EMCORE Corporation

Good morning and thank you for standing by. Welcome to the MCOR Corporation fiscal 2023 third quarter results. At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star one one on your telephone. You will then hear an automated message advising you your hand is raised. To withdraw your question, press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Tom Minichiello, MCOR's Chief Financial Officer. Please go ahead.

Thank you, and good morning, everyone, and welcome to our conference call to discuss MCOR's fiscal 2023 third quarter results. The news release we issued yesterday afternoon is posted on our website, MCOR.com. On this call, Jeff Riddichert, MCOR's President and Chief Executive Officer, will begin with the discussion of our business highlights. I'll 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 projections about future results, statements about plans, strategies, business prospects, and changes and trends in the business and the markets in which we operate. 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 and subsequent periodic reports. 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 will now turn the call over to Jeff.

Thank you, Tom, and good afternoon, everyone. Well, I guess it is morning. In Q3, MCOR's inertial navigation business came into its own, growing 10% over the March quarter, representing the fifth sequential quarter of growth. Book-to-bill kept pace with this growth at 1.0, and the business has $68 million in backlog. Non-GAAP gross margin for inertial navigation was 30%, and the A&D segment overall was 29%. Operating expenses for inertial navigation were approximately 9.9 million. Consolidated revenue in fiscal Q3 was 26.7 million. Inertial nav came in at 26.7. Defense optoelectronics was 300K, and broadband posted a negative $300,000 in revenue due to a terminated $1.3 million broadband development contract. Tom will provide additional details on this in his remarks. Simply put, inertial navigation performed significantly better than expectations, setting the stage for the company's evolution into a pure play aerospace and defense business. Turning now to the broadband business, I'd like to focus on our announcement of the letter of intent sell the linear part of the business to photonic foundries. Completion of this sale would accelerate MCOR's ability to narrow its focus onto inertial navigation. It should also meet our objectives to create a seamless transition of supply to our customers and opportunities for our employees. We expect to complete the sale during the September quarter. The last remaining component of broadband is the wafer fab. and we expect to conclude production for the last time by, pardon me, within the September quarter as originally planned. Since the completed sale of the linear product line would transfer the order backlog for the affected products to Photonic Foundries, we expect that the remaining wafer fab backlog to be approximately $3.2 million. Once the wafer fab production processes are complete in Alhambra, EMS takes over from there, assembling chips onto carriers and completing tests and burn-ins. Since there are production limits in EMS, it will take at least a year to complete all of the orders with just a handful of MCOR employees remaining to manage the process. That said, we have several interested parties conducting due diligence on the chip business and expect to have a decision on the future direction of the FAB within the current quarter. bringing the tale of two companies to an end. Moving on to inertial navigation, I'll begin my comments by stating that we had a strong performance from our space and navigation, Tinley Park, and Concord operations. Revenue was up about 10% quarter over quarter with the book to bill at 1.0. This is a little misleading by itself, considering the fact that inertial navigation has grown 30% from the December quarter. which was the first full quarter in which the former KDH team was merged into MCOR. Backlog came in at a solid $68 million. Please keep in mind that this only includes hard purchase orders against our long-term contracts, not the value of the contracts themselves. In the current quarter, we expect that the book-to-bill will remain above 1.0. Operating expenses came in below budget for research and development and sales and marketing. We are mindful of our high internally funded research and development spending, otherwise known as IRAD, and are working to drive this down substantially in the coming quarters through non-recurring engineering contracts from our customers. Consequently, we should see IRAD approach 10% of revenue within the next few quarters. We received full-rate production orders for BAE's armored multipurpose vehicle program and expect this to transition into a solid yearly order pattern from this point forward. For AMPV, foreign military sales and spare orders should book periodically from here onward, providing additional upside. International bookings improved significantly this quarter, most notably in Taiwan and Poland. These included a group of unmanned and turreted platforms. We also saw substantial interest from customers in the EN300 platform, especially in the space sector, with several key test runs starting this quarter. We've seen some positive results early in the game and eagerly await the full results of these tests to drive additional momentum. On the precision-guided munitions side of the business, we have been pursuing a tiered product placement strategy to ease licensing requirements for our international customers. This approach takes a bit more time, but we should begin to see orders this quarter based on this strategic direction. Beyond program capture, we are seeing important signs of acceleration of key programs into the low rate of initial production phase. This is a leading indicator of long-term growth. Infrared search and track has become a key area of focus, and our multiple design wins should benefit in terms of production timing. The EARTH program has secured an additional bank of orders that reflect the strength and duration of the program. We are also working with major primes on securing long-term manufacturing partnerships, and orders are expected to produce improved production costs and predictability. The Space and Navigation Team has continued to integrate multiple TAMU inertial measurement units in support of tests and validation, as it continues to meet shipment targets for BORG, which is the booster rate gyro. These two systems are critical to the launch schedule for United Launch Alliance. The next important milestone should be reached by the end of September. Beyond that, when ULA reaches its targeted launch rates, HEMU and BORG are expected to produce 20 to 25 billion in revenue per year and help significantly improve gross margins. Quartz MEMS had a very nice uptick in shipments this quarter and scaled up margin well. We saw a favorable mix in the Concord shipments, but the operations team executed a very clean quarter with no surprises in the way of unplanned variances. We expect to continue to reduce the lumpiness in Concord as we upgrade Concord to a new ERP system in the coming months. Before I move on to guidance, I'd like to provide some comments on integration, which is a key area of focus this year. We did successfully transition our Chicago operations to Siteline 10, which will end the need for transition services from KDH, as well as eliminate the expense. Since it's the last quarter of the year, we will not upgrade Alhambra or Concord to Sideline 10 until the due fiscal year and should complete this work in a quarter or so after getting started. Beyond ERP, we should complete the PLM PDM unification in early October, and we'll integrate CAMSTAR MES into the Concord and Chicago facilities after we complete the ERP upgrade. Ultimately, this will make MCOR more efficient and will help us to improve our processes, costs, and reduce inventory. Beyond the systems integration programs I've mentioned, MCOR has a solid roadmap for stripping out redundancy within engineering programs to streamline our operations and reduce development expense. Over the next few years, you should expect to see a reduction in the amount of manufacturing floor space we require a reduction in inventory, and improvements in profitability. Turning now to guidance. We are expecting a few supply chain issues and order delivery dates will tamp down on growth a bit for the September quarter. Assuming that the sale of the linear product line to photonic foundries is completed, we expect consolidated revenue in the $26 to $28 million range. This includes inertial navigation at $25 to $27 million, along with approximately $1 million in last-time buys from the chip business. Looking beyond that into the December quarter, we expect inertial navigation to have a revenue range of $28 to $30 million. With that, I'll turn the call back over to Tom.

Thank you, Jeff. Let me first start off with the restructuring plan we announced during the June quarter. This plan consisted of a shutdown of the broadband segment and a discontinuance of the defense optoelectronics product line within the A&D segment. Because we have been keeping these operations running to fulfill customer last time buy orders, both broadband and defense optoelectronics were included in consolidated results as continuing operations for fiscal 3Q. So, I'll first start with consolidated and segment results. After that, I'll provide a financial review for inertial navigation. Consolidated revenue in fiscal 3Q was $26.7 million, net of $27 million for A&D, less $300,000 reported for broadband. In an unusual set of circumstances subsequent to our announced shutdown of broadband, development contracts for chips and sensing products were prematurely terminated. Since these contracts are under the cost-incurred percentage of completion accounting method, of which the timing of revenue recognition is independent of the milestone billing and cash collection cycle, a $1.3 million adjustment was recorded in 3Q to properly account for the closeout of these contracts, i.e., true-up final contract revenue to final cash received. Excluding this adjustment, broadband was $1 million. Within A&D, defense optoelectronics revenue was $300,000. This brings total last-time-buy shipments in 3Q to 1.3 million, slightly above our guidance of 1 million. Turning to the rest of the consolidated results on a non-GAAP basis, consolidated gross margin was 16%, flat with 2Q, and for the same reason, the highly dilutive broadband segment gross margin. On the A&D side, 3Q segment gross margin strengthened to 29%. driven by significant improvements for the inertial NAV business, which came in at 30%. For the A&D segment overall, the inertial NAV 30% gross margin was partly offset by a lower gross margin for the discontinued defense optoelectronics component. Consolidated operating expenses were $11.1 million in fiscal 3Q compared to $12.4 million in the prior quarter. The $1.3 million decrease was largely due to lower material expenses for R&D work on FAR programs as well as lower G&A. Consolidated operating loss in the June quarter improved to 6.5 million compared to 8.1 million in the March quarter. Adjusted EBITDA was also better at negative 4.3 versus 6.5 in fiscal 2Q. Consolidated net loss was 7 million or 13 cents per share compared to 8.3 million or 18 cents per share the quarter before. Shifting to the GAAP results for a moment, fiscal 3Q loss was $9.9 million or $0.18 per share compared to $12.2 million or $0.27 per share in 2Q. GAAP results included a $1.8 million charge for severance costs related to the April 21st restructuring announcement and a $1.2 million credit as a result of insurance proceeds received in 3Q. Let me now turn our attention to the non-GAAP inertial navigation results. Inertial navigation revenue grew to $26.7 million in fiscal 3Q, a 10% increase compared to 2Q, driven by double-digit growth for both our space and navigation site in Bud Lake and for QMEMS shipments in Concord. Operations in Tinley Park continued on a steady growth path, with revenue up 5% sequentially. As noted, inertial navigation gross margin expanded to 30% in 3Q, not only on the higher revenues, but also driven by a better mix and significantly improved SportsMEM's production yields. Inertial NAV R&D expense was 4.2 million in fiscal 3Q compared to 4.7 million in the prior quarter. The $500,000 decrease was due to the lower project material spend noted earlier. Turning to the balance sheet, we had cash of 20.2 million at June 30th compared to 24.8 million at March 31st. The $4.6 million change during the quarter included the aforementioned insurance proceeds of 1.2 million and positive operating working capital of 1.5 million, offset by the following uses of cash during the quarter. 4.3 million adjusted EBITDA, $600,000 for litigation-related expenses, $500,000 paid for severance, $500,000 for acquisition-related costs, $900,000 used for financing activities, and $500,000 for CapEx. With that, we are now opening up the call for your questions.

Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To draw your question, please press star 11 again. Please stand by while we compile the Q&A roster. First question comes from Maxwell Michaelis with Lake Street Capital. Your line is open.

Hey, good morning, guys. First question I got to, the first one is related to the supply chain weakness you guys mentioned. I was wondering if you're seeing any material changes in the supply chain lead times, or not supply chain, just lead times, I guess.

So the question is, I'm just trying to break it up a little bit, is whether or not there are material changes in supply chain?

Yeah, sorry, the lead times. Was I breaking up there?

Yeah, it's really not. I wouldn't read a lot into it. One of the things that's become a bit of a flashpoint is that military grade systems on a chip, FTGAs, still remain quite difficult to get. And we see last minute push outs of deliveries. And unfortunately, you can have 99% of the parts available to build and be missing one and then you're stuck. So it's really that. sort of an issue as opposed to an overall supply chain deficiency. There's just a few parts that are military grade that we just don't believe we're going to get on schedule.

All right, thanks. And then my next one is related to book to bill. You mentioned it was 1.0 this quarter. Do you expect to be above 1.0 in Q4? Just wondering if you could share a few points of confidence that kind of give me that outlook. Could you repeat that? So you mentioned that book-to-bill is going to be above 1.0 in Q4. I was wondering if you could share some points of confidence that's giving you that outlook.

Well, there's really a solid demand out there in the market. We see, you know, all the product lines doing quite well. I wouldn't necessarily call it a headwind. One of the things that's occurred because of the Ukraine war, and I don't think this is widely understood, is that when products are shipped to support Ukraine, it gets registered as foreign military sales. But the reality is it comes out of the storehouses of the various branches of service. And so what happens then is the budget priorities get shifted and the service branches that have had product shift are demanding the cash in the budget to immediately replenish their stores. And sometimes that's at odds with, you know, what the, say the Navy or the Air Force program managers have budgeted. if they have to give up money to the Army, where a lot of the material has come from. So it's really caught a phase lag between shipping something from stores and then the push and pull between the branches of service against existing budget priorities, if that makes sense.

Yeah, no, that makes sense. Thanks, guys.

Thank you. And our next question will come from Richard Shannon with Craig Hallam Capital Group. Your line is open.

Well, thanks, Jeff and Tom, for taking my questions here. I get to get a few of them in no particular order. Maybe I'll just follow up on the guidance here. Jeff, thanks for the greater detail here in your prepared script versus the pressure lease here and understanding last time buys, but also want to get a sense of what you're thinking about for gross margins here. I think at the midpoint of the inertial NAV only revenues, I think it's slightly down from your performance in the quarter, but not much. Would we expect to see an inertial NAV gross margin near that 27% number you just, you just, or excuse me, 30% number you just reported?

Yeah, I think we should. You know, the only thing that really is going to move around here from this point forward, Richard, is just the product mix can shift a little bit quarter to quarter. One of the things, for example, that will affect gross margins in the next couple quarters is, you know, the AMPV order I mentioned from BAE. There are some other TAPNAP product orders. We're expecting those to have margins significantly above TAPNAP. You know, let's call it a 30% number. There are also a few products which are not quite as good. But, you know, volume drives the margin at mCorp. And so as volumes pick up, we'll expect to see continued improvement in gross margins in general.

Okay, fair enough then. Let's talk about your comments about December quarter inertial NAV getting up to 28 to 30 million here. The midpoint is a nice growth. It looks like double digits from the midpoint you're telling us for September. So can you talk to us a little bit about some of the drivers there? Sure.

There are some planned delivery dates that have moved around a little bit. You know, customers – do take advantage of the fact that government fiscal year is the end of September. And so when you look at that, some guys that have additional money will want to pull things in, and some guys who don't have money until Q1 that like to push things out. So there's a little bit of that in there. But overall, the trend is that you've got new programs that are picking up, heading into low rate of initial production, And we're expecting to see those require support in terms of shipments in the December quarter. So we're looking at some AMPV orders that will come in. We're looking for final shipments of one of our development programs. You know, one of these things that's a little lumpy, but, you know, sometimes you get non-recurring engineering billings, and then you'll have a bit of a chunk at the end of the particular program phase as the prototypes are delivered. But overall, what I'm really trying to get across is that there is a strengthening and strengthening of demand. There is a consistency within the order patterns that give us confidence to go out a little farther to provide guidance where we wouldn't ever have done that as a broadband company. Again, you know, $68 million in backlog, you know, we can see out several quarters now consistently, and we'll expect that to continue to improve.

Okay. And then given that visibility, I guess I would assume that there's some urgency behind it. segment here would be at least as high in December as September just because of the growth and all your drives are on Mars. Is that fair, Jeff?

Yep, that's completely fair.

Okay, good to hear. Maybe jumping over to the, I'm not even sure what to call the activities you announced yesterday, disposal of defense opto, et cetera, here. Do I understand correctly that there's no effective purchase price and it's really just a liability transfer and OPEX savings dynamic here for you, or do you expect some sort of proceeds on the completion of this, I don't know, disposal, I guess we'll call it?

Yeah, so I would say that it's the former scenario within what you mentioned. You know, there are significant liabilities associated with broadband with one particular supplier in the supply chain. I would also say that, you know, I think we've done a reasonable job at getting the factory or factories more correctly moving again. But every time you do this sort of thing, you run into problems as far as Gosh, you know, we need a special silver-filled epoxy. We need to get it into China. China's got export restrictions, and it's going to take, you know, eight weeks to get something that you can get here in the States overnight. So what it does is it puts all of that sort of activity that really – it's amazing how much management cycle bandwidth it takes up to crack these problems. It also enables us to thin out our organization even further. For example, we still have to have quality people and engineers available inside the business to deal with RMAs and service requirements and the sale of the linear portion of broadband essentially solve that problem for us as well. It just, you know, speeds up our ability to focus and, you know, works out, I think, well for all parties.

Okay. And I guess, can you just kind of give us some sense of what OPEX or cost structure savings that you'll achieve upon close here?

gosh well you know what we what we gave you I think was there was 9.9 million in OpEx yeah I think you go back to the restructuring announcement on the 21st of April Richard and those numbers pretty much hold up because most of it was all broadband and defense opto you know related so as the business gets transferred and eventually the uh we figure out the way for fab um you save all that money there's also a slice of it maybe upwards of around two million of it was in the gna so that'll help the business going forward so what you're likely to see in operating expenses on a go forward basis inertial navigation pure p l uh is around 10 million you know 9.8 somewhere in that that range, you know, from, what were we, 12.5 before we started all this? So, you know, there's your, and then there's some cost of goods sold savings. So there's your at least 12 million right there.

The other point that I make, Richard, is that as we get into this, we have identified a few areas where we might be able to take down OpEx a little further. We're just not quite ready to talk about those in detail, but we certainly will in our next call. So, you haven't seen the end of OpEx reduction. The other point to make, especially as we hit December quarter, will be this, you know, we've talked about research and development, you know, just as a monolithic number, but you're going to see us talk more about what the I-RAD portion, the internally funded research and development number is, and we're going to make some additional refinements, which should help to make it obvious how much we're really spending and how much our customers are supporting.

Okay. You kind of hit on my last question around this I-RAD. Relative to the numbers that Tom just mentioned, as you get more of this NRE that lets this IRAD shine out, then that'll be a further improvement in the OPEX cost structure. Is that right? Yes. Okay. All right. Great. Then I figured I'd pick that one up then. Okay. I think that's all the questions from you guys. I will jump out of line. Thank you. Thank you, Richard. Thanks.

Thank you. Our next question will come from Brian Kinslinger from Alliance Global Partners. Your line is open.

Great. Thanks so much for taking my questions. You mentioned the $68 million backlog. I'm curious if you could provide a total value of contracts that's not included in backlog, an unfunded backlog, if you will.

Oh, wow. Not off the top of my head. But I'll give you two big ones, right, just to give you an example. If you look into the, you know, we announced last winter, I think it was a $32 million contract for CROWS 5, which will go on for three years. We're expecting the first purchase order for CROWS 5 coming up here soon, but that would not appear in backlog at all. Another example, TAMU. TAMU, if you take the time to look into the original documents we signed when we purchased L3 based on navigation, it specifies that a minimum of 222 units will make their way into purchase orders at a minimum. We don't have a final production price for that yet because it doesn't have to be set until after we are done with production readiness review, which is something that happens after the final configuration is done. And that would be, you know, at least $50 million, if not more. And that's just part of it all, right? So, you know, double, triple. Yeah, it's possible, but those are just two, and those two alone would double, more than double the backlog.

Great. Understood. As it relates to TAMU, you mentioned September's the next milestone. When do you expect TAMU deliveries to become mature? Are we a year away? Are we 18 months away to get to that run rate you've discussed?

I think you're probably looking at about a year from now. The thing that you need to understand about this is you're already seeing bits of TAMU within the Bud Lake number. So we're able to recognize the revenue for an item in backlog, which is over $9 million, which is an advanced buy of long lead materials. It's not all of the material, it's just the longest lead parts. And as our customer and we complete critical design review as the configuration gets locked down, you'll see that progress into more production. The interesting part is, of course, that just recognizing revenue for the material, there's not that much margin in it. But even with that, you know, we're doing just the sheer amount of work flowing through Bud Lake has improved the operating results significantly. So, what, you know, and I've said this, I think, in every conference and in a very large number of conversations, you don't think of TEMU as a hockey stick. What you're going to see is continued sequential improvement in the revenue number for Bud Lake as we progress through the program.

Okay. My last question, I'm not sure if I understood correctly, but as it relates to the shortages, you've talked about them for a couple of quarters. Are they related to a different component or the same components, the circuit board you talked about? And are you hearing or seeing or expecting any changes in the near future on these shortages? How much revenue are you unable to generate as a result of these shortages? And does the customer wait for you to get these products, or are they urgent needs where they have to go find them elsewhere? Thank you.

Well, in the aerospace and defense business, nothing happens quickly, and it's rare that you have a situation where any supplier would have large number of these components or even the final end product on a shelf the lead times tend to be very long in this business the particular components are you know again primarily driven by temperature range and reliability requirements and so this set of things were chasing a is different from, let's call it general supply chain issues, which I think have gotten better over the past few quarters. But when you get to these high-rel microprocessors, FPGAs, systems on a chip that go down to minus 55 degrees centigrade, there are very few people that can make them, and everybody has what are called D-pass ratings, which set priorities for acquisition. And so what we may be able to buy for TAMU and get our hands on, because it has a D-pass rating of DXA2, we can't get them for some of the other products because they don't have a D-pass rating. So it's sort of complicated, but it's really confined to only several components. Hopefully, we'll see this start to ease as we get into 24, but I don't think this varies much across the entire spectrum of aerospace and defense companies in terms of getting their hands on these parts. Does that make sense? Okay. Yep.

Appreciate all your time. Thanks.

Thank you. I'm showing no further questions in the queue. I'd like to turn the call back to Jeff for closing remarks.

Thank you. And again, I apologize for bringing back a bug from the far reaches of the customer base. But I'd like to thank everyone for their interest in MCOR and recognize especially our aerospace and defense team for turning in such a strong effort in the past quarter. And we look forward to the next chapter of MCOR's aerospace and defense business.

That concludes today's conference call. Thank you for participating. You may now disconnect.