Giga-tronics Incorporated
Q2 2022 Earnings Call Transcript

Published: 15 Nov 2021

[Operator:]

Welcome to the Giga-tronics Fiscal 2022 Second Quarter Earnings Conference Call. My name is Cheryl and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. . Please note that this conference is being recorded. I will now turn the call over to John Regazzi. Sir, you may begin.

[John Regazzi:]

Good afternoon and thank you for joining our fiscal 22 second quarter earnings call. I'm John Regazzi, the company's CEO. And I'm joined today by Maya Chai , our Corporate Controller, and Dr. Lutz Henckels, our Executive VP, CFO and Chief Operating Officer. 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; 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 27 2021 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 place, I will now turn the call over to Dr. Henckels. Lutz?

[Lutz Henckels:]

Thank you, John. Welcome to our second quarter fiscal 2022 conference call. The second quarter of fiscal 2022 was encouraging, with a 33% growth in revenue and 2% net income. The growth was primarily driven by the microwave RADAR filter division, or Microsource, which received a large order for RADAR filters from a prime contractor. The EW testing division received its third order for a COMPASS system for a synthetic radar application from a large military research lab. These three initial systems for the digital front end, and are expected to be upgraded to full systems in the future. So we are very encouraged to receive these multiple orders for this application. At the same time, the EW test division did not receive certain large anticipated military orders, which have long approval cycle and processing cycles and vary significantly from period to period. We believe that, during the second half of fiscal 2022, we will be part of a military contract that greatly reduces the long approval cycles and uncertainties associated with military procurements. Let us now look at the detailed financial results. First, let's look at sales. Net revenue for the second quarter of fiscal 2022 ending September 25, 2021 was $3.6 million as compared to $2.7 million for the same period in the prior fiscal year 2021. We show two components for the revenue for Q2 of fiscal 2022. The first component is goods of $297,000, which is for our RADAR/EW business. This $279,000 compares to $822,000 for the same period of the prior fiscal year 2021. Basically, we shipped a digital COMPASS system during the second quarter of fiscal 2022 which was lower in revenue than our TEmS system, which we shipped in the second quarter of fiscal 2021. The second component is for services of $3.3 million, which is for our Microsource product line, namely for the RADAR filters which are used in the F-15, the F-16 and the F-18 fighter jets. The $3.3 million compares to $1.9 million for the same period of the prior fiscal year 2021. As I've mentioned earlier, the Microsource business typically receives large orders, which can cause swings in quarterly revenue. As you can see here, Q2 was very good in fiscal 2022, but not so good in fiscal 2021. But overall, that business is a very steady regular business over the year of roughly $9 million a year. Gross margins. The gross margins for the second quarter of fiscal 2022 were 37%. The gross margin for the second quarter of fiscal 2021 were 38.6%. The gross margin in the first quarter of fiscal 2022 were negatively impacted by the product mix, namely much lower EW/RADAR test revenue. The RADAR/EW test business has better gross margin than the Microsource business. And so, given that mix, the gross margin changes a little bit from 38.6% to 37%. Looking at the operating expenses now. They decreased by $197,000 in Q2 FY 2022 when compared to Q2 FY 2021. R&D expenses decreased by $320,000, primarily due to increased capitalization of software engineering expenses, reduced consulting expenses, reduced personnel costs, and a greater portion of non-recurring engineering expenses for contract services which were allocated to cost of revenue. As I mentioned in my last conference call, we had received a $726,000 engineering contract from a prime contractor, and we are charging engineering hours for this contract to cost of goods sold. Looking now at the SG&A expense as they increased by $123,000. This is primarily due to higher stock-based compensation and increase in the headcount in sales. As I mentioned in the last conference call, we believe that our success in range applications and with the pandemic issues largely behind us, we have a unique opportunity with our TEmS product, and so we added to sales personnel to take advantage of it. Looking at interest expenses, they declined from $32,000 to $12,000. And this is basically due to the PFG loan, which we paid off in March 2021. During that last quarter, we also recorded a non-cash gain of the pre-funded warrant of $46,000, which I will talk in a minute about when we address the balance sheet. Net income. Net income in the second quarter was $64,000. This compares to a net loss in the second quarter of fiscal 2021 of $474,000. So, a significant improvement. And that's all due to the reasons that I stated just earlier. Looking at EBITDA, which is an important measure in our industry, adjusted EBITDA excludes interest, expenses, income taxes, other income and expenses, share-based compensation or stock-based compensation, and depreciation and amortization. Adjusted EBITDA income was $238,000 in the second quarter of fiscal 2022 versus a loss of $380,000 in the prior year. This brings me now to the balance sheet. The two items worth noting on the balance sheet are the following. There's an increase in inventory of roughly $800,000 since the beginning of this fiscal year, which is really March 28, 2021. This increase is primarily driven by an increase in the RADAR/EW test division inventories. We anticipated last orders for TEmS system in the second quarter of fiscal 2022 which were delayed, as I had explained earlier. The other point on the balance sheet is the total shareholder equity, which increased from $4.2 million at the end of March 2021 to $5.3 million at the end of the second quarter of fiscal 2022 September 25. So, during those six months, the equity increased from $4.2 million to $5.3 million. This increase is due to the $1.5 million investment in pre-funded warrants made by one investor who now owns over 20% of the company. This is also, by the way, for the first time that the shareholder equity is above $5 million since March of 2012. While we strengthen the balance sheet, it needs to be understood that the cash is mostly tied up in the inventory totaling $4.4 million. We need the orders for our EW test businesses to free up that inventory and generate needed cash. So, in summary, we saw improvements during the second quarter over the first quarter of fiscal 2022 and over the second quarter of fiscal 2021, and we have demonstrated how the business can run profitably at a modest revenue level. Now, the goal is to build on that progress we have made in the second quarter. Our EW division has a large market opportunity. However, that said, as a company, we need to do a better job gaining market share. We have invested over $23 million in this product. We w have a disruptive solution for the market and we are confident that we can gain market share over time. To that end, we are focused on five key points. First, expanding our application for the RADAR/EW test products. We started out in the lab and we have made inroads with our product now for aircrew survivability training and range testing, and this work is expected to secure multiple long-term revenue streams that should result in exponential growth over the next 2 to 10 years. Second, we have been expanding from the Navy to the other armed forces. We have broadened our sales initiative to additional parts of the armed forces, namely the Army, the Air Force and the Marines. Third, we are developing more strategic wins at various centers of excellence of the Department of Defense. We have done so at NAVAIR with our TEmS system and we have now done so with our COMPASS system for the advanced RADAR development system at a national laboratory. Fourth, we continue to improve our product. We continue to make major investments in R&D to enhance the product and to develop new applications to meet critical test requirements for next generation weapon systems that currently have a void in the test capability. And then finally, the fifth point, we are improving our sales and marketing strategy. We have an enhanced sales team by having added an electronic warfare officer, an Air Force program manager and we will continue to invest in our sales and marketing strategy to improve our ability to broaden our customer base and the end market. I should point out there is a large military tradeshow in late November called the 58th Annual AOC convention in Washington DC where we will be exhibiting. So, as you can see, incremental revenue are very profitable, and so we are focused on scaling the business. Thank you. We are now ready to take questions.

[Operator:]

. And our first question comes from Walter Belgers , Hometown Capital .

[Unidentified Participant:]

I was just wondering, can you provide any additional color on what you guys are focused on in the product development front?

[John Regazzi:]

This is John, Walter. The hardware that we have has a lot of capability that requires a digital system to take advantage of it and our threat emulation system takes advantage of our upconverter hardware, and we're working on a solution that's now taking advantage of our downconverter hardware. So that's one product. And the next thing that we're working on is kind of going on in parallel. Those two systems are being connected. So the way you test these complex machines that the Defense Department uses, you stimulate them, you listen to what they respond, and then you adjust what you stimulate them with. So, you're trying to put them through all the paces that they would go through when they're deployed in a battlespace. That's very difficult to do with a static machine that's only playing back a prerecorded scenario. Our scenarios are active, and they essentially do a dance with the device under test. And that's a very complex thing to simulate. So, that's what we're working on.

[Lutz Henckels:]

Let me enhance that a little bit because that was pretty much the original work that John started out with. And that is, our system is architected like a RADAR, but built like a test system. But it's also real time. So, to be able to drive out a RADAR signal to jammer, for the jammer to jam the signal and then for the RADAR to adjust itself because it is being jammed is an extremely difficult problem. And with our unique architecture – it was John's unique architecture, we have that capability. So we are enhancing our system to provide for that closed loop capability. In addition to that, we're also enhancing our system to improve the performance speed by a factor of 100. So there's some major stuff going on.

[Operator:]

Our next question comes from Franz from Ameriprise.

[Frank Barresi:]

I'm sorry, guys. I missed a lot of the call. I had problems and I got cut off somehow. But I heard, Lutz, you talked about a very important order. Was it received from a national lab, you said, or…?

[Lutz Henckels:]

Yes. But John will answer that because it's a unique application.

[John Regazzi:]

Well, he was talking about a recording system playback and recording system that we've invented that's called COMPASS that a national lab has purchased their work. They're developing an advanced mapping radar and this digital system is characterizing the stuff that they're working on. They're eventually going to add RF hardware to that. So we expect a second order for additional equipment. But the nice thing about the lab is that they have multiple programs going on at any one time, and we actually have received orders from two separate programs because one program heard about the other using our stuff. And we're expecting an order from a third program within the same lab. So, we've got a quite a good reference site building at that location.

[Frank Barresi:]

Did you say they only ordered part of the system? Because you were saying that they were going to add the radar component or maybe I missed it?

[John Regazzi:]

Frank, they work on things in a sequence themselves. So, they don't need the RF hardware right now. They only bought the digital piece. And they will be adding the RF hardware later when they get to that point in their program.

[Frank Barresi:]

I thought Lutz said something about three systems. You're referring to, I guess, the three different programs?

[John Regazzi:]

No. I think one of the programs has purchased two systems and then the second program purchased one, and we expect another one from the third system. This quarter, actually.

[Frank Barresi:]

And this has nothing to do with – I don't know what mapping, you mean like mapping the ground software?

[John Regazzi:]

Well, it's a synthetic aperture radar that's used for a variety of things, but one of them is ground mapping.

[Frank Barresi:]

You're still expecting, I guess, a lot of trainings – systems for the training on the range. Have those been delayed too?

[John Regazzi:]

The contract that the Air Force was negotiating with the Department of Defense got delayed, and that was the source of funding for these systems. But I believe – maybe I should let let's answer this. I believe that those contracts are now in place. And we're waiting for the PO to wind its way through the government's bureaucracy.

[Frank Barresi:]

Are there many of these systems that you expect to be ordered near term, the training systems?

[Lutz Henckels:]

The answer to that is yes. It's a question of the word many and near term. But, yes, there are multiple opportunities in at least five or six different ranges or bases that we are addressing. And so, five different programs. So, yes, each program will need multiple of our products. So the answer is yes.

[Frank Barresi:]

And I'm sorry, I get problems with my phone. That's why I missed. So, I heard parts of these. So, you've got the mapping systems, which will lead to complete orders at some point. And the training systems, at one point early on, I think you referred to that there's a new procurement method, was it, that you're going to have?

[John Regazzi:]

So, the procurement method that we went through over time was initially what's called GSA, general service administration, which takes a long time. That then got switched, whereby they engage a third party, the military, to buy the equipment, but that costs them 15% to 20%, but reduces the overall procurement cycle. But so the concept of reducing the procurement cycle and not paying 15% or 20% gets us to the third domain, which is called IDIQ, indefinite quantity, that's the Q…

[Lutz Henckels:]

And indefinite delivery.

[John Regazzi:]

Indefinite delivery, indefinite quantity. Once that is in place, that's a funded program, under which government can then quickly order material without paying the 15% or 20%, and so that is what we're looking at. Okay, IDIQ.

[Frank Barresi:]

And that's happened? This new contract that's in place, the Air Force has with – I don't know, the IDIQ is in effect, so they can start to order systems for the ranges?

[John Regazzi:]

The answer to that is yes. But we have not yet physically seen the order as a result of that.

[Frank Barresi:]

That'll be a standing order going forward? So it'll be, I guess, hopefully a lot simpler.

[John Regazzi:]

It should be vastly simpler. In the military space, if you talk to somebody, IDIQs are the ideal way of purchasing.

[Frank Barresi:]

You also mentioned you hired a new TEmS, somebody to just sell these TEmS systems. Is that something you said also?

[John Regazzi:]

This is a gentleman who comes from the military who has run programs in this very space. So, he's very familiar. He knows all the people. He knows the procurement process. And so, we hired that experienced person in Florida. So, basically, on the East Coast because our Vice President of Sales on the West Coast and there's a lot of military business on the East Coast. So that's where we hired him. So we're very excited about that. But all of that takes a little time because that's only since the beginning of this fiscal year.

[Frank Barresi:]

I guess the filter business, you expect to continue steadily for the balance of the year?

[John Regazzi:]

That is correct.

[Frank Barresi:]

Okay. Well, I'll listen to the replay. And maybe later have some other questions. Sorry about that. I just tried to ask questions about what I caught.

[John Regazzi:]

Okay, thank you, Frank. Thank you for supporting the company.

[Operator:]

Thank you. And we have no further questions in queue.

[John Regazzi:]

So, I'd like to sort of make a conclusion. While our performance has been really inconsistent, it's important to stay focused on the big picture. First, as Frank just mentioned, the strength of the microwave filter business, which I call, by the way, our rock, it provides us with a steady cash generation capability. Second, with an improved pipeline and electronic warfare radar testing, we expect to be positioned for a better second half of this fiscal year. Third, with over $23 million invested in the RADAR/EW technology and the growing list of patterns, there is a considerable unrealized value in what we have – a truly unique, disruptive product capability. Longer term, the market opportunity for EW testing is very attractive. And we are improving our go-to-market strategy to gain market share. With a tight capital structure and high profitability on incremental revenue, especially in the EW testing business, the economics are very attractive as we grow this business. Thank you for your support and we look forward to speaking with you the next quarter. Thank you.

[Operator:]

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