Giga-tronics Incorporated

Hello, everyone, and thanks for joining our quarterly earnings conference call. I'm Traci Mitchell, and I'm joined today by John Regazzi, our CEO; Lutz Henckels, our Chief Operating Officer Chief Financial Officer and Executive VP.

Before we begin, I need to remind everyone that this conference call may include forward-looking statements including statements about future results of operations and margins, future orders, growth and shipments. Actual results may differ significantly due to risks and uncertainties, such as delays with manufacturing and orders for our products and services, receipt or timing of future orders, cancellations or deferrals of existing orders, the company's capital needs, the trading of our common stock and the volatility in the market price of our common stock, results of pending or threatened litigation and general market conditions.

For further discussion, see our most recent annual report on Form 10-K for the fiscal year ended March 28, 2020, Part 1 under the heading Risk Factors and Part 2 under the heading Management's Discussion and Analysis of Financial Condition and Results of Operations. With those reminders in mind, I would now like to pass the call to John Regazzi.

Thank you, Traci. Good afternoon, and thank you for joining our fiscal 2021 third quarter earnings call.

I'm pleased to report growth this quarter in our Electronic Warfare test business, which is the result of growing customer acceptance with our integrated solutions. We are now delivering products to the prime contractors, to research institutes and to the services.

Although COVID-related travel restrictions continue to hamper our business development activities, we anticipate this will begin to ease over the next two quarters. And we should be able to return to holding the face-to-face conversations needed to further build our order pipeline.

The pandemic has also slowed the receipt of orders for our Microsource RADAR filters. However the third quarter saw a return to more normal activity and we now have backlog for all three aircraft.

We expect a strong year for the Microsource division. The Paycheck Protection loan that we received in the first quarter of this fiscal year helped the company weather the early government lockdown orders, until we were able to stand on our own after being designated an essential business.

This loan was fully forgiven during the third quarter, which was the main contributor to the company's improved liquidity. We believe the company remains on track for a strong year overall.

And we anticipate seeing growth in both our Microsource RADAR filter and our Electronic Warfare test businesses. I'll now turn the call over to Dr.

Henckels to go over numbers in detail. And then, we'll open the call for questions.

Lutz?

Thank you, John. I'm Lutz Henckels, the CFO of Giga-tronics.

Welcome to our third quarter fiscal 2021 conference call. This was an exceptional quarter for our company.

Let me start by saying that everything we are doing centers around building a much larger business. We have invested over $24 million in our technology.

And we have every intention of converting that investment into considerable market share. We are well on our way in doing so.

We delivered solid organic growth in the top line. We have a long way to go, but the performance during the quarter was excellent.

Our Microwave Filter business continued to be what I call our rock. And our RADAR/EW threat emulation products saw a strong performance across a growing list of customers and applications.

The product is now being used not only in the lab, but also on the range for pilot training and testing. Our strategy of expanding our customer base and expanding our application is working.

We also managed our expenses and returned to profitability, while investing heavily in engineering. Finally, our balance sheet has been slowly transforming.

Debt is down, cash is up and we are on a firm foundation, as we look to capitalize on our large market opportunity. Let me now go into the detailed results.

First, let us look at sales. Net revenue for the third quarter of fiscal 2021 ending December 26, 2020 was $4.08 million.

We always show 2 components for the revenue. The first component is goods of $1.56 million, which is for our RADAR/EW test business.

This $1.56 million compares to $193,000 for the same Q3 period in the prior fiscal year 2020. It is rewarding to see, that we are gaining traction with our RADAR threat emulation solutions in the labs, on the ranges, and with prime contractors.

The second component is for services of $2.52 million, which is mostly for our Microsource product line, namely the -- for the RADAR filters, which are used in the F-15, the F-16, and F-18 pilot jets. This $2.52 million compares to the $2.44 million for the same Q3 period of the prior fiscal year 2020.

The RADAR filter business is on track to deliver a $10 million revenue in fiscal 2021, which is a 20% growth over the prior fiscal year. Let me now go to the gross margins.

Gross margins for the third quarter of fiscal 2021 were 38.1%. Gross margin for the third quarter of fiscal 2020 were 41.7%.

The gross margins in the third quarter of the prior fiscal year 2020, benefited from a onetime credit in the RADAR test business. If you exclude those credits, then the gross margins remained relatively unchanged.

Our operating expenses were substantially higher in Q3 fiscal year 2021, when compared to Q3 fiscal year 2020. R&D expenses increased by 42%, because the company is investing in its advanced threat emulation business, with increased personnel costs.

SG&A expenses increased by 14% because of increased personnel costs, as well as onetime legal expenses. Interest expenses were small.

They declined however by 50% from $42,000 to $21,000. This is basically due to the fact that the PFG loan is reduced by $727,000 from the prior year, from $1 million to $273,000.

We have been paying off this loan and we are paying off these expenses' 16% interest loan by the end of this fiscal year in March of 2021, basically in two months from now. So that loan will be gone.

In addition, we were successful as John mentioned, in achieving the forgiveness of the PPP loan, which resulted in a onetime gain of $791,000. So, net income for the third quarter of fiscal 2021 was $833,000.

This compares to a net loss for the third quarter of fiscal 2020 of $156,000. And that's for all the reasons that I just explained.

EBITDA was $978,000 for the third quarter of fiscal 2021, as compared to $28,000 for the third quarter of fiscal 2020. So in summary, we had a decent quarter with $4 million in sales and a small profit, when you exclude the extraordinary item, the PPP loan and a large profit when including the PPP loan forgiveness.

Moving on to the balance sheet. Looking at the balance sheet, you will see that our working capital position has improved with a ratio of 2.44 of current assets over current liability, as compared to 2.09 for the third quarter of fiscal 2020.

This was primarily driven by the reduction in the loan balances, which reduced from $1.32 million at the end of March of 2020 to $273,000 at the end of December 2020. The PPP loan forgiveness was a key driver in the working capital improvement.

Net equity increased to $4.9 million at the end of December 2020, which is up from $4.3 million at the end of March 2020. So in summary, we made great progress on our way of being a much larger and more profitable business.

The key is to continue to build both on our customer base as well as our applications. We accomplished both during the quarter.

We continue to invest by strategically financing increased R&D expenditures, while driving down other costs as a percentage of sales. Our balance sheet has been going through a measured transformation and is much stronger today than it was a year ago.

This provides a much firmer base to continue to drive our growth, as we strive to reach $60 million in sales annually in five years. Thank you very much.

And I'm now opening it up for questions.

Good afternoon. Nice quarter.

Thank you, Todd.

John or Lutz, could you – you've mentioned in the reported text that the EW addressable market is something approaching $400 million and in the quarter you've booked about $1.5 million for that business. Could you give us some sense as to how you expect that business to ramp over the coming quarters or years?

Yes. And I think John will also chime in.

However, we are expanding it in multiple dimensions. So, we are expanding it in terms of customer base going into other services like the Air Force and the Army going into other bases.

And so we are expanding it and going to prime contractors. So we are expanding it from a customer base viewpoint.

We are able to do that, because we have gained traction with our RADAR test system at the ranges. And so other ranges are now aware of it and are very interested in our solution.

But we are also expanding it from a product viewpoint. And so we started out originally with a subsystem.

We then provided a solution in the lab for Point Mugu. We are now providing a solution for the range.

We are adding – we have added to that a capture capability. We call it coherent capture.

And so we are constantly expanding our solution. And in all fairness, even more recently, we expanded our application.

We did deliver to the Navy two systems for RADAR target generation. So that's another product expansion if you so want.

And of course, we are looking forward in the future to – really, what differentiates us the most is our unique cable architecture to provide over time a real-time closed-loop adaptive system. And our architecture allows for that and that is unique to us.

And so we see further expansion as we move into the future.

Well, let me rephrase the question then. In the quarter, we did $1 million – you guys did $1.5 million.

What kind of a rate of increase should we look for in that business in terms of dollars?

I mean, right now, because of the situation with the coronavirus we are still limited to go to the bases and expand. But once we are getting past that, we're looking at a minimum double-digit growth rate.

But we don't yet want to truly make long-term projections other than we have a plan to go to $60 million over five years.

$60 million from the $1.5 million?

No. That's – you're talking about a quarter?

Yeah.

They're talking per year. Okay.

Yes. But right now we had like – as John mentioned at the beginning, at this moment we again cannot go to the bases because of the pandemic.

But we do expect that to come to an end with the vaccination. And I hope like in about 100 days that things open up and become back to normal.

Excellent. And the EW business, the business you're doing on the Microwave Filter side, is that predominantly with one prime?

No. The Microwave Filter business is actually with three primes.

So the F-16 is with Lockheed Martin. The F-18 and F-15 is with Boeing.

And then, we have with another prime contractor components that we provide for missile type of applications.

And is it likely that we should assume a $10 million run rate of that business steady state say as we go forward?

Right now, we have seen an increase if you look over the years of about 7% per year. And while in the past, I have presented it as being flat it really isn't okay?

And so we started out back in 2013 with the F-18. And then, we added to that the F-15.

And now – and then we added to that the F-16. And all three planes are now in what we call full-rate production.

And so – and we have added to that also the missile capability. So no at this moment that business is growing at about 7% per year.

And I would expect that to continue in this coming fiscal year as well as thereafter.

Excellent. Just to refresh my memory how big an NOL do you guys have?

Actually, we are reevaluating that. And so – but maybe Traci, you have an answer for that?

We're doing a 3.42 study on that.

Just approximately.

Traci?

Sorry. I don't have that number off the top of my head.

Okay.

But I don't really think -- we're doing an analysis on that to see what portion of our NOLs are -- we can use in the future. So that number will probably change in the next month or two regardless of what number we have right now.

Yes. We have -- they have authorized the study of that.

And so we should have this result by the end of the fiscal year.

Is it likely that you'll pay taxes in the next two years?

No.

No.

Okay. Thank you very much.

God job, man.

Thank you, Todd.

How are you doing, Lutz? Karl Birkenfeld.

Could you answer what -- do you guys get progress payments on your service contracts? And can you state your current backlog for 2021?

Okay. So let me explain that.

We do get -- we have two businesses. We have the RADAR/EW test business and we have the filter business.

In the filter business, we do get payments for purchasing the inventory in order to deliver the filters. So you could call that progress payment.

So as we purchase material and move it into WIP then we invoice the customer and they are making payments. Then in addition to that we -- obviously, when we finally deliver the product we get the payment.

The difference would be in the material and -- that we already invoiced and got paid for and the final price. So I guess that would be a form of progress payment.

But in regards to the EW test business, we don't really have the concept of progress payment. We did have a relatively small $671,000 engineering contract, which when we provided the services we invoiced.

But otherwise, we get an order for a test system of, let's say, $1 million and we invoice that and then we get paid for it. There is no progress payment.

Now regarding the backlog. So they recognized that because of ASC 606 accounting, we invoice a customer -- we recognize revenue -- we must recognize revenue, when we actually produce filters and not necessarily when we ship the final product and invoice for the filter.

So the revenue backlog that we have at this moment is $4.791 million. However, I recognize that very soon we'll get an order for the next year turned on.

So basically like for the F-15, we have a three-year contract, but we only show in the revenue in the first year. We expect in this month that they will turn on the next year, and so then that adds another roughly $3 million.

And so even though we have several years of backlog like that they turn it on year-by-year, and then we only publish the year that is turned on.

Okay. Thank you.

Hi, good afternoon. Could you give us a little color on how we should think about the gross margin between -- the gross margin discrepancy between testing and microwave?

I mean, I'm thinking that as testing grows as a percentage of sales this would have a positive impact on gross margins. Am I thinking about that the right way?

You think about that the correct way. So the Microsource RADAR filter business is a sole source business.

And so therefore the military government audits us or Boeing audits us or Lockheed audits us regularly to make sure that we have -- that we don't overcharge basically. And so we get constantly audited.

So the gross margin for that business is in the high 30s. It could even touch for one product line of 40%, but think of it in the high 30s.

The EW test side is not that way. And so it's definitely over 50% gross margin.

So, as EW test increases as a percent of the total business, gross margin should definitely improve. And so between the $10 million of the RADAR filter business and then as the EW test business increases, clearly gross margins should move into the mid to high 40s over time.

Okay. Great.

That's great. That's good news.

And then touching back a little bit, you spoke a little bit earlier in the call, I think answering someone else's question regarding the -- your success in the lab and then the sales for the -- for range applications. And I'm just curious as to what are some of the other applications for that product that you see for the long-term?

I mean, there are so many applications. However, in the lab, for example, you -- they use it among others to evaluate a jammer.

So our system is architected like, a RADAR. Think of it, it is a RADAR system, but it's built like a test system.

So you can change the strength of the signal. You can put impairments into the signal.

The engineer can test boundary conditions of a jammer, using our code RADAR test system, okay? That's in the lab.

When we are on the range, we basically have this test system, in a truck or in a trailer. And through an antenna, we blast the -- what we call the battlefield environment onto a plane flying overhead.

And we also include a threat signal, to the plane. And then we record, whether the – A, what we send up, and B, how the plane and the pilot reacts to it.

So this is used to test, that indeed, everything works and how the pilot reacts. So it's used for that application.

But then, like I mentioned, we go into RADAR target generation applications with the Army. And we expect to overtime go to a closed-loop application which is very unique to us, because we have this real-time coherent capability.

And so, there is -- I don't want to call it no limit, but there's, lots of applications. And then, as I mentioned earlier, you go also from one -- now that you have established yourself for let's say, this training program in one base, people obviously say, "Well, why can't we do the same thing on our base?"

And so, it expands also into other bases and other customers.

Yeah. That makes sense.

Great. Okay.

Thank you.

Thank you.

Thank you. Okay.

I'd like to say in closing, we remain on track to deliver a strong fiscal 2021. Our Microsource filter business, which I call our rock, is delivering a 20% growth.

Our RADAR/EW test business, demonstrated the growing strength, of the market interest in our new product, from new customers and from new applications across the Armed Forces. We are confident in our capability and our ability, to achieve strong double-digit annual growth, and to drive higher margins.

The military EW business is relative recession-proof. And I actually believe its new administration-proof, because the Biden administration would want to protect with electronic warfare, ships and planes.

And so rather than building another plane or another ship, let's first protect what we have. And that's what we do.

That's what our capability is providing. So, I look forward now -- looking forward now we are optimistic about our prospects in the medium and short-term.

Thank you.