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Edited Transcript of GIGA earnings conference call or presentation 6-Feb-20 9:30pm GMT

Q3 2020 Giga-tronics Inc Earnings Call

SAN RAMON Feb 12, 2020 (Thomson StreetEvents) -- Edited Transcript of Giga-tronics Inc earnings conference call or presentation Thursday, February 6, 2020 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

* Thayer Brown Robbins

Five Mile River Investment Management, LLC - MD and Partner

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Presentation

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Operator [1]

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Welcome to the Giga-tronics Third Quarter and Fiscal Year 2020 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.

And I will now turn the call over to your host, Traci Mitchell.

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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; and Dr. 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 shipment. 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 discussions, 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 will now pass the call on to John Regazzi.

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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 2020 third quarter earnings call. Before I turn the call over to Dr. Henckels, who will review this quarter's performance in detail, I'd like to take a moment and describe our newly introduced multichannel capture system and why we're so excited about it.

To start with, this is our first standard integrated solution that we've introduced to the market in general. Prior to this, we've been focused on delivering customized solutions, such as the one we designed specifically for the U.S. Navy at Point Mugu, California. In contrast, we believe this new multichannel capture solution will have broad appeal across our entire target market.

Second, the solution leverages the unique capabilities of the company's Advanced Signal Generation and Analysis test platform introduced several years ago. Giga-tronics designed this EW test platform to match the architecture of modern RADAR and countermeasure devices, which enables our solutions to address relevant problems that competitors cannot. The multichannel capture system combines our EW test platform and a newly developed digital processing capability, which now allows engineers to observe and record complex radiofrequency events that occur between the RADAR and the jammers designed to counter them.

In a simulated engagement, many signals appear simultaneously and critical ones for only brief moments in time. This makes analyzing what happened very difficult. The Giga-tronics multichannel capture and playback system allows engineers to analyze the engagement off-line to develop machine-learning algorithms that can be used within the deployed systems during a real engagement.

Third, the very same system can be configured to play back the recorded engagement to allow engineers to replay the engagement as many times as necessary to perfect the intelligent algorithms and thus, the effectiveness of the countermeasures being developed.

Finally, the exposure the company can receive from the market due to the product introduction will let us enter conversations within the user community that should ultimately lead to more and smoother business quarter-to-quarter.

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

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

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Thank you, John. Welcome to our third quarter of fiscal 2020 conference call. I'm pleased with the progress that we are making in growing our business, which is reflected in our 39% growth for the quarter and 20% growth for the 9 months.

I started at Giga-tronics exactly 2 years ago, and turning the company around was one major objective, which we achieved. Other major objective was to reinvigorate growth. To that end, we focused the company on providing complete RADAR test solutions as opposed to providing subsystems only. And with the new product introduction, which provides a complete solution, which John described, we expect to see strong growth going forward.

Let me now go to the detailed financial results. First, let us look at sales. Net revenue for the third quarter of fiscal 2020 ending December 28, 2019, grew 39% to $2.63 million. We showed 2 components for the revenue for Q3 of fiscal 2020. The first component is goods of $193,000, which is for our RADAR test business. $193,000 compares to $100,000 for the same period in the prior fiscal year.

The second component is for services of $2.44 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 jets. This $2.44 million compares to $1.79 million for the same period in the prior fiscal year.

Into gross margins now. Gross margins for the third quarter of fiscal 2020 were 41.7%. Gross margins for the third quarter of fiscal 2019 were 43.5%. So there was a small decline in gross margins due to product mix. The overall gross margin improvement that we have experienced over the last year is one key component for the turnaround of the company. We expect the gross margins to continue to improve with the growth of our RADAR test business.

We now go to the bottom line. Unfortunately, we did make a small operating loss. Net operating loss for the third quarter of fiscal 2020 was $114,000. This compares to a net operating loss for the third quarter of fiscal 2019 of $331,000. The reduction in the losses was due to the increase in sales.

EBITDA profit for the third quarter of fiscal 2020 was $28,000. This compares to an EBITDA loss of $177,000 in the prior year. This is now the fourth quarter in a row of positive EBITDA results. The last 4 quarters of fiscal -- of calendar 2019, combined, delivered $1 million of EBITDA profits on sales of $12.7 million, and the $12.7 million represents a 27% growth in revenue.

While the results of the third fiscal quarter compare favorably to a year ago, we want to be clear that we expected better results in the RADAR test business, so we are not really happy with it. There are 2 items that we expected in the fourth quarter, which have been pushed out. First, the introduction of our new test solution, which we just announced, was supposed to be completed during the December quarter. Our test solution uses the latest advanced technology, which is in very high demand. This caused delays from our supplier, which, in turn, caused delays in meeting our schedule.

Second, we have projected greater than $1 million in upgrade business from the Navy, which we expected to realize in the fourth quarter. Due to unexpected delays in the government procurement process, the order could not be released by the end of the year. Given these 2 problems, I decided I have to see things firsthand, so I visited both the supplier and the Navy last week. The supplier assured me that they are on top of the issue, that they are tracking to resolve the issue, so that over the next 3 months, they will deliver our production quantities. Then meeting with the Navy, they stated that they have mitigated future delays, that this is a mission-critical order, that it is receiving their highest priority, and the order is now expected to be released within the next month.

I have to remind you, please keep in mind that we must be very sensitive to federal and defense acquisition regulations. And therefore, we cannot express more on this call. We are continuing to work closely with our Navy customer to ensure that there are no further unexpected delays. I want to be clear, this is not a loss of revenue. It is just a delay in realizing it.

Moving to interest expense now. Interest expenses for the third quarter of fiscal 2020 were $42,000. This compares to $159,000 for the third quarter of fiscal 2019. This major reduction in interest expense of $117,000 are due to the fact that: one, we converted the E Series preferred shares to common shares, and therefore, no more dividends or interest; and second, we reduced the PFG debt by $781,000. Combining the operating loss of $114,000 with the interest expense of $42,000 resulted into a net loss of $156,000 for the third quarter of fiscal 2020. This compared to a net loss of $490,000 for the third quarter of fiscal 2019 for the reasons that I explained in detail.

I need to make one final comment. We incurred a onetime noncash deemed dividend charge of $1.24 million. This is due to the conversion of the E Series preferred shares to common shares. What we did is we offered 1.5 common shares for every 1 preferred E Series share. This added 0.5 share is treated as a onetime deemed dividend. And so that's not cash, and it's only onetime, and it allowed us to convert the preferred shares to common shares and greatly simplify our capital structure, which was an objective for the company to allow us to uplift to NASDAQ in the future.

Going to the balance sheet now. Looking at our balance sheet, there are a couple of items that I want to point out. One main change in the balance sheet is a new accounting standard, 842, of leases. And so they are now appearing on the balance sheet. Together, they all equal out. So there are 4 items. There is a long-term right-of-use asset of $1.164 million, which is offset by a long-term lease obligation of $1.174 million. There's also a short-term capital lease obligation of $396,000, which is offset by a reduction of a long-term deferred rent of $356,000 (sic) [$358,000]. So basically, these items equal each other out, okay?

The second point that I want to make on the balance sheet is you will also note a $852,000 increase in inventory. This is primarily due to incorrect hardware delays, which we described and therefore, an accumulation of inventory in the RADAR test solution business, which I explained earlier. We will recover this inventory when we ship the system. So no worry, it will be recovered.

Looking at liabilities now, we reduced the 16% debt to PFG by $781,000, and we also reduced current liabilities by $834,000 when you exclude the lease charges that I explained earlier. So together, $781,000 and $834,000, that's $1.6 million. So we reduced our current liabilities by $1.6 million during this quarter.

Total shareholder equity increased to $4.383 million from $1.815 million. This is due to the funds that we raised in our follow-on public offering and due to the profits that we generated. But this is offset by the deemed dividend as I explained earlier.

So in summary. Number one, we achieved strong growth for the quarter. In spite of these solid results, we saw some push in orders, which will be realized over the next couple of quarters. Second, we are very encouraged about the improvement of our financial performance. Third, we finally introduced a complete playback and capture test solution. We didn't have that before. This was a major effort by the company and a major investment by the company, and it is a very large accomplishment that has been achieved primarily by our New Hampshire group. We see strong demand for this from existing and new customers. Over 50% of our pipeline relates to this new offering, so we are very excited about rolling out this new product that John described. Moreover, number four, we have recapitalized the company with a follow-on offering of common shares only, no warrants. And we converted the preferred shares to common to greatly simplify our capital structure. We have also completed the reverse split in shares and remain committed to uplifting to NASDAQ this year.

Thank you very much, and we are now ready to take 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 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 first off, I wanted to ask, last quarter, you indicated that you had completed the engineering work for 3 of 5 upgrades that you were contracted to do for NAVAIR. Can you update us on the progress you have made, if you've completed the engineering work for the other 2 upgrades?

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

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No. We -- number one, we continued working on the upgrades because we encountered some difficulties with the supplier and some engineering issues with it as well. They are now resolved, okay, but that took quite a bit of time. The 2 additional upgrades, which relate to -- that they can do their own collaboration of the test system in the lab that relates to what we call the temps upgrade to 1-gigabit IBW, as we call it, instantaneous bandwidth, have not been done yet.

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

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Okay. So then you mentioned you anticipate getting orders in about a month from the Navy. Would that be for the 3 upgrades? Or could you get orders for all 5 of the upgrades?

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

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So there are 3 upgrades. It is the -- but I have to be thoughtful how I explain it on this call here. But there is the upgrade of some digital hardware within the Navy system. There is the upgrade of what they call a Mode 5, and then there is an upgrade that is what we call attenuator control. We have developed these. We have these things in inventory. But we expect to get orders for that during the next couple of quarters.

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

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Okay. Got it. And then I was wondering if you could speak to the delay from your supplier. Is it possible to give us more detail on the reason for the delay? Is it a specific component where there was a shortage? Or is there some other issue with the supplier?

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

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So I mean I visited this supplier, and I met with a large meeting with them. And there were 2 elements to that discussion. The 1 element were some engineering issues that needed to be resolved. I don't want to bore this group here, like what we call phase-in version and so on. And they resolved that and showed very high confidence in their solution. So I believe that that is done. The second one is actually because they are using the latest technology, getting a specific FPGA part. And they have trouble getting it in a timely manner for us to deliver. So that was really, at this moment, the bigger hang-up. And so I pushed pretty hard in that meeting. But to be realistic, I think that if things go well, we have it by the end of this quarter.

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

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Okay. And do you anticipate the solution essentially resolving the problem for the long term? Or could this be a problem then that recurs?

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

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No, no, no. I mean they -- it was off the engineering problems, so I wouldn't worry about that anymore. I have complete confidence having met with them and having my engineering team there when we met. So that's no longer an issue. So at this moment, the issue is really a high-performance part for them to obtain in a timely manner for us. And I pushed very hard on that. I say, "I really need it now" and so on and they understand that. But because we're using very advanced technology, that part is in very high demand in the market. Once they get those parts, which they have a specific commitment from the supplier, then we have production quantities. Not to worry about it. So it's -- the engineering problems are resolved, and the pipe problems should be resolved by the end of this quarter.

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

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Okay. All right. And then -- so I guess shifting to the sales outlook here, considering the delays that you're seeing here, can you give us a sense for how you expect revenues to trend for the test solution? But then if you could also address the Microsource business and what the sales outlook is there?

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

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Okay. Well, I mean clearly, since we recognized a difficulty in this quarter that just went by, we then obviously shifted resources in production to the filter business. And so that business came in stronger than what we had projected or anticipated, actually significantly stronger, okay? So that's allowed us to manage the quarter reasonably, okay? We do expect now, going forward, that the RADAR test business would kick in and give us a revenue. In fact, we already received 1 order from a prime contractor in the RADAR test business. So we expect now for that business to start kicking in.

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

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Okay. Can you share what the size of that order was and what your backlog is at this point (inaudible)?

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

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It's not a big order. It's from a major supplier -- prime contractor, and it's a first order of a total of 2 or 3. And we haven't published it yet, so I'm not sure how much we should share. But we will deliver that order this quarter and actually this month.

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Justin Lars Clare, Roth Capital Partners, LLC, Research Division - Director & Research Analyst [14]

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Okay. And then maybe just one last one for me. You raised capital in the last quarter here, and it sounds like you've had some issues where you had more inventory than you necessarily wanted to have. But was wondering what your plans are for repaying the debt that you have.

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [15]

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I mean the inventory is -- as soon as we ship things, the inventory will go down. And so basically, we purchased computer systems and subsystems, and we didn't deliver it, so the inventory went up significantly. But that is, in a way, good money that will be recovered fully. So basically, when we get the order, we get the 100% cash for it.

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Operator [16]

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(Operator Instructions) Our next question is from [Jen Wolford] with Comstock Partners.

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Unidentified Analyst, [17]

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Actually my question was answered in that last state of questions, so I'll step back, and let someone else ask a question.

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Operator [18]

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Our next question is from Todd Robbins with Five Mile River Investments.

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Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [19]

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Lutz, we've crossed paths before. I recall that you were at LeCroy in the '90s. When my memory serves me correctly, you'd taken that company from less than $10 million to over $150 million. Should I have similar ambitions for what you could accomplish with Giga-tronics?

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [20]

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Okay. Let me explain because I didn't take the company from $10 million to $150 million. What I did is when I entered LeCroy, the company was not focused. It was not making profit. It was making losses, okay, and it needed to be turned around. But we did. We focused the company on 1 specific product line, which I described as an analytic oscilloscope as opposed to a display oscilloscope. At that time, that analytic oscilloscope had $17 million in sales, and we grew that to about $143 million while I was there, and in the process, I took it public. So basically, we focused the company, eliminating all the other product lines and grew it from $17 million to $143 million.

The same thing here, okay? We are focusing the company on RADAR test solutions as opposed to subsystems and other businesses. And so we have a key differentiator in it because we are architected like a RADAR but built like a test system. And our unique differentiation that John described allows us to be differentiated the way we're at LeCroy with the analytical oscilloscope, and we expect to repeat the performance of growing the business from basically very little, like a couple of million dollars to at least $60 million or more over the next 5 years.

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Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [21]

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So help me understand. What is your addressable market in this space? You mentioned $60 million or so. Have you...

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [22]

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That's not our addressable market. That's the market share that we want to get. The addressable market is $440 million, and it has 2 pieces that has a piece which we call EW, which is like Electronic Warfare jammers. That's $230 million. And then it has a RADAR test market, which is $210 million, and this is by -- per year. So together, we see a $440 million market, of which we expect to get at least $60 million over the next 5 years.

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Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [23]

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So this is your new test system that you're beginning to ship.

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [24]

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Correct. Right.

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Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [25]

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But what's the ASP on this thing on average?

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [26]

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That's a good question. It varies, okay? So when we sell these fully loaded system with many channels and all capabilities, they can go up to all the way $2 million. If you take the smallest piece of that system, just 1 channel, okay, and with a very limited capability, you are in the $350,000 domain. So it can go from $350,000 to $2 million or even $2.5 million, and it depends on how many channels and how many features. Is it detection? Is it capture? Is it playback? You can put those 3 systems together. So you can make very large systems. But the entry price is in the neighborhood of $300,000, $350,000.

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Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [27]

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Is it your belief that the supplier will be able to satisfy that level of demand? Or are you going to have to go to another supplier?

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [28]

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There should be no problem. And so let me explain that one. We provide a Microwave/RF solution, which -- that was a vision of John. The whole company is rallying around. But we had only a subsystem, so we used this to provide a complete solution, okay? So the complete solution consists of a super microcomputer into which you plug cards either for digitizing or capturing data or for generating, we call it, AWG, arbitrary waveform generator, for generating the data, okay? So we buy these cards, okay? And so we had an issue with 1 supplier in these cards. They have resolved those issues. And by the way, we had that as a previous supplier, so it's not an issue.

It's not something that is unique or for the first time. But at this point, they have resolved those engineering issues. And so now it's just a matter of getting the latest advanced part, and that's an industry common thing. When you want to get this latest FPGA from people like Xilinx and so on, they are in very high demand and they have long lead times. And this is actually a quite normal thing when you deal with state-of-the-art components. And we are state-of-the-art, and therefore, we have that challenge. The supplier has that challenge, but they have resolved that also and so we expect to have material in hand by the end of this quarter and surely by the beginning of next quarter.

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Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [29]

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So as you think about the $60 million in 5 years that this test business could generate, how linear is that business? In other words, is that $60 million going to be bulked into the last part of the 5 years? Or is that going to be relatively evenly spread over the 5 years?

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [30]

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Well, I mean if you're making this comparison with LeCroy, you better grow your business every year to get to $50 million. And that's what we did at LeCroy. We called it -- actually, we called it, at that point, staircase to heaven, okay? And so yes, I fully expect to build a staircase to heaven.

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Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [31]

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Say -- give us a little help on the filter business. That came in ahead of schedule at $2.5 million, roughly. Is that likely to be a number that we should hold flat going forward? Or is there going to be some growth in that as well? Or are you going to divert resources back to test and let the filter do that?

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [32]

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So let me go to 2 points there, and that is, number one, that business is not necessarily flat quarter-by-quarter. Because of -- we are providing these components to Boeing and Lockheed, and they have a certain schedule. And when we get a little bit ahead, which we did, then likely, in the future, we would be a little bit slower because we have provided supply, okay? However, you're talking about -- I mentioned in my presentations that this business is between $7 million to $9 million per year. Right now, it's running a little hot, so they are coming closer to the $9 million than the $7 million. However, we intend to grow that business.

And for the first time actually in recent history, we are now bidding on additional planes and additional opportunities with 2 customers. And so we do expect that business will also grow in the future beyond the $7 million to $9 million. But given where we are right now, it's between $7 million to $9 million, and it can be a little bit hotter and a little bit cooler from quarter-to-quarter.

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Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [33]

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What is your cash position at the end of December?

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [34]

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Go ahead. My controller is right here answering that question.

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Traci Keiko Mitchell, Giga-tronics Incorporated - Corporate Controller & Principal Accounting Officer [35]

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$1.2 million.

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Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [36]

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Do you expect to be generating cash as you go forward? Or are you going to consume cash?

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Lutz P. Henckels, Giga-tronics Incorporated - CFO, Executive VP & Director [37]

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Both. I think we need to get our sales level higher than what we are right now to generate cash. So we are right now consuming some. But I do expect fully this coming fiscal year to generate cash. And actually, we have that -- when you make profits, they come to the bottom line. I do expect to generate cash out of inventory instead out of working capital. So yes, I fully expect to generate cash.

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Operator [38]

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We have no further questions at this time. 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 [39]

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Okay. In closing, we are -- we recognize that the orders pushed out, but they are not lost at all. They are delayed. You can be rest assured that we will get these orders and that we will deliver, and so I'm happy that we have this new test capability. That's a major, major accomplishment to have a complete test solution. And so I believe that, looking forward, we should expect good growth, group profitability and cash generation. Thank you very much.

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Operator [40]

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