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Edited Transcript of EMKR earnings conference call or presentation 8-Aug-19 12:00pm GMT

Q3 2019 EMCORE Corp Earnings Call

ALBUQUERQUE Aug 11, 2019 (Thomson StreetEvents) -- Edited Transcript of EMCORE Corp earnings conference call or presentation Thursday, August 8, 2019 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

* Mark A. Gordon

EMCORE Corporation - Interim Principal Financial & Accounting Officer

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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

* 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 Third Quarter 2019 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 Eric Mannion (sic) [Erica Mannion] of Sapphire Investor Relations. Ma'am, 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 or achievement through 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 and business -- and the business that are included in the company's filings with the SEC 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 and quarterly reports on Form 10-Q.

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. Investors are encouraged to review these non-GAAP financial measures as well as the explanation and reconciliation of these measures to the comparable GAAP financial measures included at the end of our earnings press release included as Exhibit 99.1 to Form 8-K we furnished with the SEC today. These materials can also be found 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 Mark Gordon, Interim Principal Financial and Accounting Officer. Mark will review the financial results, and Jeff will discuss business highlights and fiscal fourth quarter guidance before we open the call for questions.

Now I will turn the call over to Mark.

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Mark A. Gordon, EMCORE Corporation - Interim Principal Financial & Accounting Officer [3]

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Thank you, Erica, and good morning, everyone. Today, I will focus my discussion on EMCORE's fiscal year '19 Q3 financial results ending June 30, 2019.

Consolidated revenue for the quarter came in at $17.2 million, with broadband revenue representing 57% of total company revenue, down from 65% in the prior quarter as MSO spending within the cable TV market remained soft during the quarter. Chips represented 11% of revenue as compared to 16% in the prior quarter, principally as a result of the continuing trade dispute with China, while navigation grew to 33% of revenue from 19% in the prior quarter. Overall, cable TV was 40% of revenue for the quarter.

GAAP gross profits in Q3 were approximately $3.7 million or 21.6% of revenue, down from 26.7% in the prior quarter. The sequential decrease in gross margin was largely driven by under-absorption in our manufacturing facilities related to the softer-than-expected demand from cable TV and chip products. Total GAAP operating expenses for R&D and SG&A were $13.9 million, $2.5 million higher than the prior quarter and $3.8 million higher than the prior year. On a non-GAAP basis, which excludes the impact from the arbitration award which was accounted for in the third quarter, operating expenses were $9.3 million, $1 million higher than the prior quarter due to additional investment in aerospace and defense and the inclusion SDI of operating expenses for the last 3 weeks of the quarter.

On a GAAP basis, the consolidated operating loss for the third quarter was $10.2 million. Our non-GAAP operating loss from continuing operations, after excluding current adjustments, all of which are set forth in the non-GAAP tables included in today's press release, was $5.1 million, a $2.9 million decrease compared to the prior quarter, primarily due to the lower gross margin level I referenced earlier, combined with the partial period inclusion of SDI. As a percent of revenues, in Q3 fiscal year '19, non-GAAP operating income was a negative 29.7%. Our non-GAAP pretax loss from operations was $5 million.

Moving on to the balance sheet and cash flow statement. At the end of Q3 fiscal year '19, the company's cash and cash equivalents, including restricted cash, were approximately $20.6 million or a decrease of $30.1 million quarter-over-quarter. The largest contributor to this decline was the purchase of Systron Donner Inertial for $22.8 million on June 19. Beyond this expenditure, the remaining decline in cash was due to a combination of lower-than-expected volumes in the quarter and our continued investment in our fab and the modernization of our campus.

Regarding our working capital metrics, DSOs were 78 days, down compared to 84 days in the prior quarter. Net inventory turns, including noncurrent inventory, were 2.8x. Capital expenditures in the quarter was $3 million, and depreciation in the quarter was $1.8 million.

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

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [4]

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Thank you, Mark, and good morning, everyone. EMCORE has been working on its transition from cable TV to aerospace and defense for several years now. While our Q3 results reflected strong headwinds to our cable TV and chip products, our aerospace and defense offerings performed extremely well, showing 100% year-over-year growth. Raytheon is now EMCORE's largest customer, and aerospace and defense will be our largest product family in Q4 and beyond.

In the navigation market, demand for our fiber optic gyroscope-based products remained strong, with revenue increasing 100% year-over-year, putting this product line on track to double its revenue from FY '18 to FY '19. This year's mission is focused on developing our new generation of inertial measurement units and delivering the prototypes to customers. To that end, we delivered the first prototype IMU for an F/A-18 application as planned and expect to deliver the remaining units in Q4. Our customer is very pleased with the performance of the unit and looks forward to moving on to flight testing as soon as possible.

EN-300 IMU production units, which are designed to replace a Northrop Grumman product, have also begun to ship and will start flight testing soon. We've also been developing chip products for the aerospace and defense business over the past year and have started to ship them to our first customers.

Additionally, on June 19, we announced the acquisition of Systron Donner Inertial, a world-leading manufacturer of Quartz MEMS navigation products, for $22.8 million in cash, plus about 811,000 shares of stock. As we mentioned in our prior call, SDI designs, manufactures and sells high-performance Quartz MEMS, gyroscopes and accelerometers to leading customers such as Raytheon, Lockheed Martin, Rockwell Collins and other Tier 1 contractors. There are only a small handful of merchant Quartz gyroscope vendors in the market today and, among them, SDI is the clear market leader. These navigation products complement EMCORE's fiber optic navigation products and will increase our serviceable market by at least $500 million.

For example, now that SDI is part of a U.S. company, it is free to compete for a far wider range of defense contracts then it could while it was owned by a French parent. We continue to forecast that SDI will generate cash and profits in the December quarter, as previously indicated, and generate additional cost synergies with Alhambra.

Beyond the numbers, a little over 2 months into the integration, we're pleased with the progress the team is making and are more excited about the opportunities for our Concord team then we were when we closed the deal. Our customers think that this is a great move for both EMCORE and SDI, and we've received significant positive feedback on the combination from industry leaders.

Within the SatCom product line, which is now part of aerospace and defense, demand remained strong with revenue up over 100% year-over-year. These high-frequency communication products are almost exclusively purchased by the same Tier 1 aerospace and defense customers that purchase our inertial navigation systems. Application for these products have moved substantially beyond their roots in satellite ground stations and are now used in Navy ships, radar systems and similar applications, significantly expanding the market opportunities that we see.

We received the first half of an estimated $6 million project to modernize FAA traffic -- air traffic control towers and should start shipping these products in Q1 FY '20.

Within the cable market, MSO spending remained unusually soft in the third fiscal quarter despite indications from the MSOs that spending would pick up from the seasonally soft second quarter. Furthermore, late-June relief on the 25% tariffs, which were due to be imposed on China, stalled end-of-quarter transmitter orders, causing us to miss guidance. With both major publicly traded MSOs releasing earnings and CapEx guidance within the past 2 weeks, we can confirm that the cause of the weakness in cable TV orders was yet another drop in MSO infrastructure CapEx spend. While both MSOs indicated that capital expenditures will increase in the second half of the calendar year, we remain skeptical that this will occur and have factored out any improvement in the current quarter. The most important takeaway is that infrastructure demand has hit an 8-year low, which is consistent with the historical bottom of cable TV cycles. We expect the demand to improve from these levels, consistent with the comments from the MSOs, but don't believe that this will occur before calendar Q4. Consequently, we are going to take aggressive actions to create a smaller, more profitable cable TV business going forward.

We continue to make progress in the wireless market with our new product initiatives within the DAS and 5G market segments. Laser shipments for 4G LTE DAS market remains steady, and we should expect to see early shipments of 5G product for several applications beginning in the new year -- new calendar year. We're expecting wireless to at least double its revenue in FY '20, and OEMs are evaluating our products for large testing facilities, small cells and DAS systems.

Moving on to the chip market. As we highlighted in our pre-announcement on July 11, the ongoing trade disputes with China are having a material impact on the demand for our chip products, most notably for GPON and those products sold into the Huawei supply chain. Furthermore, an anti-American stance has been taken for many new design-ins in China, threatening to limit future opportunities to only those products that cannot be sourced from China, Taiwan, Korea or Japan. Given the ongoing certainty -- uncertainty around mid- to long-term demand within this market, we've chosen to exit many of the lower-margin segments earlier than planned and focus our efforts on a smaller subset of higher-margin products. We believe that this trade dispute will not end anytime soon. Consequently, we are also working to change our supply chain strategy to minimize the impact of additional tariffs.

The combination of the trade dispute and cyclical cable TV weakness demands that we speed up our timetable to resize and move to an EMS manufacturing model for cable television while retooling our chip business. In 2015, we began to automate our assembly and test processes in China and completed that work in 2017, making it possible now to move to a true variable cost EMS model for cable TV manufacturing within approximately 9 months from now, with testing and qualification taking up the majority of the time line. During this period, we expect to see a gradual improvement in absorption as the EA facility shrinks its role. Beyond our move to EMS, we also plan to make additional changes in our staff to align expenses with revenue.

In addition, we are in the midst of working on alternatives to monetize our Concord, California facility. While we ultimately -- we will ultimately consolidate certain functions between our 2 California facilities, Concord has very important strategic value for EMCORE, and we are looking forward to a bright future there. When complete, the sum total of the various actions we're taking should gain us somewhere between $15 million and $20 million in cash.

Between these initiatives and a scaled-back CapEx plan, which we are still reformulating, we expect to have the cash that we need to meet the ongoing needs for the business.

Where aerospace and defense was just an R&D initiative a few years ago, it's become our largest opportunity. What started out as organic growth of our Fiber Optic Gyro products has been accelerated by the purchase of SDI and strengthened by a redesigned Satcom product line. Aerospace and defense will be EMCORE's largest business in the current quarter and going forward.

We're adjusting our cable TV strategy to maximize profits as quickly as possible while our chip business is being redesigned to be strategically congruent with our aerospace and defense product line. While there's still much work to be done to take advantage of the full benefits of this transaction, I'm excited about the progress we've made so far.

Turning now to a forward-looking view of the business. I think it's important to point out that the current EMCORE business, excluding contributions from SDI, is running with a breakeven point of about $24 million. Even though gross margins in Q3 came in at an anemic 21.6%, the primary cause of this was $3.3 million in factory under-absorption. Correcting for this reveals that gross margins on the current mix of products would have otherwise been around 35%. Pricing has not changed in the cable TV market nor has the competitive situation. This dictates that we need to match the breakeven point of EMCORE's legacy business to the new market realities. I'm committed to making an impact on this in the current quarter.

To achieve this, we're taking 4 major actions to reduce our breakeven point for legacy Alhambra products. First, we're moving to an EMS model for manufacturing, which will eliminate the under-absorption from EA within 3 quarters. Secondly, we're reducing the wafer fab operations to a single shift to reduce fab under-absorption as we emphasize our higher-margin chip products. Third, we're going to adjust the size of the organization. Fourth, we're working to accelerate the synergies between our 2 facilities in California to maximize cost savings and our opportunities.

This should provide us with a steady improvement in gross margin over the next 3 quarters, culminating in a return to the mid-30s when these initiatives are complete.

Moving on to our outlook for the fourth fiscal quarter, we expect revenue to be in the range of $22 million to $24 million, which reflects strong growth in our navigation products with a full quarter's worth of contribution from SDI, offset by continuing softness in cable television and the chip market.

Now I will turn the call over to the operator and open up for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question will come from Tim Savageaux with Northland Capital Markets.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [2]

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A couple of questions. So you had some pretty strong organic growth in the gyro business in Q3. I wonder if you feel like those levels are kind of sustainable, you can grow from those levels. Or whether -- if you look at your guide for fiscal Q4, that essentially reflects the inclusion of SDI at kind of the anticipated run rate and sort of flat performance in the organic business?

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

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Yes. So first of all -- I mean on a sort of a -- I hate to call it an average basis, yes, we certainly believe that we can grow the Fiber Optic Gyro business from where we are as we're just starting to ship new IMU units per production. It's not as simple as the commercial side of the business in that, oftentimes, when we deliver prototypes, they're pretty expensive. And the -- they don't immediately transition into production because there's flight testing that has to go on. So there could be periods going forward where we'll see what is apparently softness, but in fact, it's just the normal sort of structure in the way that test and qualification occur. As more programs go into qualification, these ripples will tend to smooth out.

SDI will continue to grow beyond where it is right now. We're real happy with where things are. And so again, the 2 navigation product lines, we see growing from here and are, by far, our largest opportunity, essentially, the long-awaited move to become far less dependent on cable TV is upon us right now.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [4]

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Right. So would it be fair to say that defense and nav would be about 50% of revenue contemplating your guidance for fiscal Q4?

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

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It's going to be bigger than that, quite a bit bigger on a percentage basis.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [6]

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Okay. Great. And then given that you had a little bit higher OpEx than expected and some higher losses, any sense for, as you include the balance of the SDI operating spending, what's relative to what you put up in Q3? I don't think you've guided to the bottom line, but given you're incorporating the acquisition, I wonder if you can provide any more color as to what that combined OpEx run rate will look like from a baseline and then maybe what you hope to reduce that by from a combination of synergies and what looks like potentially some pretty significant restructuring on the cable TV side.

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [7]

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So first of all, as we take a look at the integration of SDI, it's important to understand that it's a bit of an anomaly in Q3 because these guys, unlike where we were in cable television, were actually sort of forward-loaded in the quarter from a revenue perspective, and you had pretty linear OpEx. So it may look a little bit strange that there was, call it, what appears to be in the surface, a bunch of expenses from SDI when, in fact, it's just indicative of the way that their quarter turned out. So we shouldn't see that sort of an impact in the current quarter and beyond.

So it was just a little bit of a transition thing, right, with expenses appearing without the necessary revenue because they'd already made the overwhelming majority of their shipments.

So does that clarify things for you, Tim?

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [8]

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Sorry, put myself off mute there. A little bit. I mean -- so are you saying you -- I think you talked about 3 weeks of expenses for SDI. So I assume there's another substantial chunk to be recognized in Q4. But it sounds like you're saying maybe not.

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [9]

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Yes, but you'll have the revenue along with it. So essentially, since we only owned them for the last 3 weeks of the quarter, all the revenue they shipped prior to that date, of course, we don't recognize, right? So you just sort of had this stub period in which you have sort of normal expenses, but you don't have the revenue that goes along with it because those products had already shipped.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [10]

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Okay. (inaudible)

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [11]

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Yes. In the current quarter, you'll see the full quarter's worth of revenue and the full quarter's worth of expenses. And we're not expecting much of an impact at all, net-net, in terms of -- I mean they're going to be pretty close to breakeven this quarter, but we're projecting that, that occurs in the following quarter.

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Operator [12]

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(Operator Instructions)

Our next question comes from Jaeson Schmidt from Lake Street Capital.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [13]

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Just looking at the September quarter guidance, wondering if you could provide what sort of contribution from SDI that assumes. And relatedly, your comments that the -- you're more bullish on the SDI business now compared to at close. I think at the time, you had expected sort of a 10% growth rate for the SDI business going forward. Should we assume that expectations are probably a little better than that now?

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

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Yes. Jaeson, the -- I think expectations are a little bit better, but you've got to temper those by the reality of, call it, qualification times. We've already had integration work done between the sales forces. We've uncovered 1 or 2 places where we were selling against each other, and we've de-convolved those. So I mean, largely, I'd say, 95% of the forecast actually looks pretty clean and that they were chasing opportunities that we weren't and vice versa, okay?

So beyond that, I think it's going to take a little while for a more accelerated growth to occur. It's just the nature of aerospace and defense. It takes a long time to get designs in, and it takes a longer time even to get designs out. In the next quarter, we're not going to break out the -- and going forward, we won't be breaking out SDI separately. But what I would say is that the movement or the guidance that we have basically doesn't change too much of what is going to occur out of Alhambra. Okay?

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [15]

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Okay. That's helpful. And I know there's a lot of moving parts with the restructuring, but looking at your expectation for gross margin to eventually migrate back to the mid-30% range, does that assume any significant work or change on SDI's gross margin?

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [16]

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No. No. Where we are with SDI's gross margins is they're actually -- they're pretty good. And we've uncovered a few things that are going to allow us to make continued sequential improvements. So SDI doesn't really need to do anything other than what we're already doing to continue to make improvement. But we're not relying on those factors to pull the legacy products margin forward.

Again, I'd point you back to the points that we made about gross margin, which was, at 21.6% looks really bad, but the -- almost the entire reason for that is under-absorption, right? So as we go to transition from EA and transmitters go first and then laser modules and then you make the final set of changes downward over in China, the under-absorption from China goes -- starts to go away, right? And some impact will be made even in the current quarter on that. But it's all about how quickly we can break down headcount because nothing has changed on the pricing side, nothing has changed with competition, and probably 80%, 90% of the reason why margins are depressed is just volume.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [17]

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Okay. And the last one for me, I just want to make sure I heard you correctly that you expect to see CATV business to bottom in December?

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [18]

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No. No. We're saying that we believe right now we're at the bottom, and we're not forecasting an improvement in the current quarter. But when you take a look at what the MSOs have said about capital spend, the only conclusion you can reach is that calendar Q4, we'll see some improvement and potentially significant improvement. It just depends on orders materializing that we have not seen yet. And given that we're 5 weeks into the quarter, we're [allowed] to project that the spigot's going to turn back on, and we're going to be able to get everything built and shipped before the end of this September quarter.

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Operator [19]

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I'm currently showing no questions in the queue. I would now like to turn the call back over to Jeff Rittichier for closing remarks.

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Jeffrey S. Rittichier, EMCORE Corporation - CEO, President & Director [20]

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In closing, I'd just like to thank all of you for your time this morning and your interest in EMCORE. And I look forward to our follow-up calls and visits over the next week. Thank you very much.

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Operator [21]

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Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.