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Edited Transcript of GIGA earnings conference call or presentation 14-Aug-18 8:30pm GMT

Q1 2019 Giga-tronics Inc Earnings Call

SAN RAMON Aug 30, 2018 (Thomson StreetEvents) -- Edited Transcript of Giga-tronics Inc earnings conference call or presentation Tuesday, August 14, 2018 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John R. Regazzi

Giga-tronics Incorporated - CEO & Director

* Lutz P. Henckels

Giga-tronics Incorporated - Interim Chief Financial & Accounting Officer, Executive VP and Director

* Timothy Frederick Ursprung

Giga-tronics Incorporated - VP of Sales & Marketing

* Traci Mitchell

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Conference Call Participants

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* William Velmer

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Presentation

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Operator [1]

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Hello, and welcome to the Giga-tronics First Quarter Fiscal 2019 Earnings Teleconference. My name is Michelle, and I will be your operator for today's call. (Operator Instructions) Please note that this conference is being recorded.

I will now turn the call over to Ms. Traci Mitchell. Ma'am, you may begin.

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Traci Mitchell, [2]

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Hi, everyone, and thanks for joining our quarterly earnings conference call. I'm Traci Mitchell, and I'm joined today by John Regazzi, our CEO; Lutz Henckels, our Chief Financial Officer and Executive VP; and Tim Ursprung, our Vice President of Sales and Marketing.

Before we begin, I need to remind everyone that this conference call contains forward-looking statements concerning operating performance, future orders, long-term growth and shipments. Actual results may differ significantly due to risks and uncertainties, such as delays of manufacturing and orders for our new ASG, receipt or timing of future orders, cancellations or deferrals of existing orders, the company's potential need of additional financing, ability to be traded on the OTC market, uncertainty as to the company's ability to continue as a going concern, 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 31, 2018, Part I, under the heading Risk Factors; and Part II, under the heading Management's Discussion and Analysis of Financial Conditions and Results of Operation.

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

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

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Thank you, Traci. Good afternoon, and thank you for joining our quarterly conference call. Dr. Henckels will go over the numbers in a few moments, but I wanted to highlight a few things about our recent quarters. First, our margins have improved significantly, beginning in the fourth quarter of last year, and continuing in the first quarter of fiscal 2019, which reflects our focus on production efficiency and overhead costs. We have been in our new facility for one full year now and have things running more smoothly than when we first began occupying the new offices in April of 2018.

Second, our operating expenses have been reduced due to our focus on rightsizing the company in terms of headcount and investment.

With regard to our sales, our RADAR filter business continues to run well, and we anticipate higher shipments this fiscal year due to several new long-term contracts we received during the prior fiscal year. Although the order situation remains the same regarding our Advanced Signal Generator platform, we have revamped our sales team in line with the strategy -- pardon me, with the change in strategy of selling full solutions rather than just the enabling pieces, which we believe will improve the order picture for this business in the quarters ahead.

Mr. Tim Ursprung, our VP of Sales and Marketing, will add remarks later in the call, outlining his perspective on the market opportunities available to Giga-tronics. Overall, we believe the elements are in place for the company to return to profitability this fiscal year.

With that, I'd like to turn the call over to Dr. Lutz Henckels to go over the numbers. Lutz?

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Lutz P. Henckels, Giga-tronics Incorporated - Interim Chief Financial & Accounting Officer, Executive VP and Director [4]

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Hi. Thank you for being on this call. I think there are several new people on the call, so I want to briefly summarize what we expressed in the last conference call, in that, we outlined a major transition that the company has made over the last 6 years. The transition from being a company that has lots of product lines, little differentiation, me-too products, with poor gross margins. We divested those businesses, and we transitioned to a highly-focused microwave RADAR EW, electronic warfare, product company, with highly differentiated products and good gross margins.

We achieved that by building on our strength, which is microwave-integrated circuits, which means building on our very solid foundation, which I call our rock, which is the -- our Microsource division. This division is a sole source supplier of YIG RADAR filters used in fighter jet aircrafts. We sell those to 2 prime contractors for the F-15, the F-18, and the F-16 fighter jets. This business delivers between $9 million to $10 million of revenue for the company in 2019. We have over a year's worth of backlog. It has 40% plus gross margins, and is really an assured business for the next 5 years as we are the sole source supplier. I call that our rock.

By focusing on our core competency, our strengths, which is designing and producing microwave-integrated circuit products, the company developed a microwave test platform for our RADAR and EW testing. And we refer to that product often by the name Hydra or also by the name ASGA, Advanced Signal Generator and Analyzer.

The company has spent over $13 million in R&D on this endeavor alone, and I should say, we really overextended ourselves in the past. However, the good news is that we finally have completed this transition, and that we believe firmly that we are at an inflection point for the company. And so I now will talk about the progress that we have made in Q1 of fiscal '19, which ended in June.

Now before going into that, I need to express to you that there is a change in accounting standards, and that's also expressed in the press release. Effective April 1, 2018, the company was required to adopt the accounting standard update called ASU 2014-09. This is also called revenue from contracts with customers, commonly also referred to as ASC 606. So I will be the using word ASC 606, which changed the way the company must recognize revenue for certain contracts. So until the end of fiscal '18, which ended on March 31, '18, we recognize revenue when we ship and invoice to a customer. I think that's simple. I like that one. But we are not allowed to do that. Under ASC 606, we must recognize revenue based on the completion of the contract as it incurs costs.

The financial results for the 3 months ended on June 30, 2018, presented today have been adjusted to reflect that new accounting method. However, the comparison is more difficult because Q1 FY '18 a year ago did not have this new accounting method. I will try, however, in this presentation today, in the discussion, to always identify to you the impact that ASC 606 made on every item. However, independent of this accounting change, be clear that we believe we are at an inflection point, our results are vastly better than a year ago, and that's completely independent of this accounting change.

So now let me go to the details, okay? Let's first look at sales. Net sales for the first quarter FY '19, which ended on June 30, 2018, was $3.05 million. This is a 53% increase as compared to a year ago, $1.993 million, which was the first quarter of fiscal 2018. The increase in the first quarter net sales versus the prior period was due to 3 components, primarily. The first component indeed, was ASC 606. $596,000 in increase in revenue was due to that change in accounting. $630,000 increase was due to higher shipments of fighter jets' filters. We are now in full production with the 3 planes, F-18, F-15, and F-16, and so by having more planes to ship, we increased the sales by $630,000, independent of this accounting method.

We also increased sales slightly by $52,000 for a legacy service. However, then sales were reduced by $221,000 because we had no Hydra shipments in the first quarter of this fiscal year.

Going to the gross margins now. The gross margin for the first fiscal quarter, fiscal '19, was 43%. This compares to a gross margin of 23% a year ago first quarter fiscal 2018. More so, as John also expressed, this is now the second quarter in a row with above 40% gross margins. And I should point out that we fully expect that every quarter going forward from here on out will have gross margins over 40%. And ASC 606 has really no impact on gross margins. So you -- that percentage did not change because of ASC 606. That's just an absolute performance improvement, which is huge, okay?

Then, when it comes down to the losses, the losses -- the net operating loss for the first quarter fiscal 2019 was $70,000. This compares to a net loss of the first quarter of fiscal 2018 of $1.157 million. There are 4 components to the reduction of the loss from $1.157 million to nearly breakeven, to $70,000. So $492,000 of this improvement was due to the improvement in the gross margins. That gave us $492,000 better performance. $249,000 improvement was due to lower operating expenses. We reduced operating expenses. And then, $108,000 was due to an increase in sales. And then, $238,000 improvement in the operating loss or reduction in the loss, was due to the ASC 606 change. So $238,000 impacted that, okay? A $492,000 gross margin improvement, $249,000 lower operating expenses, and $108,000 higher sales.

Then, going below the line, the operating line, to interest and other expenses. They were $217,000 in Q1 fiscal 2019. This compares to $101,000 for Q1 fiscal 2018. So this difference of $116,000 in interest and other expenses was due to the following: $62,000 was due to an income tax dispute settlement for the fiscal year 2011, so we owe more money in regards to taxes from the year 2011; $24,000 was due to interest expenses for our loan with PFG, Partners for Growth; $19,000 was due to the 6% interest for the E series; and then, the remainder was to Bridge Bank.

I should want to make the point here that our cash payments, in terms of interest and other expenses, is typically $50,000 per quarter. So that's where the cash goes, okay? So when you combine the operating loss of $70,000 and the interest payments of $217,000, then we have a net loss of $287,000 in the first quarter. And this compares to a net loss of $1.258 million for the first quarter of fiscal 2018. So a major improvement, quite independent of ASC 606.

Now let's go to the balance sheet. Looking at our balance sheet now, it is still weak. Shareholder equity stands at $1.297 million and cash at $748,000. This compares to the March-ending 31, 2018 period, which 3 months before, was an equity of $131,000 and a cash of $1.485 million. So you say, "Wow, the equity improved lot." That is all due to ASC 606. Because remember that we made losses, so we cannot improve equity. So that's all due to ASC 606. So you see entries there like a large change in inventory, changes in prepaid expenses and other current assets. You see huge change in deferred revenue and changes in retained earnings, all due to this accounting standard. So the fact that the equity improved, that's all ASC 606.

So let's talk more about cash, okay? The actual cash decreased by $738,000, primarily due to a reduction in accounts payable. We paid off more bills by $239,000. And then -- and actually, net reduction in deferred revenue of -- by $550,000. Deferred revenue means we invoice a customer for inventory that we purchase, and that deferred revenue decreased during that period of time. It fluctuates. I should go and say that it's -- that's not a trend. It goes up, and it goes down, and it went down during the quarter. And then, of course, we had the net losses.

What stands out in the balance sheet is a net inventory of $3.438 million. And while it seems that it has gone a lot, that's only because of ASC 606. What needs to be understood is that $2.656 million of this inventory is for the RADAR test products. That is way too high, and we believe that we can easily get at least $1 million out of this inventory in this fiscal year, because as soon as we get the order for the -- that is -- that we will talk a little bit later about, okay, that system is already in finished goods, and it will be shipped, and it will be all cash. So we will get some good cash out of inventory.

However, cash is clearly still the concern, and we're addressing that concern in multiple ways. First, we expect a large order of $4 million of which 40% is shippable immediately. We have it in finished goods. As I mentioned, that's pure cash. We have been also raising funds through the E series. It was oversubscribed, and so we increased the limit from $1.5 million to $1.75 million. And then, we expect to eliminate losses. And so I think we are addressing the cash funds fine.

In summary, we are near breakeven performance, even without the RADAR test business. This was really achieved because of the much improved gross margin and lower operating expenses. But yes, our ASC 606 change did improve our net earnings by $238,000, so I want to be clear about that, okay?

Now moving forward, going beyond the financials. We are focusing on growing the business to achieve at least a 50% growth in fiscal '19 and fiscal '20. And we expect fully to deliver net profits in fiscal '19. Now to achieve these 2 goals, require that we change our sales strategy and we change our sales team.

And to explain these changes and our outlook, I'd now like to introduce to you, Tim Ursprung, who joined Giga-tronics as the Vice President of Sales and Marketing on July 2, 2018. And Tim will also answer the question that we get a lot of, "Where are the fricking orders?"

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Timothy Frederick Ursprung, Giga-tronics Incorporated - VP of Sales & Marketing [5]

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Good afternoon. This is -- yes, this is Tim Ursprung. Thank you very much for your time. And let me go forward with the discussion.

First, people ask me about my background. So I'd like to give you a little overview there. I was Vice President for a company called Microwave Power Devices, which built power amplifiers for the communications, electronics warfare and radar markets for about 10 years. From there, I worked with a number of other companies that were in the same market space. Then joined Aeroflex Test Solutions as Vice President of Marketing and Sales, where I worked there for 10 years.

At Aeroflex, we really focused on standard and mostly, custom test solutions for the communications, radar and electronic warfare systems. Here, we sold the first [non-camp haptic] transmit receive module test systems for 2 major radar manufacturers, resulting in major revenue stream for Aeroflex. Aeroflex -- after Aeroflex, I was an owner at a manufacturers' representative firm in the Mid-Atlantic and Southeast for about 8 years, also concentrating on the military/aerospace customer base.

So after that, people ask me, "Well, why did you join Giga-tronics?" So I just wanted to go over that briefly. I reviewed the product offering of the Hydra next-generation EW RADAR test and development solution, and felt that this product has disruptive benefits for customers in EW RADAR marketplace and has the right features to become the next-generation platform. I'm extremely excited about the opportunity and know we will become a major force, supplying complex solutions for our customers.

Now on to discussing Giga-tronics, what we're doing, and where we're going. As discussed earlier, our rock, the Microsource Group, is very strong and growing. So I'm not going to focus especially in that product area. But I do have experience with these type of products and know -- feel that these products will have potential for growth and going into different market areas as well.

Now to discuss the strategy for Hydra, the next-generation EW test development solution. While I could start with saying that I will discuss the status of orders, but I really want to go through what we're doing with the changes, the focus, and the sales and marketing team. So first, we're changing the overall approach from a product focus to a solution focus. The reason for this is, each customer has specific needs requiring minor changes to our system to meet their specific needs. Second, we're assembling a team with a detailed technical understanding of these requirements to enable Giga-tronics to properly position the right solution. Third, we're developing the sales channel, locating the team in areas with -- close to military bases and prime contractors, focused on electronic warfare and RADAR systems.

Now just a regard to that point, we hired a person, Dan Kirby. He's a retired Air Force Master Sergeant, who worked his career in electronic warfare systems. Dan is located close to the customers in the Southern California area, and has full understanding of the technical requirements of our customers and the solutions we can offer to meet their needs. I worked with Dan at previous employers as a colleague. I know he has the capability and success rate for our products.

In conclusion, this change in strategy is an extremely targeted approach, efficiently pursuing the right opportunities for Giga-tronics. We want to make sure we can figure the right features and benefits to win a business that adheres to the product roadmap we have developed.

Now for what everyone has been waiting for, the status of our new major order. So first of all, this order has been fully funded by the U.S. government. The order has been submitted into purchasing and is moving forward, and we're really keeping close contact to every step of this order.

Previously, we discussed that this order was estimated to be roughly $2.7 million, which included test systems and product support. The value has now increased to $4 million, and is expected to book by the end of the current fiscal quarter. The timing has slipped slightly, but we have high confidence this order will happen in the time frame we've outlined. And as mentioned, we are staying closer to the customer at every step. We've also been told it's not a matter of if, but when the order will book, which we still expect to be in Q2.

So receiving this order will solidify our foothold with this customer, and this customer has also been designated the center of excellence for electronic warfare systems and has stated that our solution has differentiating features that our competitors do not have. Second, it will drive prime contractors to use this solution in the testing of their air systems. Now that's a key aspect is that using it from their major government that it drives it down to the prime contractors. Doing this will also focus our efforts to carry this solution across other RADAR and electronic warfare platforms.

In addition to that order, we are working with strategic partners to add additional capability to our Hydra platform, and should be able to demonstrate this feature within the next 30 to 60 days.

And Dan and I worked in the past with another company that had a product in this product area that has been obsoleted. Our customer base still needs a solution to upgrade that platform. We feel that this product that we're developing will be able to fulfill that solution and bring additional orders in this and the next fiscal year. So as a result, with this, I believe that this success, and I'm extremely confident that our Hydra next-generation EW RADAR test and development solution will grow and become a major source of revenue for Giga-tronics.

Thank you very much for your time. Back to you, Lutz.

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Lutz P. Henckels, Giga-tronics Incorporated - Interim Chief Financial & Accounting Officer, Executive VP and Director [6]

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Thank you, Tim. Okay. Just a couple of remarks, and then we open it for questions. So I did want to express that while I think we are optimistic, at the same time, it is clear to us, we are not out of the woods yet. We're still making losses. We still have no Hydra sales. We have a weak balance sheet. And so there ought to be no confusion that we are very, very cautious. At the same time, being in the woods, we do see the meadow that we want to reach, and I expect to report you at the next conference call that we are on the meadow, and that we are past the inflection point.

With this, I'd like to turn it over for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) I do have one question in the queue from William Velmer from S.A. Advisory.

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William Velmer, [2]

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Real quick question. What is the actual total backlog that you currently have? I mean, you've thrown out all kind of contracts, blah, blah, blah. But what is the actual backlog that you're going to work over --work off for fiscal '19?

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Lutz P. Henckels, Giga-tronics Incorporated - Interim Chief Financial & Accounting Officer, Executive VP and Director [3]

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Okay. Number one, we have 0 backlog for the Hydra product, okay? So I assume you're referring to the Microsource product and...

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William Velmer, [4]

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I'm just looking for any total backlog at all.

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Lutz P. Henckels, Giga-tronics Incorporated - Interim Chief Financial & Accounting Officer, Executive VP and Director [5]

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Yes. I just want to be clear. There's no backlog for Hydra. The only backlog we have is for the rock, for the Microsource product. And you -- we will get you that number in 1 second. One second.

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Traci Mitchell, [6]

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Sorry.

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Lutz P. Henckels, Giga-tronics Incorporated - Interim Chief Financial & Accounting Officer, Executive VP and Director [7]

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$5.8 million? So -- is this the number? $5.824 million.

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William Velmer, [8]

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$5.58 million, roughly...

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Lutz P. Henckels, Giga-tronics Incorporated - Interim Chief Financial & Accounting Officer, Executive VP and Director [9]

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No. $5.824 million.

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William Velmer, [10]

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$5.824 million. Is that -- $6 million, is that what you're saying, roughly?

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Lutz P. Henckels, Giga-tronics Incorporated - Interim Chief Financial & Accounting Officer, Executive VP and Director [11]

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Correct. Correct.

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William Velmer, [12]

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Okay. So this is where your -- that doesn't include little business opportunities that will arise every month or so that are just tiny that you don't look at backlog? It's just continual business. Because you did mention that revenue was going to grow by 50% over last year, if I'm not incorrect.

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Lutz P. Henckels, Giga-tronics Incorporated - Interim Chief Financial & Accounting Officer, Executive VP and Director [13]

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Correct. So let me just add that, okay -- to that. So we already did $3 million of business. And that's all Microsource. So the backlog is roughly $6 million that is there. So that gets you to $9 million, which is what we are projecting for this fiscal year. We said $9 million to $10 million, okay? We have no backlog in Hydra. The growth will come very much from -- nice growth from Microsource, because at $9 million, it grew from $7 million to $9 million because of the added plane, okay? So our growth really comes from, what we call, Hydra or the RADAR test business. And so we expect between $4 million to $5 million in sales this fiscal year. And notice that the order that we are expecting is for $4 million. So by getting that order, we are basically there for this fiscal year.

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William Velmer, [14]

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Okay. So what is -- many companies will state that their -- the breakeven point is, you've got $9 million in place, you're going to make money you've got to hit $8 million, you've got to hit $7.5 million. Will -- can you give us a little color on what actual dollar amount is where we're in the green? Because you're talking about profitability.

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Lutz P. Henckels, Giga-tronics Incorporated - Interim Chief Financial & Accounting Officer, Executive VP and Director [15]

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Yes. Basically, around $12.5 million per year in sales, we are in the green. Maybe $13 million, $12.5 million, we are in the green.

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William Velmer, [16]

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So when you say $9 million for the year, that means you're going to be pretty much breakeven for this fiscal year?

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Lutz P. Henckels, Giga-tronics Incorporated - Interim Chief Financial & Accounting Officer, Executive VP and Director [17]

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No. No. No. I'm not saying that. I'm saying that $9 million is for the Microsource business. As we have done $3 million in Q1, and we have $6 million in backlog, and we expect $9 million, okay? So and then, the additional business from Hydra, like $4 million or $5 million to get us to $13 million, $14 million in sales in order to be profitable. So $4 million order from -- as Tim mentioned, that is in purchasing. And so with that order and the Microsource business, we should be profitable.

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William Velmer, [18]

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$13 million? Great. So it's $13 million.

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Operator [19]

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We have no further questions at this time. So I will turn the call over to John Regazzi for final remarks.

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John R. Regazzi, Giga-tronics Incorporated - CEO & Director [20]

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Okay. If there are no further questions, I'd just like to thank everybody for their participation on the call and their continued support for Giga-tronics. Have a good afternoon.

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Lutz P. Henckels, Giga-tronics Incorporated - Interim Chief Financial & Accounting Officer, Executive VP and Director [21]

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Okay. Thank you very much.

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Timothy Frederick Ursprung, Giga-tronics Incorporated - VP of Sales & Marketing [22]

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Thank you.

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Operator [23]

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Thank you, ladies and gentlemen. This concludes today's teleconference. Thank you for participating. You may now disconnect.