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Edited Transcript of GIGA.PK earnings conference call or presentation 5-Nov-20 9:30pm GMT

·20 min read

Q2 2021 Giga-tronics Inc Earnings Call SAN RAMON Nov 5, 2020 (Thomson StreetEvents) -- Edited Transcript of Giga-tronics Inc earnings conference call or presentation Thursday, November 5, 2020 at 9:30:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * John R. Regazzi Giga-tronics Incorporated - CEO & Director * Lutz P. Henckels Giga-tronics Incorporated - Executive VP, CFO, COO & Director * Traci Keiko Mitchell Giga-tronics Incorporated - Corporate Controller & Principal Accounting Officer ================================================================================ Conference Call Participants ================================================================================ * Thayer Brown Robbins Five Mile River Investment Management, LLC - MD and Partner ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Welcome to the Giga-tronics Second Quarter Earnings Conference Call. My name is Darryl, 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 Traci Mitchell. Traci, you may begin. -------------------------------------------------------------------------------- Traci Keiko Mitchell, Giga-tronics Incorporated - Corporate Controller & Principal Accounting Officer [2] -------------------------------------------------------------------------------- Thank you. 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 Operating Officer, Chief Financial Officer and Executive VP. Before we begin, I need to remind everybody 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 discussions, see our most recent annual report 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 Conditions and Results of Operations. With those reminders in mind, I would like to pass the call on to John Regazzi. -------------------------------------------------------------------------------- John R. Regazzi, Giga-tronics Incorporated - CEO & Director [3] -------------------------------------------------------------------------------- Thank you, Traci. Good afternoon, everyone, and thank you for joining our Fiscal '21 Second Quarter Earnings Call. I have a few remarks before turning this call over to Lutz, who will go over our performance in detail. Travel restrictions due to COVID-19 continue to hamper our in-person access to military bases. Holding face-to-face conversations at cleared facilities allows the sharing of sensitive information between the customer and our sales team, which is critical for us to understand their problems and to define solutions. It has also delayed the ability to demonstrate our EW test capability, which lends confidence in our solutions and help secure customer commitments. The pandemic has also slowed the U.S. government and letting contracts to our Microsource customers, which has delayed receipt of new orders for our RADAR filters. As a result, revenues fell below our forecast and below our breakeven level, driving the company into an operating loss for the quarter. Nevertheless, we believe that the second half of this fiscal year will pick up as these delays are overcome. In addition, new opportunities being pursued are expected to materialize in the third and fourth quarters. We remain confident that we are on track for a strong year with growth expected in both our Microsource filter and RADAR EW test businesses. Finally, I would like to again recognize our essential employees who continue to show remarkable resilience in the face of rising infections in our area. We have taken many precautions to keep them healthy, which is the core reason we can successfully deliver on received orders. They represent a true strength of the company. And I very much appreciate their efforts on behalf of Giga-tronics. I'll now turn the call over to Dr. Henckels to go over the numbers in detail, and then we'll open the call for questions. Lutz? -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [4] -------------------------------------------------------------------------------- Okay. Thank you, John, and thank you for explaining why we need access to the secret labs in order to make EW sales. Welcome to our second quarter fiscal 2021 conference call. The company had preannounced its financial results on October 13, so there are no surprises here today. Basically, as John explained, because of the timing of large orders, we incurred a loss. However, we received a large order in late September. And we expect to make up for this timing delay. Let us now look at the detailed results. First, let us look at revenue. Net revenue for the second quarter of fiscal 2021 ended September 26, 2020, was $2.7 million. We showed 2 components for the revenue for Q2 of FY 2021. One component is for services of $1.87 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 $1.87 million compares with $2.6 million for the same Q2 period of the prior fiscal year 2020. So this is a large 30% decrease. This decrease was due to receiving late a large purchase order from Boeing for $4.96 million. The Microsource business is secure, but it swings between $7 million and $9 million per year. In this fiscal year 2021, we will be on the high end of this range. So there is really no concern regarding this business. It will perform on the high end of its range. The other component is goods at $822,000, which is for the RADAR EW test business. This $822,000 compares favorably with $373,000 for the same (technical difficulty) towards this challenging past 6 months period with COVID, our net cash used from operations for the 6 months period was $176,000. In addition, we have a $3.2 million inventory insuring that we have basically all the parts to deliver multiple testing solutions without significant additional expenses or cost. We expect that our inventory will likely decrease as we deliver our testing solutions. In conclusion, we expect that we will generate cash again in the second half of this fiscal year. Now let me move away from all the numbers and really go to a somewhat higher level. We have 2 businesses. We have the sole-source Microsoft Filter business for the fighter jets. I call that business our rock. It delivered $7 million to $9 million sales per year in the past and in the many years going forward at about $3 million in gross profit. It truly will deliver this performance at the high end range in this fiscal year 2021. Even though we fell short in the last quarter, Q2 FY '21, this is strictly just the timing issue. Our second business is a RADAR EW test business. This is our growth engine. And while that business indeed grew quite a bit percentage-wise in Q2, we note that it was below our expectation that this business was impacted by the pandemic because we couldn't access military bases. But that has been eliminated since September and so we expect the business moving forward at a good growth rate. So from a revenue viewpoint, we have stated that we expect the filter business to average between $7 million to $9 million per year, and we have targeted that the EW test business should double every year. Sometimes, we will be above these targets for each business, sometimes below because of the large order size, so there can be fluctuations between these 2 businesses. For example, in fiscal '21, we have lost some ground, as I mentioned, due to the COVID in the EW side because we didn't have access to the secret labs. At the same time, as we stated, the filter business this year should be significantly above last year's revenue of $8.2 million. So the sum of the 2 business should balance out, and we expect to meet the overall revenue projections. The revenue projection growth in fiscal '21 will have a dramatic impact on the profitability of the business. First, the gross margins will increase simply because of higher volume, which will absorb better the manufacturing overhead. Second, because the EW testing business is a higher gross margin business, it's above 50% as compared to the filter business, which is around 40%. So as the EW business increases in its share, we should see better gross margins. For example, in fiscal 2020, the EW test business was 27% of revenue. And we delivered, overall, a 39% gross margin. So there's lots of room for improvement when the EW business becomes a larger part of our overall business. Add to that, operating expenses should also improve. Our operating cost will grow but at a much slower rate than revenue. Operating expenses as a percentage of revenue have decreased from 60% in fiscal '18 to 43% in fiscal '20, and this will continue to come down as we grow. And finally, we have a very large NOL, so we will not be paying any taxes for a long time. So as you can see, if we execute well, it will translate into higher earnings per share for our shareholders. And with that, I want to say thank you, and we are ready to take questions. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) And we have a question from Todd Robbins from Five Mile River. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [2] -------------------------------------------------------------------------------- The delays in getting into the secret labs, how were you able to rectify that? Because that was a situation that existed back in March and April, and it took almost till September before you were able to get in. How are you able to get around that bottleneck? -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [3] -------------------------------------------------------------------------------- So initially, we couldn't do anything. We couldn't get in, okay? Then we were allowed to get in by you having to quarantine for 2 weeks near the lab in order to get into the lab, okay, which we did. And we were sitting for 2 weeks in front of the lab in order to then get into the lab. At this point, they have relaxed that restriction, and we just make an appointment. We fill out a questionnaire, and we were able to get in. For example, our people are today at the Eglin Air Force base. So we didn't get around it. They relaxed it. Initially, you couldn't get in. Then you could get in if you're quarantine for 2 weeks, and now you can get in without the quarantine. So it's really more on their side where they relaxed as opposed to what we did. However, another important point to that, and that is, you see, in order to really deal with the customer problems, which we solve with our system, you have to have people that have the secret [currents] to go into the secret labs because only there, the customer will tell you what the problems are. They will never do that outside of the secret labs and only do it with people that have clearance to go into the secret labs. And so therefore, it's critical for us to get that access. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [4] -------------------------------------------------------------------------------- Okay. In the case of the filter business, that's -- I mean you're encouraging us to think of that as a steady-state business, where if you miss one quarter, you'll make it up in the next. How should we be thinking about the EW test side of the business? Does the 6-month hiatus mean that, that's just a chunk of business you're not going to get, and you've got to start from ground 0 again? -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [5] -------------------------------------------------------------------------------- No. Absolutely not. No. It's just a delay. And so -- it's not like the business has gone away. None of the business has gone away. It's not that a competitor quoted and we've lost it. The customer still has a need. And actually, you could say slightly more urgent need. So the business is there, but simply it could not develop as quickly as we would like to have seen. On the Microsoft filter side, there's actually a lot of pressure right now causing us to really hit the maximum capacity that we considerably can have in our production the way we are currently set up. And so we are running at max there. And we expect some decent business now that we have been able to get into the lab coming -- including this quarter. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [6] -------------------------------------------------------------------------------- I'm sorry. You were talking about the filter business then? -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [7] -------------------------------------------------------------------------------- No. The filter business, we got the purchase order, so we don't need anything more in order to do very well, okay? On the EW side, we do need orders, but we expect such orders to arrive now that we have been able to access, including getting orders this quarter and shipping these orders. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [8] -------------------------------------------------------------------------------- So how should I think about the revenue ramp in the test business looking at the second half of this year? -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [9] -------------------------------------------------------------------------------- In the -- so you should think that we would be on the high end on the Microsoft filter side. And I think that on the EW side, you should think of it as it is growing, but we had a 6-months delay. So it's not growing at the same rate that we would have had if it had -- if we had access during the last 6 months. So it's north of -- go ahead. Go ahead. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [10] -------------------------------------------------------------------------------- The EW test you booked in the second quarter of $800,000, that's largely one system pretty much, isn't it? -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [11] -------------------------------------------------------------------------------- Correct. I mean it's a little bit more than that because it's $800,000. But yes, it's roughly 1 system. However -- so let me go there. So we have sales that can start at like $350,000 at the lower end and can go to several million on the high end. So it varies quite a bit, okay? And so we expect sales of $200,000 or $300,000 -- actually, $200,000 is very rare, but $300,000 or $400,000 but also like 800,000 and more. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [12] -------------------------------------------------------------------------------- This business has been sized as an addressable market in the hundreds of millions of dollars. -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [13] -------------------------------------------------------------------------------- Correct. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [14] -------------------------------------------------------------------------------- So help me think about how this ramps as you go forward. In other words, if you booked 1 system in the second quarter, do we see 2 or 3 or 4 or 5 or 10 in the second half? -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [15] -------------------------------------------------------------------------------- Okay. So let me step back a little bit in order to answer that, okay? So initially, we were strictly with the labs at Point Mugu. And with this 1 lab, which we call the Whistle lab, WSL lab, we have done, over several years, $10 million with this 1 lab, which is 1 program, a jammer program, with Point Mugu, okay? We have now moved from the lab to the range. So that increases our business because we are not just this 1 lab. Okay? The range means it's a completely different application. You are no longer in a lab. You're in a trailer. You have a plane flying overhead. We bombarded with the threat emulation, and we record what the plane and the pilot does in regards to that threat. And so we basically -- it's used as a training tool for the pilots and the planes and to make sure everything works physically out in the field. That's a very different application. And actually, the sale that we shipped during the last quarter was for this application. And there ought to be about 10 such sales, but each sale is not just one system that we ship. It was a generation -- a threat generation system. There is a detection system, a capture system, which is really critical for these applications to record, which is another $400,000. And then there would be an upgrade to a higher frequency. So each sale at the end and each trailer will be about $1.5 million. And for this 1 base or 1 range, there will be 10 of those. With that, we got into Eglin Air Force base, which I mentioned, where our people are right now. And actually, they are installing also a threat emulation system there. And so we are expanding first from the lab then onto the range for a complete different application, then into the Air Force. And we also expect this quarter to be able to get into the Army as well. So you're expanding from Navy to Air Force to the Army. You are expanding from 1 lab to multiple labs. You are expanding from a lab application to a range application, and you are going to repeat that, both with the Air Force and the Army. So the expectation is to grow it by lapse by growing it by application and by growing it by the services. And so that is how we see growing our business. Now you have to then follow that with your product line as well because there are new threats and there are more higher frequency requirements and additional capability needed, and we obviously making sure that we provide that. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [16] -------------------------------------------------------------------------------- So you're not going to be specific about the dollar amount of the ramp, but the addressable market over the next year or so is something in the excess of 10 systems. -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [17] -------------------------------------------------------------------------------- Well, I mean better said, we have -- there's this one application what we call China Lake. You have 10 systems, which, together, each system is about $1.5 million when it's complete. So you can think of that alone as being $15 million, but that is still with the marine core China Lakes, and that's not yet with the Air Force, which has a similar need or with the Army, which has an additional need. And so there's a lot more business coming than just expanding into this 1 application that I just mentioned. So we feel very confident about truly being able to double our business as we go forward, but we are setback still because of the -- in the year because of this COVID and the lack of access to the base. But we are in a good position. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [18] -------------------------------------------------------------------------------- When you say you're in a position to double your business, do you mean double it every year? -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [19] -------------------------------------------------------------------------------- I mean, at some point, you cannot do that. But when you are as small as we are, then yes. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [20] -------------------------------------------------------------------------------- Okay. And the increase in SG&A in the second quarter, how much of the $926,000 was R&D? (inaudible) the engineering bucket. -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [21] -------------------------------------------------------------------------------- When you saw [depths] the $991,000, is that what you're referring to? -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [22] -------------------------------------------------------------------------------- You have SG&A in the second quarter at $926,000. It's up 23% year-over-year. Is the R&D expenditure in that number? -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [23] -------------------------------------------------------------------------------- No. That's above. That's $554,000. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [24] -------------------------------------------------------------------------------- What would attribute the large increase in the SG&A line? -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [25] -------------------------------------------------------------------------------- There are really 2 reasons for that. And one reason is legal expenses because of the fact that we developed a rights agreement. We also had expenses associated with the Spring Mountain share transaction, which we legally carried out and had the expense of working through that, which was actually quite significant. And then we had some additional personnel expenses as well. And that in part was also due to the fact that we had the shareholder meeting during this quarter. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [26] -------------------------------------------------------------------------------- So that business should... -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [27] -------------------------------------------------------------------------------- But then add to that -- we are -- no. No, we added -- so this SG&A. I talked about G&A. So on the S side, we added people. And so we increased our personnel cost on the S side in order to drive sales. -------------------------------------------------------------------------------- Thayer Brown Robbins, Five Mile River Investment Management, LLC - MD and Partner [28] -------------------------------------------------------------------------------- So with the absence of legal expenses going forward, that should flatten out for a while? -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [29] -------------------------------------------------------------------------------- Yes. Well, actually, it should come down a little bit. It was high this quarter. -------------------------------------------------------------------------------- Operator [30] -------------------------------------------------------------------------------- (Operator Instructions) We have no more questions at this time. -------------------------------------------------------------------------------- Lutz P. Henckels, Giga-tronics Incorporated - Executive VP, CFO, COO & Director [31] -------------------------------------------------------------------------------- Okay. So let me then conclude. So in conclusion, we believe that we have a good outlook. We have a recurring revenue stream with the Microsoft -- Microsource filter business, which I call our rock; and we have a good growth engine, the military EW Threat Emulation business that is kicking in with new products that we have developed and new applications outside of the labs on the ranges. And believe -- we believe that there is a trajectory towards achieving our long-term goal of $60 million in revenue per year at higher margins than the Microsource filter business. And this military EW business is relatively recession-proof. Yes, short term, there are some hiccups because of the coronavirus and us not having access. And there could be another shutdown given how rapidly right now the cases are increasing. But medium and long term, we are definitely optimistic. Thank you very much. -------------------------------------------------------------------------------- Operator [32] -------------------------------------------------------------------------------- Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.