SAN RAMON Aug 23, 2020 (Thomson StreetEvents) — Edited Transcript of Giga-tronics Inc earnings conference call or presentation Thursday, August 6, 2020 at 8:30:00pm GMT

* John R. Regazzi

* Lutz P. Henckels

Welcome to the Giga-tronics First Quarter 2021 Earnings Call. My name is Vanessa, and I will be your operator for today. (Operator Instructions) Please note that this conference is being recorded.

I will now turn the call over to Traci Mitchell.

Traci Keiko Mitchell, Giga-tronics Incorporated – Corporate Controller & Principal Accounting Officer [2]

Hello, everyone, and thank you for joining our quarterly earnings conference call. I’m Traci Mitchell, and I’m joined today by John Regazzi, our CEO; and Dr. Lutz Henckels, our Chief Operating Officer, Chief Financial Officer and Executive VP.

Before we begin, I need to remind everyone that this conference call may include forward-looking statements, including statements about future results of operations and margins, future orders, growth and shipments. Actual results may differ significantly due to risks and uncertainties, such as delays of manufacturing and orders for our products and services, receipt or timing of future orders, cancellations or deferrals of existing orders, the company’s capital needs, the trading of our common stock and the volatility in the market price of our common stock, results of pending or threatened litigation and general market conditions.

For further discussion, see our most recent annual report on Form 10-K for the fiscal year ended March 28, 2020, Part 1 under the heading Risk Factors and Part 2 under the heading Management’s Discussion and Analysis of Financial Condition and Results of Operations.

With those reminders in place, I will now pass the call on to John Regazzi.

John R. Regazzi, Giga-tronics Incorporated – CEO & Director [3]

Thank you, Traci. Good afternoon, and thank you for joining our Fiscal ’21 First Quarter Earnings Call. in a moment, Dr. Henckels will review our financial performance in detail, but I would first like to express my sincere thanks to the Giga-tronics team for all the efforts they have and are expanding on a daily basis to make the company successful during these trying times.

I’m pleased to report that the first quarter of fiscal ’21 returned us to profitability after the significant adverse impact of the pandemic had on our fourth quarter and on our full fiscal 2020 results. We were fortunate to be able to restart operations during April after receiving authorization from the Department of Homeland Security as an essential business.

The management team had to quickly implement numerous safeguards to protect employees from the virus, including staggered work schedules, along with all the recommendations from local and state health officials. It also required working closely with our suppliers as they, too, had been impacted.

Our Microsource business delivered solid revenue growth compared to both the same quarter of the prior fiscal year as well as compared to the previous quarter. And the RADAR/EW test business was able to deliver decent results despite travel restrictions slowing the installation of these delivered systems.

We are working closely with new prospects to move opportunities through the sales process by performing online demonstrations and actively managing our business development team’s travel schedules to minimize the impact of self-quarantine requirements as they visit customers across the country.

We are also keeping a close eye on our expenses and anticipate that expense growth will remain below our revenue growth going forward. We expect the combination of growth in our higher-margin RADAR/EW test business and a steady contribution from Microsource RADAR filter shipments, along with carefully managed expenses, will continue to positively impact our profitability over the medium and long term.

I’ll now turn the call over to Dr. Lutz Henckels to go over the numbers, and then we’ll open the call for questions. Lutz?

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Lutz P. Henckels, Giga-tronics Incorporated – Executive VP, CFO, COO & Director [4]

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Thank you, John. Welcome to our first quarter fiscal 2021 conference call. Let me start out by saying that we are back on track with a profitable quarter after our supply setback in the March quarter due to the coronavirus. And as John mentioned, the Department of Defense has categorized us as an essential business, so we are once again in full production since early April. And yes, we have put many safety features in place, especially for the production people who will be at the office. And at the same time, for the safety of our employees, most engineering and administrative employees are working from home.

There still will be some inefficiencies going forward due to the coronavirus, like we’re still seeing some supply chain issues, mostly delays in receipt of materials. And as John mentioned, we are limited in travel and quarantine time when we leave a certain area and get access to customers, and that, that may cause some order delays. However, believe — we believe these are short-term issues, which we can work and have worked to mitigate during the pandemic.

So while we feel good about our business, there are still some uncertainties due to this coronavirus. To compensate for the coronavirus impact, we applied for and received $786,000 of PPP CARES loan money in April, which we intend to seek forgiveness for in October of this year.

So now let me look at the detailed results. Let’s first look at sales. Net revenue for the first quarter of fiscal 2021 ended June 27, 2020, was $3.5 million. This is a very slight increase of about $50,000 of the revenue of the prior — of the 1-year ago period for the same period Q1 of fiscal 2020.

Now when we look at the two components of revenue, you can see that the first component is shown as goods at $1.109 million. This is for our RADAR test business, and this $1.109 million compares to $1.938 million for the same Q1 period of the prior fiscal year 2020. So this is a 43% decline. And as John mentioned, it should be noted that this $1.109 million revenue is more or less equal to the revenue of the prior quarter, the fourth quarter of fiscal ’20.

And then the second component is for services of $2.439 million, which is mostly for our Microsource product line, namely the RADAR filters, which are used in the F-15, the F-16 and the F-18 fighter jet. This $2.439 million compares to $1.56 million for the same period of the prior fiscal year 2020. So this is a very large increase of 56%. This large increase, in part, is making up for the delay that was caused by the shutdown in March due to the coronavirus.

Now let’s look at gross margin. Gross margin for the first quarter of fiscal 2021 was 42.7%. Gross margin for the first quarter of fiscal 2020 was 43.7%. So this is a small decline, and that is strictly due to product mix. In fact, actually, both product lines saw gross margin improvements. However, the Q1 FY ’20 Microsource revenue was 45% of total revenue as compared to the Q1 FY ’21 Microsource revenue, which was 69%.

Since the Microsource revenue is closer to 40%, and the RADAR gross margin is closer — I mean, since the Microsource business delivers closer to 40% gross margin and the RADAR test business delivers north of 50% gross margin, it is clear that when you have a Microsource revenue of 69% versus 45%, that impacts the overall gross margin.

Now let’s look at operating expenses. They remain basically unchanged at $1.4 million. What did change is the R&D expense, which increased by 23% due to new hires, while the SG&A expenses decreased by 7.5% due to lower sales expenses, which was caused by a change in sales management and by lower travel expenses due to the pandemic.

Now we go to interest expense. Interest expense declined by 57% from $76,000 to $33,000. This is basically all due to the PFG loan, which we reduced by approximately $850,000 from the prior year from $1.47 million to $619,000. We are paying off this expensive loan at a rate of $57,000 in principal per month.

That gets me to net income. Net income in the first quarter of fiscal 2021 was $75,000. This compares to a net income of the first quarter of fiscal 2020 of $52,000, and it’s for the reasons that I just explained.

Then if we look at net income attributable to common shareholders, that was $72,000 versus $15,000 in the prior year. And the reason for that is we converted in November of 2020 the vast majority of E Series preferred shares to common shares, and this reduced a 6% dividend from $36 thousand to $3,000.

Looking at the balance sheet from a high level now, then you will know that total assets increased by $628,000 when compared to our fiscal 2020 year-end balance sheet of March 28, 2020. And so total assets increased by $628,000, total liabilities decreased by $480,000. The asset increase was driven by the increased production in the Microsource filter business, which is reflected in prepaid expenses.

The liability increase was due to the PPP loan of $786,000. And as I mentioned, we will seek forgiveness of this loan in October of this year. And as a result of these changes in assets and liability, our net equity increased to $4.45 million from $4.3 million.

If the PPP loan would be forgiven in October of this year, then our net equity would go above $5 million, which is a minimum equity required in order to uplift to NASDAQ, which is a goal that the company has.

So in summary, what I want to say is we have 2 businesses. We have the sole-source Microsoft — Microsource filter business, which produces the F-15, the F-16 and the F-18 filter for the fighter jets. I call that business our rock. It delivers about $7 million to $9 million in revenue per year. It delivers about $3 million of gross margin per year. And we believe that this will be true for the next several years, call it, 4 years.

Our second business is the RADAR/Electronic Warfare test business. This is our growth engine. We believe that this business should, as a minimum, double in this fiscal year to north of $6 million. We’re addressing what we believe is a $440 million market opportunity, and we are targeting to capture over $60 million per year within 5 years.

To do so, we introduced a new product called multichannel coherent capture solution. This allows customers to see things that they have never been able to capture and see before. There is a pent-up demand for this solution. In fact, close to 50% of our prospective opportunities is driven by this unique capability.

So one way to drive our growth is through new products, the other way is through new applications. More recently, we delivered our first programmable threat emulation system for the Marine Corps F-35 program at China Lake. That system will be used to replicate adversaries, integrated air defense systems.

Let me explain. This is our first open-air system, where our system is not in a lab, but rather it’s in a trailer at the China Lake range. And an F-35 fighter jet flies overhead the range. We bombard the plane with a variety of flight signals and observe whether the plane recognizes a threat and what the pilot’s reaction is to the threat. We expect to deliver 10 such system to China Lake over the next 2 to 3 years. And this broadens the use of our threat emulation system beyond labs and gives us an entry also into the Air Force.

So basically, we have growth drivers. So over the next year, we are targeting to double at least our RADAR/EW test business, and it has better gross margin and, therefore, should improve profitability.

And then the final point that I want to make is that given this pandemic, I do see a recession coming. But I believe that in the defense business, especially the Electronic Warfare business, we believe it is shielded from a likely recession brought about by the pandemic. We must improve our Electronic Warfare equipment.

Thank you. And we are now ready for taking questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we have our first question from [Pam Stanley].

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Unidentified Analyst, [2]

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Could you provide an update on the competitive environment you were seeing on the testing side? Are you still ahead of the competition with the disruptive technology?

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Lutz P. Henckels, Giga-tronics Incorporated – Executive VP, CFO, COO & Director [3]

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Okay. Let me answer that. So there are 2 pieces, the competitive environment and are we still ahead. As we are releasing new applications based on our unique architecture and digital solution, we are clearly separating ourselves from the competition. Even though we are a small company, our ability to be agile and provide — to tailor solutions to the needs of the customer is actually very unique and very special for us.

In terms of, are we ahead of the competition? Absolutely. And let me give you a couple of examples. By using our threat emulation system that was designed for lab use, and now using it on the range application, we offer a highly programmable and flexible solution that is orders of magnitude cheaper like by 80% or 90% than the legacy systems that they’re currently using, which are very expensive, which take 18 to 24 months to build and field and require very costly annual support contracts. Our solution can actually be supported by the end users, and so it’s a way to go.

However, let me go to the other piece that I mentioned, and that is the unique multichannel coherent and capture solution. We are able to stream in real-time up to 192 terabytes of data at 6 gigabits per second. And that’s unheard of, okay? That doesn’t exist with others. So I think we are way ahead. I feel very good about our market position.

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Operator [4]

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(Operator Instructions) It seems that’s all the questions we have at this time. I will turn the call over to Dr. Lutz Henckels for closing remarks.

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Lutz P. Henckels, Giga-tronics Incorporated – Executive VP, CFO, COO & Director [5]

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Okay. Let me close by saying the following: We believe that we have truly a good outlook. We have the recurring revenue stream of the Microsource filter business, our rock. And we have our growth engine, the Military EW Threat Emulation business, that is kicking in with new products and with new applications outside the lab on ranges with the F-35 program. We believe that we are on a trajectory of achieving our longer-term goal of $60 million in sales per year, which has higher margins than the Microsource filter business. And this Military Electronic Warfare business is relatively recession-proof.

Yes, short terms, there maybe still some hiccups due to the coronavirus. Maybe there’s going to be another shutdown. I don’t know. There could be still supply issues. But medium and long term, we are definitely optimistic. Thank you.

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Operator [6]

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And thank you, ladies and gentlemen. This concludes our conference. Thank you for your participation. You may now disconnect.