Giga-tronics Incorporated

Good afternoon, and thank you for joining us on our third quarter earnings conference call. This conference call contains forward-looking statements concerning profitability, backlog of orders, shipments and the likelihood of realizing certain tax benefits.

Actual results may differ significantly due to risks and uncertainties, such as future orders, cancellations or deferral of orders, disputes over performance, the ability to collect receivables and general market conditions. For further discussion, see the most recent annual report filed by Giga-tronics on Form 10-K for the fiscal year ended March 31, 2012, Part I, under the heading Certain Factors Which May Adversely Affect Future Operations or an Investment in Giga-tronics, and Part II, under the heading Management’s Discussion and Analysis of Financial Condition and Results of Operations.

I will now turn the call over to John Regazzi, Chief Executive Officer. John?

Thank you, Frank. Good afternoon, and thank you for joining our quarterly earnings conference call.

I apologize for the delay in getting out our results and that you don't have that in front of you for the call. I will read the numbers for you, and then I'll have a few remarks.

And then I'll open the call for questions.

Giga-tronics reported today a net loss of $865,000 or $0.17 per fully diluted share for the quarter ended December 29, 2012. This compares with a net loss of $2,613,000 or $0.52 per fully diluted share for the comparable period a year ago.

Net sales increased 41% to $3,946,000 in the third quarter of fiscal '13 as compared to $2,799,000 in the third quarter of fiscal '12.

Gross margin increased by $2,074,000 over the same quarter last year.

Operating expenses increased 15% or $323,000 in the third quarter of fiscal '13, primarily due to a $434,000 increase in product development expense and expenses associated with the previously announced restructuring totaling $99,000. This is partially offset by a decrease in sales, general and administrative expenses.

Orders decreased 10% in the third quarter of fiscal '13 to $2,247,000, down from $2,500,000 for the third quarter of last year. The decrease in orders is primarily related to a decrease in switch orders, which is a business characterized by very large periodic orders.

Net loss for the 9-month period ended December 29, 2012 was $2,636,000 or $0.52 per fully diluted share. This compares with a net loss of $3,952,000 or $0.79 per fully diluted share with the comparable period a year ago.

Net sales increased 10% to $11,409,000 in the first 9 months of fiscal 2013 compared to $10,382,000 in the first 9 months of fiscal '12.

Gross margin increased by $2,012,000 over the comparable period last year.

Operating expenses increased 11% or $692,000 in the first 9 months of fiscal '13, due to more than $1 million increase in product development expenses as we invest in new instrument products and expenses associated with the restructuring, which so far have totaled $283,000.

Orders increased 40% in the first 9 months of fiscal '13, primarily related to orders received from the U.S. government and from prime contractors.

This compares to $10,513,000 for the 9 months of fiscal 2012.

A substantial component of the operating loss for the third quarter and for the year to date is related to our continued investment in new product development, which we believe is necessary to achieve future revenue growth and profitability.

Total R&D investments for the first 9 months of the current fiscal year were 28% of sales, which is about twice what would be considered typical. The balance of the loss is the result of insufficient sales volume relative to our fixed overhead structure and to the expenses we're incurring to address this issue.

While we partially corrected the overhead problem with the reduction enforced last February, the company is also working toward improving its capacity utilization and efficiencies by consolidating the Santa Rosa operation to our San Ramon headquarters.

The Microsource move continues on schedule towards the May 1 completion date. At that time, the restructuring expenses will largely go away.

And if results go as planned, significant additional savings per year will be obtained, thus balancing our infrastructure costs with our anticipated sales volume.

It's been a challenging period for the company as our primary focus shifts toward markets addressable by the new synthesizer product. It's also been a challenging time for our employees as we have restructured the management team, worked on the Microsource move and tackled the development of a significant new product all at the same time.

I believe we will soon be arriving at the benefits of this strategy, which will first appear as improved gross margins after the Microsource relocation has been completed and ultimately as a return to profitability following the introduction of the new product in the next fiscal year.

With that, I'd like to open the call for questions.

Look, I -- since we didn't have the numbers, what was the gross margin for the quarter, percent-wise?

Do you have that, Frank?

Yes, it was 40%.

Okay, 40%. And how much -- I had a couple of questions, but how much how do you expect -- once you're in, everything's consolidated in San Ramon, how much do you expect the gross margin to increase?

I'm not sure I can quickly give you a percentage number, but I'll give you some rough figures. We were incurring about $800,000 this fiscal year to move the Microsource operation.

A good chunk of that is retention bonuses to keep everybody in place during the transition so we don't miss any shipments. And those are being accrued even though that's a cash expense that will occur later.

And once we've moved the facility, there's probably close to $900,000 in annual savings per year that we will incur between the facility and the reduction in headcount. We won't need to bring everybody down.

So it'll be like -- so $900,000 a year of savings?

Right. That's an estimate.

I think it's pretty close. The first year, you're going to see a $1.7 million swing from what I had to spend this year to move it to the savings.

But then it'll be -- here on out, it'll be about $900,000.

Okay. Then how are things going on the new product?

I mean, are you still expecting to introduce it the first quarter of next fiscal year?

Frank, I think things have slipped a little bit from that, but we're pretty close. The hardware is coming back, and we're turning it on, and it's meeting all of the performance specification so far.

So I'm very encouraged by it. I believe that in the first quarter, we will be shipping beta hardware to our early adopters.

We have a long list of customers who are interested in this, and a number of them would like to try it out and see how quickly we can get it integrated into their programs. And I suspect that the first revenue we'll see from this product won't be until the September quarter.

Okay. So you'll be shipping sometime in the June quarter then the beta units.

You're pretty confident on that?

Yes.

Okay. And you said the hardware.

So I mean, I guess there's a lot of software or firmware or the firmware counts as...

Well, it's all included. Yes, I meant all of it.

The hardware, software, it's all -- it's working pretty well. And so these beta units will shift to -- I mean, are you going to be shipping it to a lot of customers or...

It's hard for us to support too many beta customers at one time. I mean, I would think there'd be less than 6.

Okay. And so they'll get -- they're sort of like, I guess -- well, aren't they -- some of them are acting as beta customers in a way anyway.

They are -- you're finding things that don't work with them or -- I don't know.

We've been close to all of the customers interested in this. I mean, there's been 30 or 40 that we've been staying close with.

We've prioritized ones that -- where their programs are imminent, and so we want to get them hardware first. And the beta relationship is one where we offer them a look at our hardware first, and then they return evaluation information from us.

We certainly can evaluate the hardware by itself, but the proof is in how well it works within the customers' systems. We're only a subpart of these larger systems.

Right. So you've got -- you're working with these customers.

They're putting the equipment through the paces, giving you ideas, showing, like, their results.

Correct.

And then you're making, I guess, modifications in software and hardware -- or maybe it's mainly software, I don't know. And then you expect to ship -- when you say beta, you won't build them.

But they're -- you think it's a finished product, you just have to get the tweaks ironed out. You'll be shipping them some time in the June quarter?

Right, that's correct.

Okay, okay. And then you hope to start to get revenue on those, whatever, 5 or 6 systems in the third quarter and...

Well, it would be our -- I guess calendar third quarter would be our second quarter.

Yes, I meant to say the calendar to be able to build those and then start getting shipped -- those 5 customers or whatever it is, less than 6 or however, could order additional units. And then you'll start working with the other prospects because you might have to iron things out for them.

Is that how it would go? I mean, it's not like -- yet something that one size fits all or is it -- I don't know.

Well, some people -- this instrument has hundreds of specifications. And each customer is only concerned with a subset of those.

So that allows us to prioritize which ones to focus on. But if you were shipping something that's got a contingency associated with it, you can't recognize the revenue.

So what I'm saying is that it's in the September quarter that we should be able to ship units out of our second production run, if you will, and be able to invoice and recognize revenue for this.

Okay. And how fast it works?

I mean, you'll know it works for these 5 guys or whatever, whoever the -- how many beta customers there are. And you hope -- as far as it being broad based, I'm just trying to understand, will that be something that you think would be available for general use by the -- sometime in the December quarter or...

Well, for sure. I'm not going to share you the projections at this point.

But obviously, the first quarter is going to be smaller. The second quarter, there'll be more units.

And then going forward, we're going to hopefully hit some growth.

Right, okay. Then just one other question.

You thought -- on the last call, you mentioned that you thought that the sales, the new sales efforts would produce more -- you have more revenue. But you thought that you would start to see more orders.

And I guess that hasn't happened yet or...

No, it has not. We've really turned the -- we're really aligning our channel now more toward our new focus.

And so we've made a number of changes with our reps. The new ones we're picking up or picked in the markets where we're aiming right now.

And we're considering some of our more mature products. Nothing has been decided, but we're considering moving some of those into distribution.

And again, as we focus on these new markets, we're transforming the company. The switch business, as I said, is the reason our orders are down.

And that tends to have -- it's an uneven business with characterized by large orders. The shipments can be steady, but they intend to have large orders, and we don't have a large one to work on right now.

Okay. And so you feel like you're okay on cash then going -- because the revenue, I don't know how quickly it will pick up.

But the revenue for the new product, I mean, there'll some you're thinking in the September quarter, but it really won't start picking up toward December. So I was just wondered, how does the cash look at this point?

Do you want to do it?

Yes, the cash right now -- I think the cash is going to be sufficient -- well, I know the cash will be sufficient until that time period. We're going to have some fluctuations in the cash balances because our requirements change periodically due to collections and newer bills that we incur.

But we do have the ability to make some short-term borrowings against our line of credit, and we have done that. And we have made some repayments against that.

So I think we're going to be fine, plus the possibility of additional investment.

So there's not like covenants in this line of credit that you're in danger of violating, you feel?

No, no. We have a few little requirements, but no, we're well above those requirements.

Okay. And then you said something about additional investment where you...

Potentially. I mean, we're always looking for any additional debt or equity funding mainly because we have this significant effort going on.

So yes, we're always looking for that, and you can estimate that's what we'll continue to do.

So I guess my last question would be those 5, those beta customers, they seem to be very happy at this point, John?

Well, we haven't delivered them any hardware. So I think -- I would characterize it as this.

Almost every customer we've talked to has expressed interest in the finished product. And that's very encouraging, and we've stayed close to all of them because we want to make sure we don't have any misses in terms of features and performance.

We believe we've got a product that's going to meet the needs. This is a market that -- the incumbents are more of the size of Giga-tronics, as I've said before.

I think we can dominate this market. And I'm very excited about what the potential is going forward.

And you don't see any -- the incumbents, you don't see them bringing out a similar product to yours soon or...

Well, I can't predict that. But I don't think that anybody is going to have something similar to mine because we have a very unique approach.

But could there be a competitive response, for sure.

Okay. And whether -- and it would take them quite a while to make a -- I mean, to have something, say, as good as yours, it would take them quite a while to develop, I take it?

I think so.

Yes. I wanted to thank everybody for their continued interest in the company.

I apologize again that the numbers were late. And if anybody has any follow-up questions, please feel free to give Frank or myself a call here at the office.

Good afternoon.