EMCORE Corporation

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.

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.

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.