Giga-tronics Incorporated (OTC:GIGA) Q3 2019 Earnings Conference Call February 12, 2019 4:30 PM ET
Traci Mitchell – Investor Relations
John Regazzi – Chief Executive Officer
Lutz Henckels – Executive Vice President and Chief Financial Officer
Conference Call Participants
Welcome to the Giga-tronics Third Quarter Earnings Conference Call. My name is Sylvia, and I'll 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. [Operator Instructions] Please note that this conference is being recorded.
I will now turn the call over to Traci Mitchell. Traci, you may begin.
Hi, everyone, and thanks for joining our quarterly earnings conference call. I'm Traci Mitchell, and I'm joined here today by John Regazzi, our CEO; and Dr. Lutz Henckels, our CFO and Executive VP.
Before we begin, I need to remind everyone that this conference call contains forward-looking statements concerning operating performance, future orders, long-term growth and shipments. Actual results may differ significantly due to risks and uncertainties, such as delays with manufacturing and order for our new ASG, receipt or timing of future orders, cancellations or deferrals of existing orders, the company's potential need of additional financing, ability to be traded on the OTC market, uncertainty as to the company's ability to continue as a going concern, 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 31, 2018, Part I, under the heading Risk Factors; and Part II, under the heading Management's Discussion and Analysis of Financial Conditions and Results of Operation.
With those reminders in place, I will now pass the call on to John.
Thank you, Traci. Good afternoon, and thank you for joining our third quarter conference call. We have prepared a thorough review of the numbers for today's call, but I first want to acknowledge the company has now received the long-anticipated order from our government customer located at the Naval Air Station in Point Mugu, California.
The order, totaling $4 million, has two line items. The first item is for two of the company's multi-ship signal generator systems at $1.66 million apiece, and the second item is for 3,000 hours of engineering services and support, totaling $671,000. The two multi-ship systems are expected to be delivered over the next two quarters and brings the total to five of these systems owned and operated by this customer. The engineering services for selective upgrades and support of these five systems will be delivered over the next 12 to 15 months. This is a very welcome event for Giga-tronics, and we will be using some of the proceeds to accelerate development of additional systems to help the company further penetrate this market.
As we approach the beginning of our next fiscal year, we have been conducting extensive planning of engineering projects to integrate the company's ASG and ASA products with a variety of advanced third-party digital solutions to position Giga-tronics as a provider of full solutions and not just the underlying microwave components. This has been a key change in our strategy to approach the market, and we will continue along this path, as demanded by our customers.
I still believe the original vision of moving Giga-tronics into the electronic warfare test market was the correct decision. Although it has taken far longer than anticipated, we believe we have our major problems behind us, and we expect the Advanced Signal Generation and Analysis platform will be a major part of our future revenue growth and operating results in the coming fiscal year.
With that, I'd like to turn the call over to Dr. Lutz Henckels to go over the numbers.
Hi. Thank you, John, and thank you for joining this conference call. Let me give you first an overview. On the last two calls, we outlined the major transition the company has made over the last six years. During those six years, the company made operating losses of about $3 million per year on average, and sales declined to $9.8 million in the last fiscal year.
The current fiscal year has been the turnaround year for the company. Operating losses for the first nine months were about $500,000 versus a year ago, $2.7 million. And looking forward now, we expect no more losses and a profitable 2020 fiscal year. So we have finally completed this very difficult transition, and I will now talk about the progress that we have made during Q3 FY 2019, which ended in December of 2018 and during the first nine months of this turnaround year.
However, before going into our financial results, we need to explain the change in our accounting standard. Effective April 1, 2018, the company was required to adopt the accounting standard called Revenue from Contracts with Customers, which is also commonly referred to as ASC 606, which changed the way the company recognizes revenue for certain contracts. Until the end of FY 2018, ending March 31, 2018, we recognized revenue when we ship and invoice a customer, and truthfully, that's my much preferred method that I would like to do. However, we don't have that choice. Under ASC 606, we must recognize revenue based on the percentage completion of the contract as it incurs costs.
Thus, on April 1, 2018, we were required to make balance sheet entries, including adding $1.17 million to retained earnings. This $1.17 million are the gross margins of $2.7 million in revenue. Thus, this uninvoiced revenue was taken in April 1 on to the balance sheet. You never saw that revenue, it was just added as $1.17 million into gross margins – I mean, into retained earnings on the balance sheet.
So as a result, when we ship and invoice products now, then we cannot recognize this $2.7 million of revenue because it's already recognized with this onetime balance sheet entry. There is no cash impact because we still invoice upon shipment, but there is a P&L impact under this new reporting of 606. Now new contracts can compensate for this impact because, again, we will recognize revenue on new contracts prior to shipment, so there is an offsetting element. So it's a matter of timing.
The financial results for the three months, which ended on December 29, 2018, presented today have been adjusted to reflect this new accounting method. However, during the third quarter of this fiscal year, there's really a negligible impact of 606 on the bottom line between the two standards. So we will just focus on this – in our new standard because there is no difference to the old standard and new standard in Q3. So now having given you this sort of preamble, I will now present the results for the quarter and for the nine months.
So let's look at sales first. Net revenue for the third quarter of fiscal 2019 ending December 29, 2018, were $1.893 million. In the press release, we show two components for the revenue. The one component is goods at $100,000, which is really for our RADAR test products as well as for end-of-life revenue on our old signal generators. This $100,000 compares to $1.989 million for the same period in the prior fiscal year. Basically, a year ago, we had a large RADAR test shipment, but in the reported quarter now, we did not have this kind of a shipment because the order for it came in late. It came in on February 1, 2019, and so we missed that deadline.
The second component is for services, $1.793 million, which is really for our Microsource product line, namely the filters, which are used in the F-15, F-16 and the F-18 fighter jets. This $1.793 million compares with $1.231 million for the same period in the prior fiscal year. That is a 46% growth in the Microsource product line.
Now looking at the nine months as reported, goods were $416,000 as compared to $2.81 million, a decline of 85%. Again, that is due to this order that was shipped in the third quarter a year ago, and we didn't have that equivalent shipment during this period, and so that's why there is a decline.
Now services were $7.207 million as compared to $4.634 million, that's a growth of 55%. So basically, the growth of the Microsource business, the services, as we call it, made up for the lack of the RADAR product sales. So the total nine months' overall sales were roughly equivalent, 7.6% for the last nine months versus a year ago – I mean, $7.6 million versus a year ago $7.4 million, a 2% increase in sales. So consider that equal, okay?
Gross margins for the third quarter of fiscal 2019 were 44%. This compares with a gross margin of 25% in FY 2018. For the nine months gross margins of fiscal 2019 was 43%. This compares with gross margin of 24% in FY 2018. So the gross margin improvement is really one key component in the turnaround of this company.
Looking at losses now. Net operating loss for the third quarter of fiscal 2019 was $331,000. This compared to a net loss in the third quarter of fiscal 2018 of $538,000. Net operating losses for the nine months' period of fiscal 2019 was $518,000, and this compares to a net loss of $2.713 million for the nine months' period ending in fiscal 2018. That's a big deal. The operating losses went from $2.7 million down to $500,000 over the nine months.
And clearly, there are two major components to that, the gross margin improvement that I mentioned a minute ago and then lower operating expenses. And roughly, we achieved that improvement on basically the same level of sales, $7.6 million.
Going now to below the line, the operating line, to interest payment. For the third quarter of fiscal 2019, interest payments were $186,000. This compares to $106,000, 1-0-6 for the third quarter of this fiscal 2018. The increase in ADK and interest was due to the following; $45,000 was due to the PFG loan, $33,000 was due to the 6% interest for the E Series and then the remainder was for Bridge Bank and others. It should be noted, even though we had $186,000 of interest expense, roughly $50,000 are cash payments. So the cash payment is much less than $186,000.
Looking at the nine months' period, interest expenses for the nine months were $526,000 as compared to $328,000 for the prior year. The increase of $200,000 was due to the following; $86,000 was due to PFG interest, $74,000 was for the 6% interest on the E Series and $20,000 was due to interest on fiscal 2011 taxes. It should be noted that the third quarter of fiscal 2018 had a onetime gain of $324,000 due to the sale of a product line. Combining the operating losses of $331,000 with the interest of $186,000 result in a net loss of $517,000 in the third quarter, which compares to $313,000 for the third quarter of fiscal 2018 for the reasons I just explained.
In summary, we have turned the company around in the first nine months of this fiscal year having reduced losses – operating losses from $2.7 million to $500,000, except for the fact that we had no sales of the RADAR test product line. And in the past calls, there was always a question; where are the dot-dot orders? Well, we received this $4 million order for the RADAR test business, and with that, we have completed the turnaround. Meaning that we are done losses, we are looking forward to growth and profits.
Going to the balance sheet now. Looking at our balance sheet, it is still weak. And yes, we increased shareholder equity to $1.237 million from $131,000 from March 31, 2018. But since we made losses, it is clear that this equity improvement is all due to the required adoption of the ASC 606 standard on April 1, as I explained. So the large changes in inventory and prepaid expenses and current assets and deferred revenue and retained earnings are all due to this required adoption of this ASC 606 standard on April 1.
What stands out on the balance sheet is the net inventory of $3.182 million. $2.773 million of this inventory is for RADAR test systems. That is way too high. We believe that we can easily get at least $1.7 million in cash out of this inventory based on the new purchase order we received on February 1 for $4 million.
Now cash is still a key concern. We have addressed this concern by having raised the E Series investment, totaling $2.26 million. We expect to conquer this cash concern with shipping the large $4 million purchase order to the Navy. And with that, we are shipping two systems, as John had mentioned, for $3.368 million. And since those systems are in inventory, there is no cash outlay to produce these systems. So what is clear is, with this shipment of $3.368 million, we get a cash infusion of that equivalent amount, and that really changes completely the company and its balance sheet.
So in summary, fiscal 2019 has been a turnaround year for Giga-tronics. This effort is now complete. We are done with losses. We expect a profitable FY 2020. We made the needed changes to the company, and we are looking forward in FY 2020 for growth and profits. And with that, I'm ready – or we are ready to take questions.
[Operator Instructions] And we have a question from Brandon Sadiq [ph] from investor – individual investor.
So congratulations on that large order. Could you talk a little bit about where opportunities are in your order pipeline at this point?
Did you hear that? Can you talk about orders we have in our pipeline? The opportunities we see.
Okay. Well, I mean, let me answer that question in two ways, okay? We have a funnel for not just our RADAR test business but also for our Microsource business, but I think your question is possibly more focused on the RADAR test business. And so the funnel has really three components. It has follow-on business from our prime customer who just purchased $4 million, which is really NAVAIR, and we expect major follow-on business and orders during this fiscal year that we are aware of.
Second, we have three other major opportunities like future NAVAIR, if you so want, and there are three of those that, I think, at least one of them will – should come through. And then we have eight, what I call, bread-and-butter type of opportunities, meaning orders that are more like $400,000, $500,000, $600, 000, $700, 000 from eight different potential customers.
So NAVAIR follow-on business, three major opportunities that are in the multimillion dollar range and eight-bread-and-butter items. I believe we have a good funnel going forward. And this is due to the fact that we changed our sales team and our sales approach in the mid-calendar year last year, and we are seeing a growing funnel, and we have seen the first fruits of that with the purchase order we just received.
Now add to that, that we also have backlog, okay? And so – and by the way, there's also a funnel, clearly, for Microsource, okay? And so there is a follow-on opportunity for the F-15, and there's a follow-on opportunity for the F-16. And so that's – however, that's fairly standard. We get these orders on a somewhat regular basis, okay? Now however, then there is also the backlog that you have – that we have, okay? And so the backlog now needs to be viewed in two ways.
So it needs to be viewed it in terms of invoiceable backlog, okay, which is roughly $13 million, and then revenueable backlog because of this ASC 606, which is roughly $3 million less, okay? But what really matters is the invoiceable because that's cash in the bank. And so we have basically roughly $13 million of invoiceable backlog. And so add to the funnel and the backlog, and I think we are in a decent position.
Great. Could you just ask sort of how you view the sales outlook now compared to, say, six months ago or a year ago? How that has changed? And sort of what has driven that?
Yes, I mean – and that's – I think, let me – I think that's good that you sort of go a little bit further. As I mentioned, when – a year ago, when I basically arrived here, we were selling boxes with people who had a very limited or no sales experience. They came from marketing and they came from applications engineering. And also, we needed – and they hired somebody to actually do cold calling in order to get opportunities. We changed all of that, and more so, we changed the sales approach. Rather than selling boxes or blades or hardware, we are selling solutions. And for that matter, custom solutions because we architected it so that it is very easy to customize the solution because it has a digital front end that you need a program.
And so by having the approach of selling solutions for complex RADAR test applications rather than just some hardware and by having changed the sales team, who are very, very knowledgeable in this customer base, who have good connections to the customer and to the procurement offices and they really know those people, that allowed us, since the middle of last year, to really build the funnel and obtain the order that we did. And so it's really the change of the sales approach and the change of the same salespeople that are the root elements of our much-improved situation.
Great. And then lastly, could you just – a little bit about sort of how the product compares with the competition? Has there been any change as far as competitive products out there in the marketplace?
Yes, this is John. I'll try to address that, Brandon [ph]. There are – I – on the signal generation side, I believe the key competitor is Keysight, and they have a product they call UXG that was originally a machine that had no module – limited modulation capability. They have since come out with an additional box that you have to add to provide the modulation. And it's a box approach to a market that I believe is better addressed with a modular approach that Giga-tronics has used.
So I still feel that our advantage has not been eroded, and we've been working on a comparison study between the two that we offer to customers to see what the – what are the pros and cons. We're much smaller in size. This particular market is focused on not a single signal generator, but many, many signal generators. They're trying to simulate an environment where there are thousands of emitters going on at the same time. So we believe Giga-tronics has a fundamental advantage in the architecture, as Lutz mentioned, and how we've approached the market.
We also are able to create – generate more complex signals that really mimic what's going on in the real world, and our customers are finding that as a very valuable tool. So although we do have competition, I believe our approach still has an edge.
Very good. Thanks for taking my question.
Thank you, Brandon [ph].
We have no further questions.
Okay. So let me close this call by saying the following; I firmly believe that the company is at an inflection point. We have $13 million of invoiceable backlog, albeit $3 million less in revenueable backlog. We have greatly improved gross margins. We have reduced operating expenses. We have reduced losses by 80%. Our RADAR test business has now seen its first major $4 million order. So yes, we are a new company going forward. We expect from here on out to have eliminated losses and have a profitable and growing FY 2020. Thank you very much.
Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.