Operator: Welcome to the Giga-tronics Fourth Quarter and Fiscal Year-end 2018 Conference Call. My name is Vanessa, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. And I will now turn the conference over to your host, Traci Mitchell.

Traci Mitchell: Hi, everyone, and thanks for joining our quarterly earnings conference call and year-end conference call. I'm Traci Mitchell, and I'm joined today by John Regazzi, our CEO; 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 results and uncertainties such as delays with manufacturing and orders 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 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 discussions, see our most current annual report on Form 10-K for the fiscal year ended March 25, 2017, Part I, under the heading Risk Factors, and Part II, under the heading Management's Discussions and Analysis of Financial Conditions and Results of Operations.

With those reminders in place, I would now pass on the call to John Regazzi.

John Regazzi: Thank you, Traci. Good afternoon, and thank you for joining our quarterly earnings conference call. Before we get into the numbers, I'd like to review the strategy that we embarked on over 5 years ago. At that time, Giga-tronics consisted of a number of businesses that each involved commodity products with low margins and declining sales due to being challenged by much larger competitors. It was essential that the company exit these lines.

Management identified the RADAR and EW test market as one that Giga-tronics had the core competencies to achieve product leadership and as an underserved segment that the company believed it had the ability to win against the market incumbents.

Since the beginning of fiscal 2013, Giga-tronics has invested more than $13 million in R&D alone to invent a new platform that we call the Advanced Signal Generation and Analysis System. This new test platform is aimed squarely at solving the challenges faced by test engineers, tasked with evaluating RADAR and EW equipment under realistic conditions.

Although this has been a much harder road than anticipated, we have accomplished the original vision. We have divested the legacy businesses and are now a much more focused company, specializing in EW components with our microwave -- excuse me, with our Microsource RADAR filters and in complex test solutions with our Giga-tronics signal generation system.

The Microsource business continues to deliver consistent revenue and gross profits, and the Advanced Signal Generation product platform has generated over $10 million in cumulative revenues since its introduction in late fiscal 2015.

With that review, I'd like to turn the call over to our Executive VP and acting CFO, Dr. Lutz Henckels.

Lutz Henckels: Hi, thank you for being on the call. Let me first, as the CFO, present the financials. Thereafter, as Executive Vice President, I will provide an assessment of the business and an outlook. I will start out by saying that clearly the business of Giga-tronics has faced major, major challenges and that's very much reflected in the huge losses made last fiscal year and the prior fiscal years and the weak balance sheet that you see.

So now let me go first to the sales side. Net sales for the fourth quarter, which ended on March 31, 2018, was $2.3 million. That's a decrease of 55% from the year ago quarter, the fourth quarter of fiscal 2017, sales were $5.2 million. That difference is clearly due to one item and that is there were $3.2 million shipped to the Navy in the fourth quarter of 2017 and there was no such shipments in the fourth quarter of 2018. So it relates to that specific item.

Net sales for the fiscal year that ended on March 31, '18, were $9.8 million as compared to $16.3 million the year before that ended on 3/25/17, that's a 40% decrease. That $6.5 million decrease has really 3 components. It has components of -- but in the RADAR test business of the $3 million or $3.2 million that shipped in Q4 of '17, but not in Q4 of '18. So that's a major part of it. Then we have been divesting the legacy business, as John mentioned, and therefore, the sales decreased by $2.2 million in that segment, which was divested. And then Microsource had a decline of $1.2 million because we didn't have certain NRE services in '18 that we had in '17 and we also had less filter shipments.

Going to the gross margin next. The year-on-year gross margins were 28% and basically unchanged. But when you look at the Q4 gross margins of Q4 '18, they were 41.7%, versus Q4 '17, they were 24.9%. And so that difference is very significant and that was achieved with a 55% reduction in revenue. That's a big change. And that changed to 40-plus percent gross margins, I believe, would be true going forward as well.

We go to losses next. And the losses in the fourth quarter of '18, the net loss was $449,000, that compares with a fourth quarter loss of 2017 of $473,000. So basically, you could say it's comparable or actually even a slight improvement. Now that's significant also because when the revenue drops by 55% to have more or less the same loss means you have improved greatly the other side, which means the gross margin side and the operating expenses. As I mentioned, gross margins were much better, 42% versus 25%, and our operating expenses were lower basically by roughly 20%.

When I go to the fiscal year loss, that was $3.1 million, that compares with $1.5 million in the prior year of fiscal '17. And that increase in the net loss was basically due to the reduction in sales, which was 55%. And then, there were 2 other components. There was a noncash component, amortization of software, which increased by $733,000. We are done with that now. So that has gone away now. And then there was a gain in 2017, in the early 2017 fiscal year, by selling the product line -- the Switch product line and that was a gain of $802,000. So those 3 components explain the difference of $1.5 million to $3.1 million.

If I go to the balance sheet. When you look at the balance sheet, it's clearly weak. The equity stands at $132,000 and the cash at $1.485 million. Now the equity will improve by about $1 million starting on April 1. This is due to the fact that we must adopt the new ASC 606 revenue recognition standard or it's also called ASU 2014-09. And we have no choice in that. And basically, we have been very conservative in our revenue recognition and have deferred revenue of over $3 million. And under this new revenue recognition requirement, we have to be consistent with that. And therefore, we need to recognize some of that revenue going forward.

And so therefore, the equity will improve by $1 million. But that's just a book entry on the balance sheet and it doesn't reflect right away in -- it doesn't reflect equity in the P&L going forward.

What stands out on the balance sheet though is the inventory, the net inventory of $5.487 million. That's huge. Now half of that is from Microsource, the RADAR filter business. That's okay because this inventory is financed by the customers. And you can see that on the deferred revenue of $3.374 million. So we're happy with getting inventory financed by the customer.

On the other hand, the other half is from the RADAR test business. And that's way too high. And so we believe that we can get at least $1 million out of that inventory in this fiscal year, FY '19.

In summary, our year-on-year financial performance was poor. But our fourth quarter performance improvement is worth noting; much better gross margins, we're in the 40% now; much lower operating expenses and that should be holding through going forward.

With that, I now become the Executive Vice President, and I will provide you an assessment of the business and an outlook.

So as John mentioned, we have transitioned the company from a company that had lots of product lines, little differentiation, me too products and poor gross margin. And we're transitioning that or have transitioned that to a highly focused microwave RADAR product company, with highly differentiated products and good gross margin. And this was built on our strength. Our strength is microwave integrated circuits. That strength has 2 routes. The 1 route is actually our CEO, John Regazzi, who is in my opinion a microwave genius and has built a superb microwave team. The other component is our Microsource division, which is a company that we acquired actually more or less exactly 20 years ago on May 14, 1998. That company has been for 2 decades in the business of being the sole source supplier of MIC products to 2 major prime contractors for the F-15, the F-18 and the F-16 fighter jets.

Now we are the sole source supplier. This business will deliver in this fiscal year between $9 million to $10 million of revenue. And it's -- we have a year's worth of backlog, so that's assured business. We have 40% margin. We have a revenue stream very much assured for the next 5 years. I call that business a rock. And we are building the -- our RADAR test business on that rock, taking the strengths, which is microwave integrated circuit products, okay, and building that business on it. The company developed the microwave test platform for RADAR test markets. And the company, as John mentioned, has spent over $13 million in R&D alone on this endeavor and really a lot more when you consider marketing and sales. And so we went through in a very, very difficult transition for 6 years now. But we are now getting to the other side.

And when I arrived here in early January, a lot had already been accomplished. The company had already divested their low-margin legacy business line. Now that reduced sales by $8 million. So that's an impact. But that will be taken up with the new RADAR test solution, which is now completed and moved into production. And yes, you will always add to that, but they have a product that is in production. This product has been validated in the field with over $10 million of the products shipped and installed and being used. And they have reduced the expenses of the company by over 30%, and we have moved the company into a much smaller facility, which is much nicer, much more suitable and really represents the company well.

But when I entered in January 2018, it was clear that the financial -- that the company is in financial difficulties and -- which is also reflected in what you see today. But we did solve a few problems. Since January, we have accomplished the following. We have made changes to the senior management positions really in all areas, in operations, in finance, in engineering, in sales and at the corporate level. In each of those places, we have changes in the senior management. We have further reduced the operating expenses by having done a few more actions during the first quarter. We have changed the sales focus completely from selling hardware boxes to selling test solutions. We have raised $1.32 million in the E Series, and we have renegotiated debt with PFG, that stands for Partner For Growth, and with Bridge Bank. And we have incentivized our employees with granting them new stock options.

So that brings us to today, where we have these 2 businesses, we have the rock, as I mentioned, and then, we have this RADAR test business, which is addressing $150 million market. We have validated that, which is providing a truly a disruptive unique test platform for what we call closed-loop testing, which makes us very unique, nobody has that, okay. We expect 50% plus in gross margins from that and we expect to double that business in FY '19 and again in FY '20. So we have the rock and we are building on that rock the RADAR test business and the product is here, and we have a good market.

So going forward now, we still have a lot of work to do. Like I mentioned, we need to grow the business of RADAR test. Doubling it and that means we need to grow the business of the company each year, the next 2 years by 50%. We need to become profitable. We need to achieve that really next quarter. We're building a sales team that is -- comes from the industry of RADAR and test solutions. And we are working on strategic partnerships with major players in our industry and we have active discussions with 2 companies. We would like to raise at some point additional funding to eliminate the PFG debt and have a stronger balance sheet. And we need to focus very much on improving the shareholder value.

Now I would normally open for question right now, John will do this. But I know there is one question that I get several times in a week. And the question is asked, where are the fricking orders for RADAR test? Now some people use a different word for fricking, okay. And so there are 2 pieces. The Microsource business, we have a 1-year backlog. Yes, we're expecting major orders, but that's really for the following fiscal year. That's a solid predictable assured business because we are the sole source supplier. So no worry there, okay. But then, at Giga-tronics RADAR test division, there has been a lack of orders and really for 2 reasons. The 1 reason is that we expected 2 large orders from the Navy last quarter, which was for $2.7 million. That did not happen. And it didn't happen because of a change in the procurement process.

Basically, the Navy procured our systems $5 million worth in the past through a service company. That procurement vehicle was changed and is no longer available to the Navy for multiple reasons that are completely unrelated to Giga-tronics. And then, to set up a new vehicle actually it takes quite a long time. So we don't want to wait for that. And so what was decided by the Navy and us that we become part of, what they call, their GSA schedule. So we had to really get our products into the GSA schedule, which we have done. We are now in that schedule and orders are now, again, being procured through that GSA schedule. And these 2 orders are now in the procurement process. We expect those 2 orders next quarter.

The second reason of why there is a lack of orders is, we were not fed up with the sales team that sells RADAR test solution. We didn't have the right people and we didn't have the right sales strategy. We fixed that in May of this year, and we expect to start seeing the benefit of this starting next quarter.

We are very confident that we have the right product. It's unique, well architected, disruptive microwave RADAR test solution. I think John has a lot of reasons to be proud of that solution. And we are confident about the market. We evaluated the market in 3 different ways, I believe, it's at least $150 million, maybe $200 million. And so the problem has been sales, sales, sales, and we're fixing that problem.

With that, I turn it over to John.

John Regazzi: Thank you, Lutz, for that excellent review. At this point, I'd like to open the call for questions.

Operator: [Operator Instructions] And it looks like we have our first question from Frank Barresi with Ameriprise.

Frank Barresi: So did I understand correctly you expect the ASG order for $2.7 million? Is it this quarter or next quarter?

Lutz Henckels: It's not this quarter. By the way, there are 2 orders. So the 1 order is for $1.8 million, actually $1.778 million. And that is an order for a system of which they have already received 3 of them. And so that's a fourth system, okay. And then, the other one is a support contract, where they want to upgrade the 3 systems that they have and that's for $900,000. So the order -- neither of these orders are expected this quarter, they are expected next quarter, okay. So the revenue for the system of $1.778 million would be recognized next quarter. And then, the $900,000 which is a support contract, would be recognized like over a period of 9 months to a year.

Frank Barresi: Okay. And how are they using these systems? Can you make any comments?

Lutz Henckels: Yes, I mean, basically, the program -- I mean, there are -- we have $10 million out there. We're talking about right now -- when you say these systems, we're talking $5 million for the Navy. And basically, they are testing with that a jammer receiver product. And maybe, John, you want to explain a little bit more?

John Regazzi: Yes. Hi, Frank. The Navy program that we're involved with right now is called -- it's ALQ-218 and it's a specialized receiver that flies aboard the F-18 and the Growler aircraft. And that, that device -- the purpose of that device is to identify various signals that it sees out in the spectrum and to locate them. And it's a very complicated product that -- actually, it can -- several units can talk among various planes. So if you have 3 airplanes, that each have one of these devices on board, they can all talk among themselves. So it's a very difficult matter to test them under realistic conditions. And so that's what the system we've created does for the Navy. The prime contractor for that device is Northrop Grumman in Baltimore. And they have a system located on site, so they can test their devices in a similar manner. And then, we have a system here in Dublin, California so that we can support our users. So if they find something wrong, we have a copy of the system here that we can work on. So that's where the $5 million is deployed right now. We expect further systems to be purchased as Lutz explained earlier.

Lutz Henckels: What is interesting by the way about that is Northrop Grumman, who is the creator of this jammer device, is also the largest competitor in the RADAR test market. They are the gorilla. And the gorilla is buying our test system for testing their device. I thought that was interesting.

Frank Barresi: Yes. It is. Okay. And so that for this one device, there's more or besides these -- this $2.7 million, are there more orders coming to test that device? Or do you need to find other devices to test?

John Regazzi: Both.

Lutz Henckels: Both. We do expect more orders. So right now, the system that was in the purchasing process is for at Point Mugu Navy. We are expecting to also get orders from China Lakes and Pax River. And so there will be more orders coming for that device.

Frank Barresi: And this is all to test the ALQ-218?

Lutz Henckels: Correct.

John Regazzi: Correct.

Lutz Henckels: So -- but Point Mugu does, is they do the validation of the design. And then, like China Lakes does the field testing for it.

Frank Barresi: So wait. So China Lake -- what Point Mugu does...

Lutz Henckels: The validation. In other words, they have to validate that -- this device that Northrop Grumman creates indeed is doing what it's expected to do. And then, China Lakes does the field testing for that device.

Frank Barresi: Okay. All right. So there's more revenue coming for the -- beyond the current -- the orders next quarter for these ALQ-218 tester?

Lutz Henckels: Correct.

Frank Barresi: And so when you say -- well, are there other eminent orders for other -- I mean, I'm just trying to think. You're talking about -- you hope to get $5 million for the ASG this year.

John Regazzi: Yes.

Lutz Henckels: We're not just talking for this device. We obviously are talking about other opportunities. Now we don't want to tip competitors into we're going after this particular device or after this particular market segment because we obviously want to keep quiet about that. But yes, we have quite a few other prospects, including -- and I'd like to make the point that there is a lot of equipment out there that is actually aged and failing that needs urgent replacement. And so we're also into that space as well.

Frank Barresi: Testing the aged equipment or?

Lutz Henckels: Yes, in other words, you...

John Regazzi: No, no. The equipment that's aging is the test equipment. And so that has to be replaced. And we're hoping that a solution based on our Advanced Signal Generation System will be the selected device to replace this old -- the old testers.

Frank Barresi: Okay. And that's going on and that is happening now. Are you working on opportunities?

Lutz Henckels: Correct.

Frank Barresi: Okay. And when you say 106 -- you mentioned $160 million to $180 million or $200 million in opportunity. Is that an annual opportunity or?

Lutz Henckels: Right. Let me explain it. That's our total addressable market. And so there is a United States component, which is roughly $120 million. And then, there is an international component, which is roughly 50% of that or more. And so we have multiple approaches to understanding that market. One is, for example, from a company called Visiongain, which has done infinite detailed analysis of the RADAR market. It breaks it down by country, it breaks it down by is it ground RADAR, is it ground military RADAR, is it naval military RADAR or is it aerial military RADAR, it does it by country, it does it by prime contractor, it does it by contract that the prime contractor has. And so for example, they have 7 major prime contractors in the United States. They have a total of 77 programs. They have 44 sites. And it's all broken up in great detail. And so we have that information and we based one dimension of our market analysis on that. The other one we based it on was looking at all of our competitors like Northrop Grumman and so on and who was doing what and how much market do they have. So we approached it that way. And then a third one was to approach it from how many programs are out there. How many programs can we address, and therefore, we'll get a market size from that as well.

Frank Barresi: So that now on somehow your device is different than these large companies. And what is that the -- I mean, it's -- I've been -- John knows I've been following you guys a long time and...

John Regazzi: Yes, you have.

Frank Barresi: The fricking order quote is good. Like where are they? So why is it going to happen now do you think? I mean...

John Regazzi: Well, Frank, I'll take a stab at and maybe Lutz can chime in as well. But our product is not the entire solution, we have the microwave piece. But there is a digital part of the solution that you need to add. And we were going to market making the assumption that the customer was going to put together the solution by buying our piece and buying somebody else's digital piece and creating their own solutions. And we were successful in a couple of areas, one notably at Raytheon that, that team had to put -- they had the wherewithal to build their own solution. But what we've discovered is most or many customers are looking to buy the entire solution and that has caused Giga-tronics to seek out partners for the digital part and go-to-market with a complete solution, such as the Point Mugu system. So we believe that this is a better approach to the market. We've tooled up our sales organization to sell solutions rather than just selling the Advanced Signal Generator hardware. And we think that will be successful going forward, much more successful going forward with that. Let me see if Lutz would like to add.

Lutz Henckels: I think we need to let other people at this point ask some questions so.

Operator: We have our next question from Greg Berlacher with Emerging Growth.

Gregory Berlacher: Just quickly, I want to make sure I heard a couple of things correct. You believe the next quarter and I'm going to define that as the September quarter you could show profitability. That's one question. I just want to confirm that.

Lutz Henckels: The answer is yes.

Gregory Berlacher: Okay. Secondly, on the $450,000 operating loss for the March quarter, what type of cash flow did you kind of burn through? I mean, where this -- I assume the $450,000 included some noncash charges so the actual cash burn was less than that? Or can you give me a bit of guidance on that?

Lutz Henckels: Yes, I can give you guidance. And so the $450,000 is the net loss after tax. However, we have noncash charges, $35,000 for demo equipment depreciation, $77,000 for stock-based compensation and $88,000 for depreciation. So therefore, if you subtract that, that will be $222,000 negative.

Gregory Berlacher: Got it. Okay. And maybe you can give everyone a little better feel for any other involvement with the -- are you guys -- do you guys feel strongly? It sounds like you do, but you do feel strongly, you've kind of reached the bottom of the trough here and now is the time to look probably at the future. And then secondly, what is the update on the shareholder enhancement situation? Are you continuing to address that and look at that or have things changed on that front? And I'll let you answer.

Lutz Henckels: So let me take the first question, did we reach the bottom. So we had $9.8 million sales last fiscal year that just went by. And we are projecting that we will do between $9 million to $10 million in Microsource alone this fiscal year. And that's a 40% gross margin business. So therefore, you could say without anything, we have already about $9 million or $10 million of sales compared to last year. But since we have much better gross margins, as I stressed already, and since we have, like, 20% lower operating expenses, we surely are past the trough. So now the question is very much so, a, how do you create shareholder value? And b, what is it that you are expecting? And so to create shareholder value, you need to grow the top line and be profitable. That's order #1. Everything else is secondary. And you're going to have to do that first, okay. So growing the top line -- there is growth right now in the -- significant growth in the Microsource product line because all 3 planes are right now ordering. And so that's a strong growth that we see there. And yes, we fully expect to see orders coming from the RADAR test group. We have 2 orders in process right now, in purchasing process. So we are quite confident about that. And so yes, we expect to see growth of roughly 50% this year. And we expect to achieve profitability for this year. And that is a basis of any shareholder value and without that you're not going anywhere, okay. And then, of course, once we achieve that then we need to get the word out. The trading volumes are extremely low, nobody knows GIGA, we are traded over OTC. And so we will need to speak to analysts and investment bankers and make other efforts to get the word out and we will do that but we need to first do order #1, get profitable and grow the top line, okay. Where are the fricking orders, okay? And then, the third one is, we are working with strategic partnerships. And we have 2 very active discussions right now. One is with a very large company. They are quite interested in complementing what they have with what we have. And so we are also expecting some opportunities coming from that as well. That should create shareholder value. So yes, we are pursuing that, but first order is top line growth and profitable.

Operator: [Operator Instructions] It seems we have no further questions at this time. I will now turn the call over to our speakers for closing remarks.

John Regazzi: Lutz, do you have anything else to add, okay? Like to thank everybody for their participation on the call this afternoon. Have a good afternoon.

Lutz Henckels: Thank you.

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