Giga-tronics Inc. (GIGA) CEO John Regazzi on Q4 2020 Results - Earnings Call Transcript

Giga-tronics Inc. (OTCQB:GIGA) Q4 2020 Earnings Conference Call May 28, 2020 4:30 PM ET

Company Participants

Traci Mitchell - Principal Accounting Officer and Corporate Controller

John Regazzi - Chief Executive Officer

Dr. Lutz Henckels - Chief Financial Officer and Executive Vice President

Conference Call Participants

Todd Robbins - Five Mile River

Operator

Welcome to the Giga-tronics report results for Q4 and Fiscal Year 2020 Conference Call. My name is Aaron and I’ll be your operator for today’s call. At this time all participants are in listen only mode. [Operator Instructions] Please note that this conference is being recorded.

I'm asking the call over to Traci Mitchell. Ma’am you may begin.

Traci Mitchell

Hi, everyone, and thanks for joining our quarterly conference call. I'm Traci Mitchell and I'm joined today by John Regazzi, our CEO; 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 margin, future orders, growth and shipment.

Actual results may differ significantly due to risks and uncertainties, such as delays of 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 ending March 28, 2020 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.

John Regazzi

Thank you, Traci. Good afternoon and thank you for joining our fiscal 2020 fourth quarter and year-end earnings call. Before turning the call over to Dr. Henckels, who will review our performance in detail, I would first like to express my team's sincere hope that all of you are healthy and will remain so as restrictions are lifted.

As outlined in our press release, we were adversely affected by the mandated shutdowns issued by our state and local authorities relating to the COVID-19 pandemic. We were impacted mainly in two ways. First, we had a fourth quarter Microsource production schedule heavily skewed into the March timeframe in order to allow the company time to complete a cybersecurity upgrade that was a prerequisite for those shipments.

The upgrade was completed on schedule, but the shutdown pushed the planned shipments into the first quarter of the following fiscal year, meaning the current quarter. Second, the complete closure of our California and New Hampshire facilities delayed our ability to fulfill as much of our EW test backlog as planned, as well as stopping all other revenue generating activity within the company's two businesses.

As a result, our fourth quarter revenue, cash flow and profitability were lower than our plan. Fortunately, our shutdown was relatively short as we were subsequently deemed in the central business by the Department of Homeland Security due to our defense contracts. Nevertheless, we made the decision to apply for and accept an SBA loan under the payroll protection program to help us absorb the shocks relating to this unexpected business disruption.

While we are accounting for this as a traditional loan, the company believes the majority of the principal will qualify for forgiveness. Although we have now resumed production activities, we are not yet able to run at full capacity, due to the fact that some of our suppliers have also been affected by shutdown orders, and they too are in the process of catching up. We expect this situation to largely be resolved by the end of the current quarter.

During this time, we are operating with a number of safeguards in place to protect our employees. Some examples include running two shifts in order to minimize the number of people in the facility at any one time adhering to strict social distancing guidelines and temperature testing everyone entering the building.

Other measures such as wearing face masks, more frequent surface cleaning, staggered lunch breaks, and a policy of frequent hand sanitizer use have been implemented. And many of our team members who can are continuing to work from home. I’m mentioning all of this, not only to emphasize that while we were back to full operation, the costs of doing business are clearly higher, and also to affirm our commitment to the safety of our employees.

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

Dr. Lutz Henckels

Okay, thank you, John. Welcome to our fourth quarter and fiscal 2020 conference call. Let me start out by what John just said, we were clearly impacted in the fourth quarter by the shutdown mandate in March of 2020. And as John mentioned, going forward there will be some inefficiencies due to safety matters, supply chain issues, and order delays. However, on the positive side, there are three key points.

One is, we were declared an essential business fundamentally by the Department of Defense, and then second, we received 786,000 of PPP money; and third, and most important, really, our long term outlook is very strong, and our order rate in the RADAR test business is actually accelerating. And as John mentioned, the impact of the corona virus in Q4 2020 has two components.

It has the components of the cybersecurity upgrade, and so we shipped the test equipment that needed to be upgraded back to Keysight for this upgrade. We received it back on February 28 and we were expecting this multiple people and over time to do all the required testing for meeting the production expectation of Q4 and FY2020, but then there's a second element, suddenly the mandate came in shut down, and that caused two problems.

The problem was, we didn't produce anything in the second half of March and actually a little bit earlier, and they had to absorb 100% of all the overheads. And second, the required shutdown cost, you know, because we couldn't catch up resulted at the end into a negative gross profit for the RADAR filter business for the Microsource business, which has been the backbone of our company.

Now, the good news, this is all behind us. The Department of Defense sent us an unsolicited letter demanding that we produce thereby categorizing us as an essential business. We once again in full production, we started that at the beginning of April. Of course, we worry, as John mentioned about the safety of our employees, and we work in two shifts working from home for many people, and John already went over that.

And there will be inefficiencies going forward. Working in two shifts is clearly not as efficient as working in one shift. And we are seeing obviously some supply chain issues as John mentioned. For example, we expected 38 amplifiers for the F15, but we will only be receiving 16 this quarter. So, there’s supply chain issues that impact us in the near term.

We also limited and travel and therefore visiting customers and that can cause order delays and more so we are also limited of getting into the labs of customers, which is critical. So, you know there will be some impact in the near term. Of course to compensate for all of that we received the 786,000 of PPP money. So, this will definitely bridge the gap.

So, now let us look at the detailed results. Net revenue for the fourth quarter of fiscal 2020, ending March 28, 2020 was 2.6 million, and we've always showed two components for this revenue. There is a goods component of 1.547 million, which is really by and large for the RADAR test business. And it compares to [1.707 million] for the prior fiscal year, so there is a 9% decline in the goods revenue.

And then the second component is for services of 1.056 million, which is mostly for our Microsoft product line, namely, the RADAR filter business which are used in the F-15, the F-16 and the F-18 fighter jets. This 1.056 million compares to 1.818 million for the same period in the prior fiscal year. That's a huge 42% decline. And this is due to the corona virus explanation that we gave earlier.

Looking at the fiscal year now for 2020, goods were 3.5 million compared to 2.1 million in the prior fiscal year 2019. That's a 66% growth in the RADAR test business. While the order flow in this business tends to be lumpy, we expect a higher than 66% growth rate in fiscal 2021. The services business declined to 8.25 million from 9 million. This decline, 9% on a yearly basis in the RADAR filter business was due to the corona virus impact, which we explained earlier.

Looking now at gross margins in the fourth quarter of fiscal 2020, they were only 27%. This compares with 42% in the prior fiscal year. Again, this last decline was due to the shutdown in the production facility mandated by the shelter-in-place order. The RADAR filter business and Microsource business actually in March generated negative gross margin by not producing, while absorbing overhead. On an annual basis, gross margins were 39% in fiscal 2020 versus 42% in fiscal 2019. So, the impact of the pandemic was pretty much less when viewed on an annual basis.

Going to the bottom line, net losses for the fourth quarter of fiscal 2020 was $661,000. This compared to a net profit in the fourth quarter of fiscal 2019 of 74,000. Net loss for fiscal 2020, fiscal year was 687,000. This compares to a net loss of fiscal year 2019 of 937,000. The reduction in the net losses on a yearly basis was primarily due to lower interest rates, which brings me to interest rates. The interest rates for the fourth quarter of fiscal 2020 was $65,000. This compares to $156,000 for the fourth quarter of fiscal 2019.

The major reduction in interest was due to the PFG loan, which we paid down by $989,000 during fiscal year 2020. The interest expenses for the fiscal 2020 year were $252,000 as compared to $607,000 in the prior fiscal year 2019. Again this was primarily due to the reduction in the interest of the PFG loan, as well as lower borrowings from Bridge Bank. We expect even lower interest costs in FY2021 because we are paying off the expensive PFG loan.

So, the PFG loan when we entered fiscal 2020 was 1.781 million and at the end of the fiscal year it was $792,000. And we expect to pay off that loan at the end of this fiscal year that we have now entered. So, much lower interest and that’s significant, going from 607 to 252 and then even lower.

Looking at the balance sheet now, there are a few items I want to point out. One main change in the balance sheet is the actual accounting of leases on our balance sheet resulting into a long-term right of use asset of 1.183 million, long-term lease obligation liability of 1.135 million, and the short-term capital lease obligation of $426,000 and the reduction of long-term deferred rent of $358,000. All these four items basically balance each other out. So, they don't really overall impact, but they make their balance sheet look differently.

Looking at the balance sheet now from a high level and excluding the long-term lease and asset obligations that I mentioned, then you will note that assets increased by about 1.5 million and liabilities decreased by about 1 million, thus increasing the total shareholder equity by $2.5 million. This improvement in the balance sheet was driven by the capital raised during the fiscal year 2020.

Now, let me summarize, we have two businesses. We have the sole source – Microsource filter business, which produces filters for the F-15, the F-16 and the F-18 fighter jets. I always call this business our rock. It delivers between $7 million to $9 million in sales per year and about $3 million of gross profits per year. This we expect to be true for the next four years. It is this business that got hurt in March by the pandemic.

The pandemic may slow down our supply chain for the Microsource filter business in the short-term, but there is no concern about this business for our current fiscal year or long-term. We have the orders on hand. We will catch up with any delays in the supply chain, and so this is our rock. Okay?

Our second business is our RADAR EW test business. It grew by 66% in fiscal 2020 over fiscal 2019. We expect this business to double in the current fiscal year 2021. While we are working through near term challenges related to the pandemics like all companies do, it is important for us to stay focused on the huge opportunity in front of us. This is a $440 million market opportunity. We are targeting over a five year period to reach $60 million per year in this business.

We architected our test solution like a RADAR from the ground up versus $24 million investment and our solution is truly unique in this sector with very strong IP. We recently in February of 2020 released our multi-channel coherent capture solution. This allows customers to see things they've never been able to see and capture before. There's a pent-up demand for this solution in our pipeline. In fact, close to 50% of our prospective opportunities are driven by this capability, which we now offer.

Furthermore, the testing business is a higher margin business for us. So, as this side of our business becomes an increasing portion of our consolidated revenue, and we certainly expected this fiscal year, our consolidated margins should also improve into the high 40 percentages. So, over the next year, we are targeting a doubling of the RADAR test business and this will drive improved profitability.

However, as you certainly respect it is difficult to predict timing of orders given that we cannot travel to our customers and our access to the laboratories on the basis has been extremely limited because of the pandemic. And we need to be in the labs in order to talk to our customers and get the information and get the orders, but this radar test business is now in its take-off phase, so we expect strong performance after the shelter-in-place orders are lifted.

Finally, it is important to also note that the defense business, especially the electronic warfare business, is shielded from a likely recession brought about by the pandemic. So, we are definitely optimistic about our market position even though we are concerned about our near-term impact from the coronavirus.

Thank you very much. We are now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] And you do have a question in queue from [Jen Wilfred with Comstock Partners]. Your line is open.

Unidentified Analyst

Hi, good afternoon. You mentioned that some of your sales funnel is tied to the new – through new multichannel coherent capture product. Could you give a little more insight on that product and the interest that you're seeing from the upgrade?

Dr. Lutz Henckels

Okay, let me explain that. What we need to provide to our customers is a complete solution as opposed to a subsystem and we provided the generation capability to NAVAIR now a couple of years ago. We provided a complete solution, but we did not provide a complete solution on the capture side until February of this year. So, I wouldn't call it so much as an upgrade as I would call it, you know, we provide a complete solution. And it allows customers to see things which they have never been able to see before. And you may say, well, how is that? You know, explain that one?

Well, I come – obviously, some of my background is the oscilloscope business. And so basically, we have a very fast sample rate of six Giga samples per second, being able to, you know, you know, stream and capture and compute on up to 192 terabytes of data. And so by having this high resolution, you can see anomalies that you otherwise cannot see. And so you need this high resolution while capturing huge amount of data and that capability is completely unique to us, and that is what is demanded by our customers. They really want that. And having that and being unique and having that drives our business. So, we are very excited about it.

Unidentified Analyst

Okay, thank you for the details. I appreciate the clarification on that. And then just if I could do a quick follow up, I know, I believe in a previous call you had mentioned as part of a turnaround changes, you've made some changes to your sales organization. Is there any, is there any additional color on that that you could provide about how that's going?

Dr. Lutz Henckels

Yes. So, let me explain that one. And so what is needed in our business, people that have military clearance that have a deep understanding of RADAR and the technology of RADAR, and that are being able because of their military clearance to go deep inside the labs that are secret labs, to have discussions with the right people, and in regards to a secret information so that we can understand their pain points, and then offer solutions.

Today, we have three people capable of doing so. And we are adding one more person as we speak in the Southern East Coast area as well. And so we have, we're going to have four people shortly that have that capability, and that's what is needed. And so we are working on, you know, adding that capability. And they have been doing that during the fiscal year.

Unidentified Analyst

Okay, great. Thank you.

Operator

Indeed, you have another question in queue from Todd Robbins with Five Mile River. Your line is open.

Todd Robbins

Good afternoon, Lutz. How are you?

Dr. Lutz Henckels

Hi, Todd. Thanks.

Todd Robbins

Oh, you mentioned in the press release that there's an addressable market for the RADAR and EW business somewhere around 440 million, and you mentioned that you thought that this business could double in fiscal 2021 versus 2020. So, inferentially, I'm going to assume that's going to be about a $7 million business in 2021 if I’m reading your comments correctly?

Dr. Lutz Henckels

Is that your question?

Todd Robbins

That's the first question. Yeah.

Dr. Lutz Henckels

Yeah. Yeah, at least get to that level. Absolutely. Correct. That's what I stated.

Todd Robbins

So, if we're, if we're looking at …

Dr. Lutz Henckels

Now as we impacted, again, you know, in first quarter and potentially in the second quarter, as I mentioned, you know, they may be delayed, we cannot travel, we cannot go to the customer, but we nevertheless, we fully expect that as I explained.

Todd Robbins

So, if we're looking at an addressable market of $440 million a year help me understand what the lumpiness or the run rate might be as you look at what kind of business this can be in a given year? I mean 7 million is clearly not the end game, but how big [indiscernible] and what kind of a run rate would be looking at to get there?

Dr. Lutz Henckels

Well, number one, when you are small, it's relatively easy to double, okay, and you know, 3.5 million is small, 7 million is small, and even 14 million is small, we expect over five years to reach 60 million in this business. And we are expecting that in – let me explain a little bit in multiple dimensions, okay. We can expect it from a product viewpoint and there was a question earlier, you know with the unique career and capture capability, you know, we are highly differentiated, and you know, nearly 50% of our business, you know, opportunity is you know, showing that okay, but then you go to the customer viewpoint, okay. On the customer, you have the Navy, you have the Air Force, you have the army and you have the basically five prime contractors.

We have been very successful with the Navy. We have now entered the Air Force Base. We have now shipped our first system to Eglin Air Force Base. And actually the application is quite different to the application of, you know, testing at you know, the capability of a jammer at the Point Mugu lab. Here, we are training pilots that are flying F-35 planes and we basically, via a trailer and an amplifier and an antenna we sent you know, a battlefield environment signal with threat signals to the plane that flying above and then we see whether the plane sees it, how the pilot reacts and we record that and that is, you know, another application of our solution.

So there’s a large opportunity and now that we are also entering the Air Force Base and we have been very successful with the Navy, we expect this to accelerate and it's doing that as we speak.

Todd Robbins

So, if we're going to get to $60 million run rate a year within five years, how linear does that become? In other words, do we go 10, 20, 40, 60 or do we go 7, 14, 60?

Dr. Lutz Henckels

Well, I mean, number one, because we have still this coronavirus impact, so I'm saying seven for this year. And then we'll have to see. I mean, I surely would expect that to be at least double the following year, but that's now looking further out and you know, get to $60 million over five years, that's unchanged. The only uncertainty is a little bit the near term because of this coronavirus.

Todd Robbins

Okay. You indicated in your prepared remarks that the RADAR test business order rate had accelerated.

Dr. Lutz Henckels

Correct.

Todd Robbins

Help us – can you quantify the level of orders that were received?

Dr. Lutz Henckels

Well, we received actually three orders recently. We received one order from Raytheon. Basically providing – they have already purchased $1.8 million of equipment and they bought more to enhance that equipment. Then we received an order from NAVAIR, from Point Mugu to upgrade their existing test system that was a $1.5 million order. And then I mentioned that we received this order from Eglin Air Force Base for the training of the F-35.

Actually, it was only a demo system, and we actually only plan to demo and then they said, no, no, but you can't take the system back because we performed so well, we must keep it and so we basically then got a purchase order for the demo that we were not taking back, but now we expect follow on orders for that. And so, we expect that this is a significant portion of our business, because they need about 10 trailers. And when you have a production unit with all the equipment that is likely to be in the neighborhood of, you know $700,000 to $900,000 per trailer.

Todd Robbins

So, of the 60 million annual run rate, how much of that would be coming from these three entities?

Dr. Lutz Henckels

Okay, I mean, I would say that, so they are – let’s call it three entities ignore for the moment the army even though we shouldn't. So, we have the Navy, and we have the Air Force Base, and we have the prime contractors. And I think that the Navy and the Air Force Base will be larger than the prime contractors, but if you wanted to be simplistic about it, you can say you know, call it 25%, 25%, and 25% when we get to 60 million and then the other 25% is, you know, Army and other new prime contractors and so on. Everything is U.S. based by the way. It is not any international sales.

Todd Robbins

Do you anticipate any cash needs between now and the end of the next fiscal year?

Dr. Lutz Henckels

No. Number one, we did receive the $786,000 of PPP money. So, now we do not expect any cash needs.

Todd Robbins

Terrific. Thank you so much. Lutz. Have a great day. Thank you, Todd. Okay.

Operator

And there are no more questions in queue at this time.

Dr. Lutz Henckels

Hello?

Operator

Yes, there are no more questions in queue at this time.

Dr. Lutz Henckels

Okay. So then let me close by saying that clearly there is an impact in the near term because of the pandemic. We, however, look at our business a little bit further out. It is solid. The Microsource filter business, the orders on-hand, there may be delays or there are delays because of the supply chain, but you know, that will be caught up. It's just a matter of when. And then on the RADAR filter business, it is also taking off, but since we cannot travel right now or go to the labs, again, there is a delay, but fundamentally those two businesses are sound. We look forward to significant growth and I’m very excited about our fiscal year and our prospects. Thank you very much.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.