CML Cml Microsystems Plc

Introduction

FY24 was a resilient and strategically pivotal year for CML, marked by the acquisition of Microwave Technology Inc (MwT) in October 2023 after US Government regulatory procedures delayed completion of the acquisition by over four months. MwT, a leading US designer of semiconductors for the telecoms, defence and medical markets has added a talented team, new customers and a major opportunity to expand our target market.

The Company performed well through the first half year of trading, reporting solid growth. In the second half, we experienced more mixed trading patterns, typical of the wider sector, with some customers and channel partners reducing their inventory levels.

On a more encouraging note, the revenue contribution (October 2023 to March 2024) from MwT has been very positive under CML's first period of ownership and has been above management expectations. The progress made so far is pleasing and we are advanced in our programme to unlock the operational synergies that are expected to realise the full potential of the combined business over the medium term.

Group revenues finished the year in line with market expectations, and while the change in mix between higher-margin core products and lower-margin MwT products did impact the overall Group margin, the Company retained a strong balance sheet, with net cash reserves of over £18m.

Industry data pointed to a mixed performance for the wider semiconductor market in 2023, with growth accelerating through the year before a downturn in early 2024. For context, these trends include memory ICs and microprocessors and are heavily influenced by consumer-related applications such as mobile phones. Whilst the performance of the general semiconductor market may not be directly applicable to CML's industrial and professional end markets, an uncertain economic environment coupled with an excess inventory situation affects most submarkets, making it difficult to call the timing of a pick-up in end demand with any accuracy.

Nevertheless, it is important to note that CML remains a key partner to its customer base. As a typically sole source supplier, our customers are reliant on CML products to drive their own success and we fully expect a return to core product growth through FY25 as the current inventory situation normalises.

Strategy

The global communications market is vast, with a myriad of end-application areas ranging from mobile networks to precise positioning systems to short-range remote-control devices. Within this landscape of opportunity, CML is actively participating in a number of sub-markets that play to our strengths and have excellent growth potential on a sustainable basis. These sub-markets include mission critical communications, wireless networks & satellite, Industrial Internet of Things (IIoT) and more recently, broadcast radio. Combined, this represents an addressable market in terms of semiconductor content which easily exceeds $1bn.

One key objective for the financial year to 31 March 2024 was to continue with our markets' expansion strategy through the addition of high-frequency microwave & millimetre wave semiconductor products, targeted at global mega trends including satellite communications, 5G and IIoT. This objective builds upon many years of experience producing baseband and RF components for professional wireless and critical communications applications and follows from the strategic decision taken to enhance the Group's design engineering capabilities to include microwave and mmWave compound semiconductor devices, including PAs, LNAs and gain blocks under the SµRF brand.

A major step forward was made on 2 October 2023 with completion of the acquisition of Silicon Valley-based MwT, complementing organic product development activities and accelerating delivery of the technology roadmap. This acquisition not only expands the GaAs and GaN MMIC portfolio, it adds a range of discrete devices and hybrid amplifiers, thereby widening the addressable market to include Aerospace & Defence, Medical and Test & Measurement application areas.

The integration of the MwT business into the Group has proceeded at pace. The relevant MwT products were incorporated under the CML SμRF brand with effect from January 2024 and the enlarged SμRF product portfolio is now being marketed and supported on a global basis. MwT adds engineering, manufacturing and final test capabilities within the US to complement existing resources in the UK and Asia and deliver flexibility to customers in terms of regional product supply. Appropriate investments are being made in personnel and local operations to cope with the very welcome challenges that globalisation will bring and unlock the operational synergies to realise the business' full potential over the medium term.

Another key objective for the year was to enter the digital radio broadcasting market through the launch of a receiver IC and associated module targeted at the Digital Radio Mondiale (DRM) marketplace. DRM is a global, open, green, flexible, efficient, cost-effective digital radio broadcasting standard covering all frequency bands, including LW, MW and SW for large coverage areas and VHF for local and regional coverage. DRM provides high-quality sound along with data services such as emergency warning functionality (EWF), distance learning and traffic information. India, countries in the East and South of Asia, South Africa and Latin America are key DRM development markets.

CML's DRM1000 is a complete 'antenna to speaker' module, containing all hardware, software, IP and patent licenses required for a radio equipment manufacturer to easily realise a dual mode (digital and analogue) DRM capable receiver. The module is a joint development by CML and Cambridge Consultants, part of Capgemini Invent, combining CML's world-leading expertise in wireless IC design with Cambridge Consultants' world-renowned expertise in low-power digital signal processing. First announced at IBC2023, an international broadcasting event held in The Netherlands during September 2023, the module achieved production ready status post the financial year end and offers a 60% cost reduction and 80% power reduction over existing DRM technologies in the market.

Early customer adoption has started and a programme of product enhancements to widen the available market further is underway. Revenues are expected to commence through the year ahead.

The Group's multi-year growth strategy has not changed, and we continue to place the emphasis on execution, with the goal of securing a larger share of the expanding global semiconductor communications market.

Markets

The mission critical communications sector is a multibillion-dollar market that is estimated to grow at a CAGR of close to 9% over the next few years. Applications include public safety, government agencies, transportation, energy and utilities, mining and others. Growth is being driven by the increased adoption from energy and utility sectors, rising investment by military forces and trends within the transportation industry where real-time data is being used to support dynamic decision-making. Mission critical communications has been a cornerstone of CML's global business for many years and the year under review was no exception.

Revenues from these end markets recorded a mixed result year-on-year. Shipments into many of the Group's customers increased by a healthy margin; however, a selection of customers continued to work through their elevated inventory levels, leading to delays in the placement of new orders. Ordering patterns for the affected customers should ultimately normalise once end-market demand exhausts excess stock levels. Whilst it remains difficult to precisely predict the timing of a return to normality, we currently anticipate it will commence during the second half of the financial year.

CML has a long history in supporting data-centric applications with decades of experience in helping to solve customers' design problems through delivering class-leading modem and RF ICs. In more recent years much emphasis has been placed on the Internet of Things (IoT), or in CML's case, the IIoT. Simply put, this is an extension of machine-to-machine communications (M2M), enabling the physical world to be monitored and/or controlled through a variety of technologies and mediums that ultimately connect to an external network. Wireless communication continues to play a key role.

Our semiconductor solutions for IIoT include modem ICs, with and without embedded DSP cores, along with a wide range of RF ICs. Customers frequently select a number of CML devices to form a chip-set solution to their engineering needs which helps them minimise issues associated with multi-vendor supply agreements and forced end-of-life programmes that are a typical characteristic with the larger global semiconductor manufacturers.

Combined product shipments into the Group's top customers active in these sectors was slightly stronger than the prior year despite being constrained by the inventory situation in one or two cases.

On a very positive note, good progress is being made with an important strategic objective to broaden our customer base. This is evidenced by the fact that over the last four financial years, excluding the Storage business that was divested during FY21, the number of customers with an annual spend exceeding £0.50m per annum has increased from three to twelve. As a result, several new sub-application areas contributed to Group revenues, including commercial satellite, phased array radar, wireless mesh networking and medical imaging. Across the same four-year period, Group revenues have increased from £13.1m to £22.9m, equating to a CAGR of 20%.

Most of the market sectors being addressed have an industrial or commercial focus and meaningful revenue takes time to flow through after achieving design-in success. However, the above customer metrics validate the strategy being followed and demonstrate the underlying progress being made.

Operations

A rapidly growing product range places greater demands on the Group's internal operations. The expansion of the UK-based in-house testing capability to include the SµRF high-frequency microwave and mmWave product line has presented interesting challenges across the last couple of years, as has the more recent and ongoing incorporation of MwT into the Group. It is testament to the capabilities of the global operational team that challenges are continually overcome with a combination of dedication and professionalism.

The sales, marketing and customer support teams have each worked diligently to ensure the Group's routes to market remain appropriate, the expansion of the product range is well communicated, and the ongoing customer design-in activities are supported to the high-level that customers have grown to expect from us.

Across the year, as planned, the Company participated at a number of trade shows relevant to the sectors and industries being addressed. These included IMS2023 (San Diego), European Microwave week (Berlin), IBC Amsterdam and BES Expo 2024 (New Delhi). These activities were well received and are an important ingredient for success given the strategy being followed, raising awareness of CML across a wider customer base.

In recent years, the Group has invested heavily in its R&D activities to position the business appropriately for the opportunities that lie ahead. Cash allocation towards R&D is categorised into several sub-areas to ensure the right balance between growing revenues in core CML markets, expanding the addressable markets to capture future growth and internal research and innovation to maintain product superiority and suitability.

R&D expenditure for the year represented 20% of sales and is further detailed within the Financial Review; however, for the year ahead, an appropriate amount of funding will also be directed at a strategic initiative to ensure long-term supply of certain key products to support important existing revenue streams within the core business. This initiative will also have an impact on inventory levels over the next two years but is independent of current end-market dynamics.

While the whole process is one of evolution and refinement over time, the level of effort, commitment and achievement from the employee base globally has been exceptional. Of the 160+ staff employed around the world, staff turnover remains relatively low with the average length of service at 17 years and 51% of our team having worked for our businesses for more than ten years.

Multi-year high levels of R&D focused on markets expansion coupled with the recent enlargement of the product range through acquisition has had a very positive effect on the sales opportunity pipeline. It has doubled since FY20.  Two-thirds of the design wins recorded during the year under review were for customer projects that will drive new revenue streams, while the remainder consisted of existing customers switching to new or different semiconductor solutions from CML.

Outlook

Clearly global issues remain, including geopolitical and economic uncertainties. We remain mindful of this and continue to manage risk appropriately, whilst staying steadfastly focused on the growth opportunities seen, both in existing and emerging market sectors.

The results for the year to 31 March 2024 demonstrate resilience in challenging conditions and the trading environment for the current year will continue to be influenced by the customer inventory overhang. However, it is important to note that CML remains a key partner to its customer base, who are reliant on CML products to drive their own success.

The business continues to make very good progress from an operational perspective, executing against a solid expansion strategy with an experienced, skilled and enthusiastic team. The relatively strong balance sheet allows longer-term decision-making that is intended to benefit all stakeholders through the years ahead.

The current full financial year is expected to show a further revenue advance, albeit not at the compounded rates seen across the prior four-year period. The full year inclusion of MwT's cost base along with necessary activities to unlock the full potential of the enlarged business will have an impact on operational profitability. However, these are essential and value-added strategic steps in the drive towards much higher medium-term gains.

The longer-term ambition remains unchanged, to drive significantly higher revenues and profits through providing class-leading semiconductor solutions into large and growing end markets. The business has the resources and market focus to drive the progress required and continues to increase its presence in new and emerging growth sectors.

FINANCIAL REVIEW

Revenue

The Group's full-year revenues improved by 11% to £22.89m (FY23: £20.64m), including a contribution of £3.31m from the newly acquired MwT business. Excluding MwT, reported revenues declined by approximately 4%, having been impacted by an ongoing inventory correction across a number of customers and a challenging environment within China. On a constant currency basis, revenues would have been approximately £0.9m higher (4%).

From a geographical perspective, classified by shipment destination, 51% of revenues were derived from Asia (FY23: 59%), with the vast majority of the balance split between the Americas and Europe, contributing 24% (FY23: 19%) and 22% (FY23: 19%) respectively. MwT's revenues were dominated by its US-based customers and are included within the above percentages. The largest customer represented 10% of Group revenues.

Gross profit

Gross margin achieved was 71% (FY23: 76%), reflecting the blended outcome of lower voice and data-centric product sales, increased SµRF shipments and the incorporation of the MwT product range for the second half of the year. That said, the overall revenue improvement more than compensated for the margin effect, leading to a 4% increase in gross profit to £16.21m (FY23: £15.61m). Looking to the future, gross margin as a percentage is expected to reduce as Group revenues move higher and the overall share from the SµRF product range increases.

Distribution and administration

Distribution and administration expenses increased to £14.23m (FY23: £12.64m) with the increase driven largely by the inclusion of the MwT business for the second half period. The figure also includes £0.46m of acquisition-related costs. On a like-for-like basis (excluding MwT), D&A expenses were approximately 2% higher at £12.84m, highlighting the diligent focus of the Group's operational management team globally.

The combined research and development expense for the year amounted to £4.50m, of which £0.96m was expensed (FY23: £5.13m, of which £0.68m expensed). This reduction in overall R&D expenditure is not a reflection of any change in commitment towards expanding the product portfolio. Instead, it reflects the completion timing of certain development projects along with a strategic review of the Group's product roadmap following the substantial MwT portfolio acquired.

Operating profit

After accounting for share-based payments and the positive effects of an R&D expenditure credit (RDEC), profit from operations amounted to £1.94m. This compares to a prior year operating profit of £2.93m, excluding the exceptional profit from the sale of excess land that occurred during that year (£2.06m).

Profit before tax

An improved interest rate environment enabled the Company to achieve a higher return on cash and short-term deposits held. Finance income climbed to £0.55m (FY23: £0.26m) lifting profit before tax to £2.52m (FY23: £3.16m excluding exceptional item).

Profit after tax

In addition to the RDEC credit that is accounted for under other operating income within the Consolidated Income Statement, the Group continued to benefit from the R&D tax credit scheme that has existed for some years in the UK. For the year under review, tax assessed for the period is lower than the 25% standard rate of corporation tax in the UK, providing an effective tax rate of 18%. Profit after taxation was £2.06m (FY23: £3.09m excluding exceptional item).

Earnings per share

Basic earnings per share for the year equated to 13.00p. After adjusting for the prior year exceptional sale of land, this represented a decline of 33% (FY23: 19.44p). On a reported basis, including exceptionals, the figure for FY23 was 30.29p.

Cash

At 31 March 2024, the Group's cash reserves, including short-term deposits, stood at £18.21m. The reduction of £4.05m across the year follows an R&D cash spend of £4.5m, a share buyback of £1.75m, dividend payments of £1.74m and a one-off spend of £1.08m relating to the relocation of the Oval Park HQ car parking to unlock the maximum potential benefit from selling the excess land held. For the year ahead, an ongoing programme of capital investment is in place to support internal development and production capabilities for the high-frequency SµRF product family, which is a cornerstone of the growth strategy.

Cash flow will come under pressure for the year ahead for two main reasons; firstly, working capital to support the aforementioned strategic R&D initiative and secondly, as a result of further payments relating to the MwT acquisition, being $1.17m already paid on 2 April 2024 and a $2.65m payment due 2 October 2024.

Inventories

Inventory levels ended the year at £3.67m (FY23: £2.43m) and consisted of £2.81m relating to the pre-existing CML product portfolio and a further £0.86m attributable to the inclusion of the acquired MwT products. It has been an intentional strategy to maintain a higher level of raw material inventory to address semiconductor supply chain disruptions that have been a feature of recent years. The expanding product range also plays a role. In conjunction with the strategic R&D initiative mentioned earlier in this review, the raw material inventory levels for a selection of key products will rise further through the year ahead. Of the £3.67m, 45% was held as raw material.

Pension scheme

The Group currently has a retirement benefit obligation in respect of an historic defined benefit pension scheme, which was closed to new members in 2002 and to future accruals in 2009. The most recent triennial actuarial funding valuation of the scheme carried out by an independent professionally qualified actuary, as at 31 March 2023, resulted in a net pension surplus of £0.13m with the assets of the scheme valued at £15.70m. An annual update of the schemes position, as at 31 March 2024, showed that the surplus had improved to £0.41m.

The pension scheme surplus calculated under the funding valuation basis above differs from the accounting valuation presented in the Consolidated Statement of Financial Position, which shows a net pension liability of £1.70m. Differences arise between the funding valuation and accounting valuation, mainly due to the use of different assumptions in valuing the liabilities in accordance with the accounting standard IAS 19 Retirement Benefits.

All administrative expenses of running the scheme are met directly by the scheme along with pension protection fund levies.

Dividend

As communicated within the Chairman's Statement, the Board is proposing a final dividend of 6p (FY23: 6p), giving a full-year dividend of 11p (FY23: 11p).

Chris Gurry

Group Managing Director

1 July 2024