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Edited Transcript of EMKR earnings conference call or presentation 7-May-20 12:00pm GMT

Q2 2020 EMCORE Corp Earnings Call

ALBUQUERQUE May 24, 2020 (Thomson StreetEvents) -- Edited Transcript of EMCORE Corp earnings conference call or presentation Thursday, May 7, 2020 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeffrey S. Rittichier

EMCORE Corporation - CEO, President & Director

* Thomas P. Minichiello

EMCORE Corporation - CFO

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Conference Call Participants

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* Jaeson Allen Min Schmidt

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

* Ku Kang

B. Riley FBR, Inc., Research Division - Senior Analyst of Optical Components

* Timothy Paul Savageaux

Northland Capital Markets, Research Division - MD & Senior Research Analyst

* Erica L. Mannion

Sapphire Investor Relations, LLC - President

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the EMCORE Corporation Fiscal Second Quarter 2020 Earnings Conference Call. (Operator Instructions) As a reminder, today's call is being recorded. At this time, I'd like to turn the call over to Erica Mannion of Sapphire Investor Relations. Please go ahead.

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Erica L. Mannion, Sapphire Investor Relations, LLC - President [2]

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Thank you, and good morning, everyone. 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 our business. Such forward-looking statements include, in particular, projections about future results, statements about plans, strategies, business prospects, changes in trends in the business and the markets in which we operate. Management cautions that these forward-looking statements relate to future events or our 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, achievements of the business or 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 in the business that are included in the company's filings with the U.S. Securities and Exchange Commission that are available on the SEC's website located at www.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 at the end of our earnings as Exhibit 99.1 to the Form 8-K we furnished to the SEC today -- yesterday, excuse me. These materials can be obtained in the Investors section of our website at www.emcore.com.

With me today from EMCORE are Jeff Rittichier, President and Chief Executive Officer; and Tom Minichiello, Chief Financial Officer. Jeff will begin with a review of the second quarter and business highlights, and Tom will review the financial results before opening the call up for questions.

I'll now turn the call over to Jeff.

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [3]

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Thank you, Erica, and good morning, everyone. Before discussing our second quarter results, I would like to take a moment to address how COVID-19 is impacting our business. I'm thankful to report our employees remain healthy and safe, and we're grateful for their diligent efforts in minimizing disruption to our customers and business in these unprecedented times. As the Lunar New Year began in January, we recognized that COVID-19 was going to have a meaningful impact on our Asian operations and began integrating probable shortages into our planning process and guidance for the March quarter. The framework we used to examine options was to deconstruct our supply chain into its labor component and logistics service functions and assign these areas to individual teams, which met several times a week to drive actions to stay ahead of the changing obstacles. These techniques proved effective. Within China, we were able to reestablish 75% of operations by February 10, and were at plant capacity by the end of February. Office staff worked on the line to bolster output while manufacturing engineers who are in quarantine guided them with webcams and by video conference. By March, we saw activity return to normalized levels in Beijing.

Keep in mind that prior to the COVID-19 problem, nearly half of our equipment had already been transferred to Hytera in Thailand and was unavailable to offset production shortfalls as we were still awaiting customer Product Change Notification or PCN approvals before beginning production in Bangkok. Although our Beijing facility was up and running by the end of February, all 3 of our California factories were subsequently impacted in mid-March. When shelter-in-place orders were first implemented, they created labor and key component shortages at a critical juncture in our normally back-end loaded March quarter. These initial disruptions ultimately gave way to a determination that EMCORE was an essential business that serves defense, commercial aviation and telecommunications industries, and thus, our facilities were able to remain open, albeit at reduced capacity.

As such, while demand from aerospace and defense customers remained as expected during the quarter, supplies to certain critical components were impacted, which caused delays in being able to ship product at the end of the quarter. Related to the strategic initiatives we outlined in our last call and despite the obstacles within China during the quarter, we completed all of the transmitter qualifications from Hytera's Bangkok facility and received the necessary PCNs on schedule. These customer approvals authorized EMCORE to build production transmitters at Hytera SDI during the June quarter, we expect to complete the PCN for all of the laser and linear EML modules, enabling us to completely switch manufacturing to Thailand during the September quarter. The exact timing of the cutover remains somewhat fluid because it's crucial that our engineers be able to travel to support the production processes in the new facility. Travel to Thailand remains difficult with mandatory quarantine periods in effect.

We're also being cautious with this transition, so as not to concentrate our geographic risk during the COVID-19 pandemic. By building across Chinese and Thai facilities in the current quarter, we will hedge the risk of labor shortages at the cost of lower total capacity in our operations and some additional costs. We see this as the right bet given the circumstances. Furthermore, we successfully completed our ERP installation in the Concord facility as planned, enabling us to remain on schedule in our efforts to reduce operating expenses.

Turning to individual product areas. Broadband performed as expected in the second quarter. With our wireless modules and sensing products shipping according to plan. Cable TV overperformed slightly and showed stronger demand towards the end of the quarter. While welcome, this additional demand created unplanned complications in securing airfreight capacity in time to recognize revenue. Furthermore, getting products through customs in time also proved problematic, preventing us from recognizing the full value of our shipments as revenue in the second quarter.

In aerospace and defense, we expected a seasonally soft Q2. I however, the mid-March shelter-in-place orders in California presented additional challenges to completing our revenue plan. Not only did our Concord and Alhambra facilities experienced disruptions but our contract manufacturing partner in Orange County was also impacted. Although EMCORE is an essential business, the orders created limitations in labor and component supplies. In addition, the rapid decline in commercial airline traffic created shortages in airfreight capacity, making it more difficult and costly to produce.

As COVID-19 spread, it continually changed the challenges that we faced over the quarter, making our jobs much more difficult. In addition to the increased risk from identifiable areas such as labor, and material supplies and logistics service, the pandemic also created what can best be described as increased friction in ongoing business activities. Normal business actions took significantly longer and required more energy to complete than they did just a few months prior. With that said, our team responded with energy and creativity, making the best of a very difficult situation. As we look ahead, I'll take a moment to discuss the demand we see in each of our business segments and provide color on the contingency plans we have put in place to manage the challenges that COVID-19 created.

Starting with broadband. We expect the smaller wireless and chip components in the broadband business to maintain their contribution, but we are seeing strength in our cable television products. Recent comments from the MSOs have pointed to significant bandwidth demand from workers complying with work-from-home initiatives. In one particular case, a leading MSO stated that a whole year's worth of bandwidth growth concentrated itself into a single month. The MSOs are now reacting strongly to improve capacity and response to their networks, which has resulted in a full order book for EMCORE's cable TV business going out into Q4. It's clear that MSOs are relying on proven technology to meet their needs and that any thoughts of larger DAA or Remote PHY deployments are being pushed into the distant future.

I would also offer that Remote PHY shelf products, which incorporate linear optics built by EMCORE, continue to gain traction in the longer-term planning of the MSOs. Although it's impossible to say with any degree of certainty, how long this upgrade cycle will last, EMCORE is very well positioned to meet these demands as it works to complete its EMS transfer by the end of the fiscal year.

Within aerospace and defense, our defense customers continue to place orders for programs that are in production. These represent most of the revenue in this segment. New defense products going through design validation and qualification tests are being delayed because many engineers are working from home. We expect to continue to make progress on these programs, but have to accept that time lines will continue to push to the right until our customers are back in their facilities and working with equipment every day. Although we fully expect these challenges to be transient in nature, it's difficult to project the testing milestones at this point. Our aerospace customers tied to commercial aviation are showing signs of weaker demand and have requested pushouts for the December quarters and September quarters that we are still negotiating.

Given the broad uncertainty in the markets around us, as a company, we're focused on managing the aspects of our business within our control and preparing action plans around various demand scenarios which may emerge. As we move into the June quarter, labor shortages due to COVID-19 remain our biggest concern. Beyond that, we expect the general amount of friction in the supply chain will continue to present a changing set of obstacles for us to overcome. We have plans in place to deal with shortages of airfreight, custom staffing as well as sourcing of certain limited components, but we do recognize that unpredictable events could create new challenges in the months ahead.

During our second fiscal quarter, we implemented the reduction in force, redesigned our wafer fab workflow and optimized other R&D functions around the smaller staff. As I mentioned before, the finance team completed their ERP implementation in Concord, which will result in smaller accounting financing going forward. The remaining synergies with the SDI integration are on track to be completed by the end of the June quarter.

As evidenced by our first half results, improved operational performance, combined with expense reductions and actions to improve our cash balance and liquidity levels, have placed us in a much improved financial footing even at the current revenue levels. This leads us to believe that we have the necessary resources to navigate through these unprecedented times.

Moving on to guidance for the third fiscal quarter. While we're cautiously optimistic about the level of demand we're seeing and the plans that we currently have in place, we can't ignore the sheer magnitude of uncertainty in the supply chain and the fluid nature of the challenges that will doubtlessly arrive. Consequently, we're taking a cautious view and expect revenue to be in the range of $25 million to $27 million.

With that, I will turn the call over to Tom.

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Thomas P. Minichiello, EMCORE Corporation - CFO [4]

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Thanks, Jeff, and good morning, everyone.

Consolidated revenue in the fiscal second quarter was $23.8 million compared to $25.5 million in the first quarter. At the segment level, aerospace and defense revenue was $13 million compared to $13.7 million in the prior quarter, and broadband revenue was $10.8 million this quarter compared to $11.8 million in the quarter before. 2Q revenue was largely impacted by the typical March quarter seasonality of our 2 largest product lines, our Quartz MEMS navigation products within A&D and our cable TV transmitters and components within broadband. Team MEMS was additionally affected by the COVID-19-related supply chain headwinds that Jeff noted. For the A&D segment, the lower Q MEMS revenue was partly offset by double-digit percent increases for RFoG navigation and defense optoelectronic product lines. For the broadband segment, the typical cable TV demand softness early in the quarter and the impact of the extended Chinese New Year was somewhat mitigated by a stronger-than-expected rebound towards the end of the quarter.

Moving on to the rest of the operating results. Non-GAAP gross margin was 28% for the quarter compared to 30% in the prior quarter. There were a number of factors that netted to the 2% sequential change. The more significant items being: the lower revenue, which resulted in about 1.5 decrease; lower A and B production yields accounting for about another 1.5 drop and cost reductions within broadband, which drove about a 1 percentage point improvement.

Additionally, while swings in overhead cost absorption at the consolidated level was not a significant factor when you compare the March quarter to the December quarter, it did have a meaningful impact on our segments. A&D was unfavorably impacted by lower absorption due to decreased production output, and broadband improved as a result of reduced under-absorption largely as a result of lower costs in China. As a result, non-GAAP gross margin for A&D in 2Q was 23% compared to 33% last quarter, and broadband was 34% compared to 26%. On a fiscal year-to-date basis, segment gross margins for A&D and broadband were 28% and 30%, respectively.

Non-GAAP operating expenses were $10.4 million compared to $9.4 million in the prior quarter. The majority of the sequential increase was in SG&A and was largely attributable to onetime credits in the prior quarter. Driven by recent expense reduction actions, quarterly non-GAAP OpEx has been reduced by $2 million or 15% from just 2 quarters ago. Due to the revenue seasonality and lower gross profit, non-GAAP operating loss was $3.8 million in the second fiscal quarter compared to $1.8 million last quarter. Adjusted EBITDA, which adds back depreciation, was negative $2.5 million compared to positive $200,000 in the quarter before.

Turning to the balance sheet. We had $22.1 million in cash with no debt at March 31 compared to $10.9 million net of short-term debt at December 31. The net cash increase of $11.2 million was attributable to the following factors: $12.8 million received from the February 10 sale and leaseback transaction of our Q MEMS facility in Concord, California; $100,000 received from a previous quarter shipment of cable TV equipment as part of our production asset sale agreement with Hytera; and $1.7 million used during the quarter of which $900,000 funded routine operating activities and $200,000 was for employee severance. The balance covered previous period CapEx and legal matters.

Finally, yesterday after market close, we issued an 8-K regarding securing a loan in the amount of $6,448,000 under the Paycheck Protection Program, or PPP. In accordance with the requirements of the PPP, we intend to use proceeds from the loan primarily for payroll expenses.

With that, we'd now like to open up the call for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will now take our first question from Jaeson Schmidt of Lake Street Capital Partners.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [2]

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I just want to start with the cable TV business. Jeff, just curious if you could quantify how much revenue you were unable to recognize in March due to supply constraints.

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [3]

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Well, not so much, Jaeson, on the cable TV stuff, it was really getting product into 1 customer and over the border. It was $200,000.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [4]

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Okay. And then just sticking with the cable TV business. When you look at inventory in the channel, what are your thoughts there? And I guess, more specifically, with this uptick from, sorry, the work-in-home trends, that you're benefiting from here in March and likely June, do you think there are pull-in orders into this first half of calendar 2020?

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [5]

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Yes. So first of all, as it relates to inventory in the channel, there's basically none, and -- at least not that we're able to find anywhere, and that's based on where we see orders coming. One of our major customers uses distribution and the other does not, but we're intimately familiar with the situation in both customers so that's not a factor.

What we're really seeing is the result of, call it, a year's worth of bandwidth expansion that showed up in a month and the realization by the MSOs that they needed to go in and break bottlenecks. And so what you're seeing is a lot of node splits. And so anybody in the node business, anybody in the transmitter business should benefit from that. In our particular case, the orders in cable didn't show up until March, and then they started to show up with a vengeance into the current quarter. So not only are we booked completely for the current quarter of going fairways out into the September quarter as well. So the demand is very strong. It's unusually high. And the big question becomes, as far as how quickly we can meet it, is largely actually driven by material.

While TSMC and the other big semiconductor manufacturers, guys that build wafers and cell dye, they're doing quite well, the issues are going to be in the packaging area in places where COVID has hit, and that includes the Philippines and Malaysia. So the bottlenecks tend to be where packaging occurs. And the good news is we're not trying to buy millions of things, right? So we're able to go into smaller parts of the distribution channel to get what we want. But largely in the short term our production capacity is going to be limited by the number of components that we can bring in.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [6]

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Okay. Appreciate that color. And then the last one for me, and I'll jump back into queue. Broadband gross margins, very strong in March. How should we think about that going forward given the moving parts of mix within that segment as well as the cost reductions you guys have undertaken?

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Thomas P. Minichiello, EMCORE Corporation - CFO [7]

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Yes. Jaeson, its Tom here. So I think the way to think about it is continue at the levels we're at. We got the benefit of some cost reductions, both here with the restructuring actions that we've taken. And then we also had some costs that were taken out in China related to the move to Hytera. For example, the depreciation expense is now off the books because, if you'll notice on our balance sheet, those assets have been moved in a held-for-sale mode. So that's a permanent change going forward. So I see it's still in the low to mid-30s. We just did 34%, given where we're headed here, volume-wise, going forward, we'd expect it to be -- to continue at that level.

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Operator [8]

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We will now take our next question from Tim Savageaux of Northland Capital Markets.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [9]

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Congrats on the solid execution in this environment. I have a couple of questions. With regard to the strength in cable, any chance you can give us color on, I guess, magnitude of booking strength, I don't know if you have book-to-bill-type metrics you can share as you saw this surge in March that continues into the current quarter. And I guess in line with that, you characterized pretty solidly up sequential guide as cautious, I guess. Without that caution, what would it have been?

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [10]

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Well, that's a tough question to answer. So the caution largely revolves around access to components, Tim. We think a lot of these situations will resolve themselves in the September quarter as we get into June and July shipments from the big packaging operations. But cable would be up even more substantially than we'd indicated. I think the best way to explain it -- and we haven't been providing book-to-bill. But normally, cable -- our production cycles are so short now, our customers -- we typically end our quarter with only about a month to 6 weeks' worth of backlog. Right now, in the current quarter, we are completely booked. And we are well past the normal, call it, July 1 number. We're long past that a week or 2 ago.

So I think the book-to-bill would be sort of numbers that you haven't seen since 2016, 2017. But more concentrated because back in '16 and '17, of course, there was a bunch of RF Over Glass stuff that is no longer being deployed. So it's really transmitter and laser focused. It's all in node splits, and it's across all 3 major MSOs, those being Comcast, Charter and Liberty Global. And we also -- we can recognize where it's going just by the channel plans and other specifics. But we're also seeing additional demand from places like Cox, Rogers and Shaw from the 2 major equipment OEMS. So it's everywhere, right? Matter of fact, we've even seen products going into Japan. And normally, they're extremely steady and there are very few surprises either on the upside or downside. So it's a pretty uniform uptick everywhere, and it's very strong.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [11]

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Got it. And then just sort of follow-up on that. It seems like there's a particular focus among cable operators on pressure on upstream traffic in the network. I wonder if you can describe how EMCORE is exposed to operator efforts to try and address that concern.

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [12]

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Yes. So first of all, the node splits themselves solve a lot of that problem even without throwing technology at it. Where we tend to see some, let's call it, impact by changing technology on the return path, we see it in the node with some of our high-speed receivers, but that's not really big dollars. I mean, these things are pretty cheap, and so I wouldn't describe that as a major driver.

I would say that the changes going forward into increased bandwidth on the return side are being figured into our product plans, but that has very little if nothing to do with the next couple of quarters. That's really sort of a year out. So I wouldn't describe changes in the return path plan is driving anything over the next couple of quarters. But a year from now, yes, we're going to be in the middle of that.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [13]

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Got it. And 1 more for me and then I'll pass it on. You mentioned, I think, in the context of the overall kind of in line broadband in the quarter, anticipating contributions on the laser chip side. You've seen some growth there recently. I wonder if you could give us any more specific color on chip demand, either on GPON or telecom side and what your expectations are there heading forward.

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [14]

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Yes. So as we've described before, we really have deemphasized, what's called the commodity GPON parts at 2.5G. And we supply not even a handful, right? I think 2 customers with those parts, just because we've got big relationships with them that we need to maintain and, hey, sometimes you do things you don't really want to. But it's important to the customer.

We are seeing more activity in 10G components. We are seeing additional demand for other types of telecom products that I can't quite describe, but they are certainly -- they fall way out of the category of commodities. And we've had good traction with our major customer on the game chip side, that's NeoPhotonics, and meeting their requirements. So I -- what I would describe them as, Tim, is more high end-focused sales. It's not huge dollars, but it pays a lot of bills in the fab.

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Operator [15]

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(Operator Instructions) We will now take our next question from Dave Kang of B. Riley FBR.

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Ku Kang, B. Riley FBR, Inc., Research Division - Senior Analyst of Optical Components [16]

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Regarding the fiscal third quarter outlook, it looks like you're guiding about $2 million growth there. Should we assume perhaps equally split between A&D and broadband or maybe mostly broadband-driven? Any color on that?

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [17]

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I would describe it at this point is it's probably pretty evenly -- call it, pro rata evenly split. Again, the thing that's going to limit some of the broadband production in the current quarter is just availability of components. The demand is there for a bigger number but there's just a bunch of stuff that's really hard to get. And so there's just some supply chain challenges. Going forward, we're looking at a real strong Q4 table. We're not prepared right now to come up with a number there. But you'll see growth from Q3 into Q4, from the June quarter into the September quarter. And we expect to see A&D continue to do good things as well.

The only -- there's 2 pieces that I want to make sure that everybody understands. The defense piece, orders are continuing to move along for production programs as if nothing happened. The new stuff that's being qualified and flight tested, that's being delayed because our customers' engineers are working from home and they can't be with their equipment. And so we depend on them to get back to work and finish their testing.

The second major point is that we are going to see some push-outs in Q -- in the September quarter and December quarter from commercial aviation. We see those in the low single-digit millions, and we're still negotiating that. So the only place where there's real weakness in demand is the commercial aviation side, right? The Boeing 777 project and some of the biz jet stuff that goes through the large avionic suppliers, guys like Collins and Garmin and folks like that. And it's no secret that they're going to have issues just because of their exposure to commercial aviation.

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Ku Kang, B. Riley FBR, Inc., Research Division - Senior Analyst of Optical Components [18]

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Got it. Next question on FOG. So how close are you or is -- how close are you for FOG to reach production programs that you talked about in the previous call?

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [19]

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Very. We're just -- it's the last bit of testing, well inside the red zone. It's maddening that we got clobbered with this stuff in March, and a lot of people went home. So we're hoping that the stuff gets finished -- the testing gets finished for one of the major programs in the current quarter, which would enable orders to be released. And the second larger program heads into what's called LRIP, low rate of initial production, if you like those military acronyms. And that will happen in the December quarter. Very high ASPs and good margins.

So again, Dave, my comments about friction, I think, are probably, albeit a little bit fuzzy, the most accurate ones I can come up with. Things just are taking longer and require more effort.

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Ku Kang, B. Riley FBR, Inc., Research Division - Senior Analyst of Optical Components [20]

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Got it. And my last question is on OpEx. Obviously, a lot of moving parts. How should we think about more of a normalized OpEx going forward?

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Thomas P. Minichiello, EMCORE Corporation - CFO [21]

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Yes. Dave, Tom here. So there are a lot of moving pieces. We've had some credits last quarter. We've got a lot of other expense items that are moving the OpEx around. But our outlook and expectation is, is right around $10 million non-GAAP OpEx in the next quarter, plus or minus. I mean, it can move up or down a bit, but that's what we're forecasting.

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Operator [22]

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And as there are no further questions, that now concludes the call. Thank you for your participation. You may now disconnect.