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Edited Transcript of GIGA earnings conference call or presentation 12-Nov-19 9:30pm GMT

Q2 2020 Giga-tronics Inc Earnings Call

SAN RAMON Dec 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Giga-tronics Inc earnings conference call or presentation Tuesday, November 12, 2019 at 9:30:00pm 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 - CFO, Executive VP & Director

* Traci Keiko Mitchell

Giga-tronics Incorporated - Corporate Controller & Principal Accounting Officer

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Conference Call Participants

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* Justin Lars Clare

Roth Capital Partners, LLC, Research Division - Director & Research Analyst

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Presentation

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Operator [1]

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Welcome to the Giga-tronics Second Quarter Earnings Conference Call. My name is Vanessa, 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 your host, Traci Mitchell, Corporate Controller.

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Traci Keiko Mitchell, Giga-tronics Incorporated - Corporate Controller & Principal Accounting Officer [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.

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 with 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 30, 2019, Part I, under the heading Risk Factors; and Part II, under the heading Management's Discussion and Analysis of Financial Condition and Results of Operations.

With those reminders in place, I would now pass the call on 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 fiscal '20 second quarter earnings call. I'd like to open with a few general remarks before our CFO, Lutz Henckels, goes over this quarter's performance in detail.

First, I am again pleased to report that the company has completed another quarter with positive operating and net income. This is our third consecutive profitable quarter, and I wish to acknowledge the entire Giga-tronics team for this accomplishment.

Second, I would also like to acknowledge the successful completion of our follow-on public offering. We raised $2.6 million, which strengthens the company's balance sheet and positions us to pursue our EW test business more aggressively.

Third, we just received a new multiyear contract, valued up to $8.4 million for the continued production of the F-15 variant of our Microsource RADAR filter. The contract includes a firm commitment for the first year's production valued at $2.9 million, with options for the following years valued up to $5.5 million.

Finally, I just returned from attending an industry trade show held in Washington, D.C., where the company was an exhibitor. Our business development team had numerous quality engagements with potential customers who are now generally convinced the Giga-tronics solution can meet their advanced simulation needs.

Just as important, these customers see and believe that the Giga-tronics team understands their application. This has already led to a follow-up meeting with one military base for a more detailed demonstration of our solutions. We continue to believe our EW test platform is the company's best path to drive revenue growth with good gross margins.

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?

(technical difficulty)

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Operator [4]

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Our speakers have returned.

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

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Okay. So I was just saying, thank you, John. And welcome to our second quarter fiscal conference call.

The second quarter results demonstrate consistent progress in the turnaround and growth of our business. We are committed that we will deliver consistent profitability going forward. And this is now the third quarter in a row of net profitability, though still small profits. Also, we just concluded, as John mentioned, the follow-on offering of $2.6 million. This was indeed a major milestone for our business for the following reasons. First, it provides us with growth capital to pursue the RADAR and Electronic Warfare test opportunity be. We have been running profitably, but this financing provides the extra horsepower to go after this market more aggressively.

Second, the follow-on public offering dramatically simplifies our capital structure. As part of the deal, we converted over 90% of the E series preferred shares and removed all the rights that the remaining 9% of E series shareholders have, except for their liquidation preference and roughly $1,000 a month in dividends.

The E series, through which we had raised capital as recently as 8 months ago before the turnaround started to take hold, had a 1.5 liquidation preference, 6% dividends and many other rights limiting our control of the business. Those rights are no longer in effect.

Third, the capital raise was done with simple, straight common stock, no warrants. This is a testament to the progress we have made with the business. Furthermore, we could not have asked for a better group of investors for such a small deal and small company, at least small today. These are largely very sophisticated fundamentals-driven investors.

Finally, with the help of Roth's Capital, our investment banker, we're in a stronger position to pursue a Nasdaq exchange uplifting and continue to evolve into a real viable public company for our shareholders.

Now we are well aware of that the best way to drive shareholder value would be to drive growth and profitability. But we also believe that this new simplified capital structure, the improved balance sheet and -- will help our business to make progress to reflect our true value once we are uplifted on Nasdaq.

Now let us get to the detailed financial results. We start out with sales. Net revenue for the second fiscal quarter FY '20, which ended on September 28, 2019, was $3.035 million. We showed 2 components for the revenue. The first component is goods of $373,000. This is for our RADAR test business. This $373,000 compares with $109,000 for the same period in the prior year.

The second component is for Services of $2.66 million, which is mostly for our Microsource product line, mainly for the RADAR filters, which are used in the F-15, the F-16 and the F-18 fighter jets. This $2.66 million compares with $2.57 million for the same period in the prior fiscal year.

Going on to gross margins. The gross margins in the second quarter of fiscal 2020 was 41.2%. The gross margins for the second quarter of fiscal 2019 was 42%. The overall gross margin improvement to the low 40s is -- was one key component in the turnaround of the company. We expect the gross margins to continue to improve because of the growth of the RADAR test business, which has higher gross margins than the RADAR filter business.

We now go to the bottom line. In the past, we talked about losses, now we're talking about profits. Net profits -- net operating profits for the second quarter of fiscal 2020 was $148,000. This compares to a net operating loss for the second quarter of fiscal '19 of $117,000. The improvement in profits was due to the increase in sales and lower operating expenses. Now the lower operating expenses from a year ago masks the fact that we added substantial resources to engineering with the establishment of a laboratory and office in New Hampshire. The reason why you do not see this increase in R&D expenses is due to the fact that we received from NAVAIR a large engineering contract to develop upgrades for their 5 test systems that they purchased. We took revenue on this engineering contract during the quarter and charged the engineering expenses to cost of goods sold rather than R&D. Having engineered these upgrades now. We expect that NAVAIR will place the orders for it to purchase and install these upgrades.

Going to EBITDA. EBITDA for the second quarter of fiscal 2020 was $295,000. This compares to an EBITDA of $7,000 in the prior year. This is the third quarter in a row of positive results. The last 3 quarters combined delivered $991,000 EBITDA on sales of $10.06 million, which represents an average growth of 25% and roughly a 10% EBITDA.

Interest expense. For the second quarter of fiscal 2020, the interest expenses were $66,000. This compares to $141,000 for the second quarter of fiscal 2019. The major component of this interest expense was $55,000 due to PFG interest expenses, and they were $121,000 in the prior year. So those expenses are very high from PFG, which is a 16% loan that we have taken out a long time ago.

Historically, the interest of the E series was combined with interest expenses. However, this is now reflected as deemed dividends on Series E on the statement of operations. This amount was $36,000 for the second quarter of fiscal 2020 and compared to $22,000 for the comparable quarter a year before. It should, by the way, be noted that we paid in common shares the accrued E series interest through July of 2019. Combining the operating income of $148,000, with the interest of $66,000, the deemed dividends of $36,000 and the $2,000 income taxes resulted into a net income attributable to common shareholders of $44,000 for the second quarter of fiscal 2020. This compares to a net loss of $282,000 for the second quarter of fiscal 2019 for all the reasons that are explained above.

One final comment, when you make losses, the number of shares shown are basic shares, which means only common shares, which were 10 million -- 10.55 million shares. When making profits, we count all shares, including preferred shares, warrants, options, using the treasury method of accounting. This total is 23.7 million shares.

In summary, we have turned the company around and are looking forward to exciting growth and making profits.

Looking at the balance sheet now. There are a few items that I do want to point out. The main change in the balance sheet is the accounting of leases on the balance sheet, which we were required to implement. This resulted into a long-term right-of-use asset and the long-term and short-term lease obligations. These items balance each other out. So there's really zero impact in some on the balance sheet. However, the short-term lease obligation of $384,000 impacts our current ratio, which was 1.38 at the end of Q2 FY '20 as compared to 1.41 at the end of 2019.

Looking at liabilities now. We reduced the 16% debt to PFG, Partners For Growth, by $548,000 to $1.23 million. But the increasing accounts payable, I said $765,000, which was due to legal and accounting expenses for the following offering and also to inventory purchases for the RADAR test product in anticipation of the upgrade orders from NAVAIR as well as some private contractors. We reduced other liabilities such as accrued payroll expenses by $200,000 and an additional $200,000 for other liabilities.

Looking at equities now. There is a $593,000 gain in total shareholder equities. This is due to the conversion of some preferred shares to common shares, the exercise of warrants and due to net profits. There were no new investments during Q1 and Q2 of this fiscal year. The follow-on offering occurred in the current quarter, the third quarter.

So in summary, we are done with losses and expect a profitable FY 2020. We made the needed changes to the company and are expecting growth and profits going forward. We have achieved 3 profitable quarters in a row, totaling $10 million in revenue and roughly 10% EBITDA. Also, we have recapitalized the company with a follow-on offering of common shares only with sophisticated investors who have taken time to study the company and the opportunity.

We are in a very strong position to grow our testing business. Our pipeline is healthy, our relationships with customers and prospects is stronger than ever, and we have a clear strategy to drive high-margin growth on that side of the business.

Thank you very much. We are ready for taking questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Justin Clare with Roth Capital Partners.

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Justin Lars Clare, Roth Capital Partners, LLC, Research Division - Director & Research Analyst [2]

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So I guess, first off, I wanted to ask you about your backlog. With the $8.4 million order that you just recently announced, could you update us on where your backlog stands now? And how much of it is associated with the RADAR filter business versus the test solution business?

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

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Sure. Okay. Since the order that you are referring to came in, basically, very recently, we are -- you want an update really that goes beyond September 30. So we show -- is that correct, Justin?

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Justin Lars Clare, Roth Capital Partners, LLC, Research Division - Director & Research Analyst [4]

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Yes. That's correct. If that's possible.

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

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So the order that we received of $8.4 million has 3-year components. So we took into backlog $2.9 million for the first year. We have not yet taken into backlog the addition of $5.5 million, which will happen, but we haven't taken that into backlog. So without the $5.5 million. We have an $8.8 million backlog for the RADAR filter business and not counting the additional $5.5 million. So if you were to add the $5.5 million to $8.8 million, then that is roughly $15 million -- $14 million, I guess.

Now however -- and I'd like to add one more point, and that is because of the accounting method of ASC 606, that is revenue backlog in terms of shipment of backlog, that is roughly $4 million higher.

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Justin Lars Clare, Roth Capital Partners, LLC, Research Division - Director & Research Analyst [6]

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Right. Okay. So then, I also wanted to ask about the visibility you have into orders. I guess, specifically, for the Navy. I know you've done some engineering work and you're expecting upgrades. Any sense for when the timing of those upgrades could be? And then also, I know there's multiple programs that you could potentially win with the Navy. Could you comment on any progress you're making in -- towards winning those programs?

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [7]

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Okay. I will do that. So let's first go to the upgrades with NAVAIR. We were contracted to do 5 -- to engineer 5 upgrades. By the end of September, we had engineered 3 out of those 5 upgrades. We have still 2 to be finished, which we expect to finish by the end of this current quarter.

And so for the 3 that we have completed, we expect to get orders for them this quarter now that we were able to quote it to them, and that's now in procurement with NAVAIR. So those 3 upgrades together make about $2.8 million. The additional 2 upgrades, we haven't quoted yet, so it'll be premature to give that information.

Regarding NAVAIR, we are in one program for a jammer from Northrop Grumman, and we have 5 test systems associated with that at NAVAIR. And we had enormous success with that test system because they were able to improve the performance of the jammer by using our test system to evaluate the behavior of the jammer. And so -- however, because of -- they are now using it extensively, they want to have this added, that added and that added, and it's fair to say that you have a recurring revenue once you're in a program for each program. And one program, NAVAIR has 6 programs, and I believe that we are now seen as really the best solutions that they have and I expect that we will get into other programs with the Navy as well.

Now we're also working with prime contractors in addition to NAVAIR. And we know that there are some requests in purchasing at this point at 2 prime contractors. So we expect other orders as well.

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Justin Lars Clare, Roth Capital Partners, LLC, Research Division - Director & Research Analyst [8]

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Okay. That's very helpful. And then just as it relates to the prime contractors. I know you've expanded with a new facility in New Hampshire. Can you comment on how that is helping potentially gain traction with customers and what the response has been?

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [9]

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Absolutely. And so what is important is that when you deal with either prime contractors or the Navy that you are consultative to them. You help them solve their difficult problems. That means you must understand RADAR very well. You must understand the Warfare equipment, the jammers and so on very well. You really need to internalize and understand the customers' problem.

To do that, you even need to have secret friends go deep into the lab because otherwise they wouldn't communicate with you, okay? But by having established the New Hampshire office, it's really a laboratory as opposed to a sales office, with 4 engineers that are able to provide what I just described, this consultative help. They're able to engineer solutions for them. They're able to communicate with them at their level. And having them right next to the prime contractors like BAE and Raytheon, there's just enormous confidence with these prime contractors, and they say, "Wow, these guys know what they're talking about. They can support me. I want to work with them." And that's what's happening.

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Justin Lars Clare, Roth Capital Partners, LLC, Research Division - Director & Research Analyst [10]

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Okay. And then I guess, just shifting to your RADAR filter business. I know you just landed a big order there. But I was wondering if you could comment on any potential visibility you have into further orders for that business?

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [11]

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Well, I mean, we get these orders every year. And that will continue, what I believe, for the next 4 or 5, maybe even 10 years. We get typically in our business of $7 million to $9 million per year. And we have pretty good visibility for the next couple of, I would say -- even say, 3 years out, okay? So we got -- just got this 3-year order that turn on each year. But we expect other orders for the F-16 and so on as we move forward.

It's a sort of an assured business because it's sole source. There is no competition. There cannot be competition because it would be extremely difficult for somebody to enter this world. It would be way too expensive. We are very much liked contractors. We were -- we received the golden award from Boeing, which means there are 20,000 vendors, only 82 received the golden award, we are one of them. So since we are highly regarded and have a very reliable, excellent product, it's a guaranteed business. And so we feel very confident that every year, we will generate between $7 million to $9 million for the next few years to come.

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Justin Lars Clare, Roth Capital Partners, LLC, Research Division - Director & Research Analyst [12]

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Okay. Great. And then one last one for me. With the completed equity rates here, just wanted to see how you are planning to deploy the proceeds near term, and should we anticipate any reduction in your debt potentially this quarter?

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [13]

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The answer is, number one, it strengthens the balance sheet, which was also important because we are dealing with very large prime contractors and the Navy. And when you're dealing with a Lockheed and BAE, those billion-dollar companies, it's important that they have confidence in the financial stability of Giga-tronics. So this money raise definitely helps that, okay?

But yes, we have a 16% interest in the PFG loan. And we do intend to see that we can get rid of that. And so we haven't decided that finally yet, but the plan is to stop paying 6% -- 16% interest as soon as possible.

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Operator [14]

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(Operator Instructions) We have our next question from [Mike Hussey] with Catamount Capital.

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Unidentified Analyst, [15]

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I was just hoping you could give us a little bit of insider sense into the size of your NOLs.

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [16]

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Okay. We have a $23 million NOL. And so clearly, we don't pay taxes for a long time to come. And so that's an assured NOL of $23 million as -- you needed more characterization or is that sufficient as an answer? $23 million.

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Operator [17]

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I see we have no further questions in queue. I will now turn the call over to Lutz Henckels for closing remarks.

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [18]

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Well, thank you for being on this call. As I described, we have gotten now the strength financially through the follow-on offering. We have 3 quarters of profits. Our commitment is to continue profitable growth, and we expect to accelerate that because of the RADAR test business which has better gross margins, and it's -- we are on an inflection point. So we are looking forward to good reports going forward. Thank you very much.

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Operator [19]

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