Giga-tronics Incorporated

Joey Thompson – Chairman and Acting Chief Executive Officer Temi Oduozor – Corporate Controller & Principal Accounting Officer John Regazzi – Chief Technical Officer

Jeff Porter – Porter Capital

Hi, everyone. Thanks for joining our quarterly earnings conference call.

I’m Joey Thompson and I’m joined today by John Regazzi, our CTO; and Temi Oduozor, our Controller & Principal Accounting Officer. Before we begin, I need to remind you that this conference call contains forward-looking statements concerning operating performance, future orders, long-term growth and shipment.

Actual results may differ significantly due to risks and uncertainties such as delays with manufacturing and orders of new products, receipt or timing of future orders, cancellations or deferrals of existing orders, the company’s potential need for additional financing, our ability to be traded on NASDAQ, the volatility in the market price of our common stock, results of pending or threatened litigation and general market conditions. For further discussions, see Giga-tronics’ most recent Annual Report on Form 10-K for the fiscal year ended March 26, 2016, Part I, under the heading Risk Factors, and Part II, under the heading Management’s Discussion and Analysis of Financial Conditions and Results of Operations.

With those reminders in place, let’s begin. If you reviewed our press releases and 8-K filings for the quarter, you are aware that’s there has been quite bit of unusual activity within the company.

Most obviously you’re hearing two new names on the call today. I was appointed Acting CEO on mid-August and Temi was named our Principal Accounting Officer at the end of August.

My appointment was driven by the board’s desire to enable John Regazzi to focus all of his energies on continued improvements to our Advanced Signal Generator product. John has always been the visionary behind the ASG product.

As you probably know, the company experienced delays in the initial release of the product and there was a general perception that the ASG could benefit from additional attention from John. John’s more focused attention is already had benefits and you will hear an update from John, later in the call.

Meanwhile Temi, who has served as Giga-tronics Controller since 2014, was appointed our Principal Accounting Officer and Principal Financial Officer at the end of August after Steve Lance departed to pursue an opportunity in the fintech space. To be clear, Steve departure was unrelated to my arrival at the company.

Although I admit that the timing was unfortunate. Nevertheless I’m delighted to see that Temi and the rest of the finance team at Giga-tronics has rhythm to the challenge admirably.

One other thing to note in terms of personnel of the changes, we’ve had on the board. As a slate of recommended directors was assembled for the proxy this year, there was general recognition that the existing board might benefit from a new perspective.

The end result is that as of October 26, the date of our annual meeting, we had two longstanding board members retire, Gary Garrison and Ken Harvey. At the same time, we are joined by new board member Jamie Weston and we reduced the size of the board to six.

We are grateful to Gary and Ken for their service to Giga-tronics and shareholders. Meanwhile Jamie is already having an influence on the company and we look forward to his continued contributions.

You also know that Giga-tronics announce the sale of certain product lines over the past year. The sale of our ASCOR switch product lines with Astronics is essentially complete.

Prior agreement with Astronics, we completed shipments of open orders of switch products to end customers during the second fiscal quarter, the quarter that just ended. Personnel the transferred to ASCOR moved out of our facility at the end of September and the last material associated with the sale left our factory last week.

There are still some electronic records with which we are helping Astronics, but these are not material to the sale. Overall, we’re happy with the outcome of the transactions and we believe that the customers for ASCOR switch products will be well supported by Astronics.

The transaction with Spanawave has been substantially more challenging. As you recall Giga-tronics entered into an agreement to sell substantially all of our legacy test and measurement products to Spanawave almost a year ago.

And as you also probably know from our 8-K filing at the end of August, Spanawave and Giga-tronics have been in the dispute regarding that transaction. I hope to be able to tell you on this call that the dispute has been definitively resolved, but at this point all I can say is that we are working to come to a resolution as quickly as possible.

At this point, I’m turning the call over to Temi, who will review our results from fiscal Q2. Afterward, I’ll have some additional comments and John will update everyone on the status of the product development.

Temi?

Thanks, Joey. Net sales for the second quarter of fiscal 2017 were $4.4 million, compared to $2.1 million reported for the second quarter of fiscal 2016.

Net sales for the first half of fiscal 2017 was $7.8 million compared to $7.4 million for the first half of fiscal 2015. The increases in net sales for both period was primarily due to an increasing new YIG RADAR filter shipments and the completion of related nonrecurring engineering services, as well as increased Advanced Signal Generator hardware shipments, all of which was partially offset by lower legacy product sales.

Net loss for the second quarter of fiscal 2017 was $396,000, or $0.04 per fully diluted common share. This compares to a net loss for the second quarter of fiscal 2016 of $1.3 million, or $0.20 per fully diluted common share.

Net loss for the first half of fiscal 2017 was $498,000, or $0.05 per fully diluted share. This compares to a net loss of $1.9 million, or $0.30 per fully diluted common share for the first half of fiscal 2016.

The reduction in net loss for the second quarter of fiscal 2017 compared to the prior year period was primarily due to the increase in net sales and lower operating expenses. The lower net loss during the first half of fiscal 2017 compared to the prior year period was primarily due to the $802,000 gain associated with the sale of the Switch product line during the first quarter of fiscal 2017.

We ended the quarter with $2.3 million in cash compared to the $1.3 million reported at the end of fiscal 2017. Joey?

Thanks, Temi. So for those of you on the call that have been following the company for a while, you’re aware the Giga-tronics has experienced losses for quite some time and we lost money this quarter as well $0.04 per share.

Before we address how to change that, we need to review how the company got here. Several years ago it became clear that the company’s ASCOR branded Switch product and the general purpose test and measurement products were insufficiently differentiated to command higher margins in the marketplace.

It was also increasingly difficult to maintain scale when competing against Me2 product from larger companies with much broader distribution channel. And we know that to survive and prosper small technology companies must focus and must have differentiated offerings.

And to that end, over the past few years, the company has invested heavily in a new type of test and measurement product, specifically targeting test and validation problems in the electronic warfare market. Thus the source of our losses is clear, lower sales with lower margin products, while we invested heavily in new product.

Regardless of the reasons, the situation is untenable and we are working hard to correct it. Ultimately, we need to increase revenue while controlling cost.

So increasing revenue is straightforward, but it’s still challenging. We’re well aware that it’s time for the Advanced Signal Generator platform to carry its own weight.

And we’re making changes across the organization to make that happen. We’ve made additions to our customer facing team to help us improve the targeting and reach of our sales effort for our ASG product.

We’re also discussing partnerships to broaden our sales channel. John is hard at work driving development effort.

And our operations group is focused on improving our ability to produce the products quickly since one of our strength is offering a commercial off-the-shelf solution in a market that traditionally required custom solution. For the quarter on which we reporting today, the ASG accounted for less than 15% of total revenue, but we believe that development change, I hope in the current quarter.

The exact timing of that change will depend on the timing of two shipments to the U.S. Navy for the customized Threat Emulation Systems that we announced in June.

Regardless of when it occurs, that first shipment is a major milestone for Giga-tronics. Up until now, all ASG systems we’ve ship has been hardware only.

Our customers buy our ASG hardware and integrated into test systems that they design. The systems that are being prepared to ship to the Navy are the first that are integrated with the Threat Emulation software that stems from our partnership with Lockheed Martin that we announced in December 2015.

So with the approaching ship date of the systems destined for the U.S. Navy, we know that the percentage of our revenue due to the ASG platform will increase in the near-term.

But we don’t yet have the revenue history to assure that the increase is permanent. Nevertheless we’re confident in the market opportunity and we believe that the efforts we are making are pushing in the right direction.

Our other major source of revenue our MSI filter product continues. Looking forward we expect our revenue rate to remain relatively steady for that product line throughout this fiscal year.

We expect to decline in revenue rate for the MSI filter products in the second calendar quarter of 2018, as we complete a major contract for filters for the F-15. We do expect follow on contracts for that particular filter, but we don’t yet know when that will be done.

The key message here is that we do expect the MSI business to continue to be a substantial source of revenue for us for the foreseeable future. But there will be ups and downs in revenue run rate at contracts come and go.

We view MSI as a sustaining business and the ASG product as our opportunity for revenue growth. At this point, John is going to provide some details on the Advanced Signal Generator product and afterwards we’ll open the call for questions.

Thank you, Joey. Let me describe the Advanced Signal Generator in more detail than I have before.

The ASG is essentially a very compact, calibrated transmitter that is able to switch between multiple frequencies in such a manner that it can emulate between 20 and 50 simultaneous radars. Electronic warfare engineers by our signal generator to simulate the environment their products will experience when placed in service to help perfect the design.

The products we’re talking about here are countermeasure devices designed to protect pilot and aircraft against surface to air missiles launched for example by an adversary, who may oppose implementation of a no-fly zone. The countermeasure equipment must be thoroughly tested to prove its effectiveness before being approved for use and that’s what the ASG helps engineers achieve.

This is essentially what the system we sold to the U.S. Navy at Point Mugu will be used for.

As I’ve said previously, the system is based upon our real time Threat Emulation System along with some third-party hardware specified by the customer. Most of the subsystems have been tested and we’re now on the process of integrating the complete system.

Our navy customer will be on site at Giga-tronics in early December to witness the acceptance testing prior to delivery, which we anticipate prior to the end of our fiscal third quarter. Just to clarify further, because our system is modular, there are many ways that customers can order our ASG product, but in one way of looking at it there are basically three different types of configurations that our customers can buy.

They can buy our hardware only. And this is what all of our shipments have been up until now.

These customers buy our hardware and integrated into their own test systems. Ultimately, they can buy our Threat Emulation Systems from us that combines our hardware along with the customized Threat Emulation Software that was developed in partnership with Lockheed Martin.

These Emulation Systems include a computer along with some additional hardware, so that the system is fully functional without substantial engineering from the customer. Finally, the customers can request an additional level of customer integration.

The Point Mugu system represents this third type of configuration. Believe it or not 50 emitters is sometimes not enough in this business and the ASG platform lends itself very well to this requirement given its compact modular implementation.

Several customers have purchased four signal generators along with our large chassis in order to emulate even more emitters at one time. Something our competitors can’t do and even twice the size.

The down converter product that was a derivative of the up converter is coming along nicely due to its benefiting from everything we learned on the ASG. The down converter is another blade that slides into our chassis, but in some ways the down converter represents the opposite of what the ASG blades do.

Instead of emulating threads, the down converter enables an engineer to perform analysis of the signals produced by a radar threat. We are finding that customers often want both capabilities in the same system.

And we are anticipating shipping additional down converter units in November and December. Every application has unique requirements and the ASG program has accumulated a list of bug fixes enhancements and desired new features that will prioritizing based upon customer need, market potential and resource availability.

Looking to the future, our future roadmap includes a design concept that will facilitate fitting up to 10 Advanced Signal Generator units within our large chassis. Although we are resource constrained to move this idea forward as rapidly as we would like, early market testing of the concept has been very favorable.

We also expect to continue our partnership with Lockheed and to add additional capabilities to our Threat Emulation System. Now turning to our Microsource business has been previously announced in August, we’ve received $1.9 million nonrecurring engineering order from Boeing to address a compound in obsolescence issue related to an amplifier used within the F-15 filter assembly.

The amplifier redesign effort will require a complete requalification of the filter, which is expected to take until September of 2017 to complete. Orders for the F-15 Radar filter shipped after February 2018 will contain the new amplifier.

Now turn the call back over to Joey.

Okay. And I’m turning call over to our listeners.

I’d like to open the call for question.

Hi guys. I have question here.

I noted that, there was announcement that Boeing made about a big order from the U.S. Air Force to upgrade the F-15 Eagle fighter jet.

And they talked about replacing the jets tactical electronic warfare suite. Is that something that our filter goes into and might we get some of that order?

Hi, Jeff, you’re talking about announcement that came out in last few days, correct?

Yes. I think it was November 3.

Okay. So I’ll answer that, but let me give you some background to put it all in the context.

So the filters that we produce are – they’re very good filters with a very narrow filter range meaning, the filter only a very specific frequency and they can move frequencies very quickly. And they get deployed into aircraft, when those aircrafts switch their radars and the problem with the new radars in the aircraft is, those new radar switch their frequencies very quickly.

And they basically blind the electronic warfare systems that are already in the aircraft because those frequencies bleed into the EW systems. So the filters that are that we manufacture are unique and they get deployed when aircraft upgrade their radars in order to allow the existing EW systems to work.

So I read – I think the same announcement that you did and that announcement look to me like BAE [ph] is going to be making an all digital electronic warfare package. And if it’s all digital, my expectation is that our filters probably do not contribute to that solution.

It’s not to say that they couldn’t, but if I had to layouts on it, I would say probably not. So then the question is, what is the implication for us?

So in that announcement, it said that the development, manufacturing development – engineering manufacturing development was targeted at 2020 and after that of course they have to fly planes around and do some testing. And so you could imagine production could actually begin in 2022.

And then, these would be major upgrade to the aircraft. Currently, our view of the world is that we’re looking at two multi-year contracts that we believe there is a reasonable probability that we achieve those contracts and we would expect those contracts to be complete by 2022.

So there’s sort of two answers your question. Our visibility of what we expect to happen with the filters that we produce for the F-15.

We don’t actually expect any substantial changes to what we’ve already believed internally to be true. However, when we look at that announcement we also aren’t jumping for Joey saying, hey this is a whole bunch of new revenue that we weren’t expecting.

Does that answer your question?

You said, this could be a bunch of new revenue that you aren’t expecting but it is…

No. I am saying we do not expect that whole bunch of new revenue.

Okay.

Our expectation is that existing EW systems that are out there. Will get upgraded with these filters are substantial number of them.

But at some point, those EW systems will be completely overhauled with all digital systems. And then really the question is, like it will be a while before that actually happens in would impact our business.

Because regardless of when those things get released the foreign militaries will be even further down the list of people who get that stuff. And so they will still need to have upgrades to their systems to enable things to work.

So we don’t expect it has any impact in us in the next five or six years beyond that then probably we don’t participate in that, it’s my guess.

Okay. Thank you for the answer.

Okay. I think we’re done.

I hope we speak with you all again three months from now and we have great things to tell you. We look forward to it.