did to screw up as far as, you know, deliveries or quality or anything like that. And, you know, it's COVID took five years of demand, put it into two, and, you know, the same, the backside of the forces that caused, you know, the cruise industry to lose, I don't know, 90, 95% of its business Collins Aerospace had a huge, you know, sort of equivalent percentages decrease between 19 and 20. And, you know, eventually things equalize and they pop back up. Cable in particular, you know, someone had said, well, you know, cable business fell off a cliff. I said, yeah, but cable is sort of like cliff diving with a bungee cord. It tends to spring back. It's just only a question of how low it goes before it does. And that's the nature of the beast, right? And it's just increasingly congruent with where we're trying to go with this business. And that's, you know, a challenge that, you know, we in management and our board have been working on for forever, really, but continue to look at alternatives.
spk04: Okay. That's a lot of helpful detail. I'm going to take some of that and directly go into the guides for the September quarter here. So, Uh, 24 to 26. Uh, if I take roughly half of the run rate you mentioned here, uh, per quarter, maybe three or 4 million, that would put the midpoint here, like 21, 22, um, uh, with the organic M core business. Um, so if you're growing QMS a little bit, it seems like cable TV has got to be much, much lower. I think he had 7 million in, in the June quarter, if I caught that correctly. So it sounds like you're literally talking about one to two or 3 million in September. Am I doing that math right? uh your math is uh impeccable as always richard must have been that engineering education it's actually probably sam but uh that helps too um okay thanks for that and then maybe two quick questions on kvh and i'll get out of line here so an interesting business which i don't know a lot about here but let's uh let's try to understand some of the synergies here it seems like if you're making an asset purchase there isn't necessarily a lot of overhead to be taken out here. So maybe you can discuss the synergies you expect near term and over time.
spk01: Yeah, so true that there isn't a lot of overhead other than corporate overhead, and I think our numbers are smaller. But when you look at it, there's a lot of opportunity to improve costs, things they buy that they're getting for a better price and vice versa. You know, I made the point in my prepared comments that we are in a position, or will be in a position, to supply them with more advanced technologies for closed-loop fog control at a price that you just can't get in the merchant market because we make them. They wind coils and can reduce our coil cost by 30%. You know, we will certainly see synergies in the sales and marketing side a little bit of overlap in engineering but it's it's really hard to make that judgment being that we're so busy in development so you know not a lot was figured out other than we took out you know to get to the synergy number some let's call it a project expense and outside material and development that maybe we don't need to do because we've already got a bunch of that technology that we can forklift into Tinley Park. And they've got a whole bunch of know-how that we can take advantage of in Alhambra and maybe even in Bud Lake.
spk04: I'm going to jump out of line and maybe jump back in and ask some more detailed financial questions. But the last one I want to ask you, Jeff, here is you've obviously made two acquisitions here, and the $55 million less the debt raise here takes your cash balance down a bit here. Does this end your appetite for M&A, or can you still potentially see it after, of course, a digestion period continuing?
spk01: Well, you know, we'd like to see – We'd like to see improved results drive, you know, Wall Street's opinion of us and less reliance on cable TV contributing to that. Does it make us want to stop M&A? No. But as always, you know, it's a pretty narrow laundry list of things that we're interested in. Again, we started talking to Martin Kitzvan Heineken, about this business in 2017. We had been working on trying to pry L3 space and navigation out since 2019. So it's not like we're sitting there, you know, throwing darts up against the board and trying to figure out what we're going to do next. In fact, we've been very deliberate, which is something I think our board appreciates.
spk04: Okay. Thanks for that answer. I will jump on the line. Thank you, Jeff.
spk02: As a reminder, press star 1 if you have a question. We'll pause for a moment. We have a follow-up from Richard Shannon with Craig Hollam.
spk04: All right. Well, I guess just like last quarter, I didn't have to jump out of line. Tom, a couple questions here as we look at the September quarter below the sales line here. Looking at the filings for KVH, it looks like the gross margins might have been in the 30% range here. So it looks like it's accretive on that line. If you can help us maybe do the quick math about how we should think about total gross margins and the optics here. I haven't been able to do all that math here. Maybe you could help us out a little bit on that, please.
spk03: Yeah, sure. If you look at, and it's obviously easy to get to, they were a separate reportable segment for KBH. You'll see revenues ranging from low 30s to high 30s. There's a base business of FOD products that is the majority of the business, but there's also a product line called TACNAV that is a little bit more lumpy, and when that in quarters where there's a lot more of TACNAV revenue, the revenues in total for the navigation business is in the high 30s, and it's also high margin, so it really changes the combined gross margin of the segment. So on average, if you average out, you're looking at mid-30s in revenue, mid-35, you know, 35-ish, plus or minus on gross margin, and their OPEX is if you on the carve out is in the sort of 11 million annualized range. So that should give you, you know, a good sense for, you know, what you can expect from the business. You know, we were planning on synergies, call it over the next, you know, year, year and a half that Jeff spoke about to help it further. But it is a,
spk01: Contributory business that we expect that to continue and get even better as the quarters tick by as it's part of em core yeah, the point to mention here is that all the synergies that we figured in in our case in the board and Obviously we had a team evaluating an outside team evaluating their their revenue quality of revenue We were represented by Cowen on the banking side. And, you know, so we got pretty conservative numbers. The synergies are all on the cost side as opposed to the revenue side. And so revenue upside represents gravy on top of things. And obviously, we're going to be working in that direction. But those weren't the base commitments in the acquisition case. It was just the cost side because it tends to be more controllable.
spk04: That makes sense. So maybe one question, one more question for me on the topic of classified chips. Let's hear Jeff. I think you said that you're starting to ship into production for your first customer, which is great to see. You talked about kind of tens of millions of dollars by 2025. Maybe, I guess the first part of my question is, can you summarize the number of customers and contracts that you have? And does that number, both in customers and contracts, Is that sufficient to get you to kind of that tens of millions of dollars of revenue? Do you need to see more? And if so, how do we think about, you know, future announcements?
spk01: Yeah. So, and I think I've got this right. So forgive me if I'm off by a customer here or there, but I believe there are five and a total of eight projects. So there are customers with multiple projects. Does this get us to tens of millions? Yes, it does. But there are additional large players that we are continuing to work with to bring in additional volume in these areas. And so the way to think of it, Richard, is we've got a set of core technologies and customers oftentimes want certain tweaks, a peak power level, a slope efficiency. They want it to fit on a certain kind of sub-mount. There's a particular mounting scheme they've got. And all that requires process engineering and a significant amount of expertise. And so when you say 70% of the chip may be sort of common to a couple of customers, there's also a significant amount of difference in terms of the way it's implemented. And in particular, the target for packaging on that. So it's not like we're going out reinventing the wheel each time. I would say, you know, within the next quarter or so, there's good probability we'll have two more customers with at least one program each. And, you know, we just see this continuing to grow nicely. Team's executing well. And, you know, it's going to be the primary growth engine over in broadband, period. Okay. Great. That is all from me, Jeff.
spk04: Thank you.
spk02: And that will conclude today's question and answer session. And I'll turn the call over to Mr. Jeff for any additional closing remarks.
spk01: Sure. I'd like to thank all of you for your interest in MCOR today. I want to recognize our team and actually the extended team of experts that worked with us on the KVH transaction for tremendous effort to get this done. And please stay safe, everyone, and goodbye for now.
spk02: This concludes today's call. Thank you for your participation. You may now disconnect.
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