10-K 1 giga20170325_10k.htm FORM 10-K giga20170325_10k.htm

 UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K

 

[X]

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 25, 2017

 Or 

[  ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

  For the transition period from      to      .

 Commission File No. 001-14605

 

GIGA-TRONICS INCORPORATED

(Exact name of registrant as specified in its charter)

 

California

 

94-2656341

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

5990 Gleason Drive, Dublin, CA

 

94568

(Address of principal executive offices) 

 

(Zip Code)

 

 

 

Registrant’s telephone number, including area code: (925) 328-4650
     
Securities registered pursuant to Section 12(b) of the Act:    
     
Title of each class   Name of each exchange on which registered
Common Stock, No par value   The NASDAQ Stock Market LLC

 

Securities registered pursuant to Section 12(g) of the Act: None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes [ ] No [X]

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes [X] No [ ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer     

[ ]

 

Accelerated filer

[ ]

 

 

 

 

 

Non-accelerated filer     

[ ]

 

Smaller reporting company

[X]
(Do not check if a smaller reporting company)   Emerging growth company [ ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X]

 

The aggregate market value of voting and non-voting common equity held by non-affiliates of the Registrant computed by reference to the price at which the common equity was sold or the average bid and asked prices as of September 24, 2016 was $8,703,636.

 

There were a total of 9,784,203 shares of the Registrant’s Common Stock outstanding as of June 2, 2017.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the following documents have been incorporated by reference into the parts indicated:

 

PART OF FORM 10-K

DOCUMENT

PART III

Registrant’s PROXY STATEMENT for its 2017 Annual Meeting of Shareholders to be filed no later than 120 days after the close of the fiscal year ended March 25, 2017.



 
 

 

 

TABLE OF CONTENTS
   

Page

PART I
     

ITEM 1.

Business

3

ITEM 1A.

Risk Factors

7

ITEM 1B.

Unresolved Staff Comments

9

ITEM 2.

Properties

9

ITEM 3.

Legal Proceedings

10

ITEM 4.

Mine Safety Disclosures

10

 
PART II
     

ITEM 5.

Market for Common Equity, Related Stockholder Matters and Issuer Repurchases of Equity Securities

10

ITEM 6.

Selected Financial Data

11

ITEM 7.

Management's Discussion and Analysis of Financial Condition and Results of Operations

12

ITEM 7A.

Quantitative and Qualitative Disclosures About Market Risk

21

ITEM 8.

Financial Statements and Supplementary Data

22

 

Consolidated Balance Sheets as of March 25, 2017 and March 26, 2016

23

 

Consolidated Statements of Operations for the years ended March 25, 2017 and March 26, 2016

24

  Consolidated Statements of Shareholders' Equity for the years ended March 25, 2017 and March 26, 2016 25
 

Consolidated Statements of Cash Flows for the years ended March 25, 2017 and March 26, 2016

26

 

Notes to Consolidated Financial Statements

27

 

Report of Independent Registered Public Accounting Firm

47

ITEM 9.

Changes In and Disagreements With Accountants On Accounting and Financial Disclosure

48

ITEM 9A.

Controls and Procedures

48

ITEM 9B.

Other Information

49

     
PART III
 

ITEM 10.

Directors, Executive Officers and Corporate Governance

50

ITEM 11.

Executive Compensation

50

ITEM 12.

Security Ownership Of Certain Beneficial Owners and Management and Related Shareholder Matters

50

ITEM 13.

Certain Relationships and Related Transactions, and Director Independence

50

ITEM 14.

Principal Accountant Fees and Services

50

     
PART IV
     
ITEM 15. Exhibits and Financial Statements Schedules 51
SIGNATURES 52

 

 

 

 

Unless the context otherwise requires, we use the terms “Giga-tronics Incorporated,” “Giga-tronics,” “we,” “us,” “the Company” and “our” in this Annual Report on Form 10-K to refer to Giga-tronics Inc. and its wholly owned subsidiary.

 

FOWARD-LOOKING INFORMATION

 

This Annual Report on Form 10-K includes "forward-looking statements" within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including but not limited to certain disclosures contained in Item 1A, “Risk Factors” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. These forward-looking statements include, but are not limited to, statements about our plans, objectives, representations and contentions, and are not historical facts and typically are identified by the use of terms such as "may," "will," "should," "could," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential," "continue" and similar words, although some forward-looking statements are expressed differently. You should be aware that the forward-looking statements included herein represent management's current judgment and expectations, but our actual results, events and performance could differ materially from those expressed or implied by forward-looking statements. We do not intend to update any of these forward-looking statements or publicly announce the results of any revisions to these forward-looking statements, other than as is required under the federal securities laws.

 

PART 1

 

ITEM 1. BUSINESS

 

General

 

Giga-tronics Incorporated (Giga-tronics, or the Company) includes the operations of the Giga-tronics Division and Microsource Inc. (Microsource), a wholly owned subsidiary. Giga-tronics Division designs, manufactures and markets the Advanced Signal Generator (ASG) for the electronic warfare market. The Giga-tronics Division over the past thirty-five years has produced a broad line of test and measurement equipment used primarily for the design, production, repair and maintenance of products in aerospace, telecommunications, RADAR, and electronic warfare. Giga-tronics has recently completed a move within the test and measurement market from legacy test and measurement products to the newly developed ASG. As part of this evolution certain legacy product lines were sold to raise additional capital. For example, we sold our SCPM product line to Teradyne in 2013, and in December of 2015 we sold our Power Meters, Amplifiers, and Legacy Signal Generators to Spanawave Corporation (see Note 10, Sale of Product Lines). In June of 2016 we sold our Switch product line to Astronics (see Note 10, Sale of Product Lines). These transactions will allow us to increase our focus on the ASG and Microsource YIG RADAR filters. With the sales of these legacy product lines, the Giga-tronics Division is solely focused on the ASG product in the test and measurement equipment market.

 

Microsource develops and manufactures a broad line of YIG (Yttrium, Iron, Garnet) tuned oscillators, filters and microwave synthesizers, which are used by its customers in operational applications and in manufacturing a wide variety of microwave instruments and devices. Microsource’s two largest customers are prime contractors for which it develops and manufactures YIG RADAR filters used in fighter jet aircraft.

 

Giga-tronics was incorporated on March 5, 1980, and Microsource was acquired by Giga-tronics on May 18, 1998.

 

The combined Company principal executive offices are located at 5990 Gleason Drive, Dublin, California, and our telephone number at that location is (925) 328-4650.

 

Operating Segments

 

The Company has two reporting segments: Giga-tronics Division and Microsource.

 

For more information regarding the Company’s two reporting segments, see “Part II-Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements-Significant Customers and Industry Segment Information.”

 

 
3

 

 

Products and Markets

 

Giga-tronics

 

Our Giga-tronics Division produces modular signal sources, up-converters, receivers and down-converters in the AXIe format covering a radio frequency (RF) range of 100 megahertz (MHz) to 18 gigahertz (GHz). The Company also produces a 5-slot and a 9-slot AXIe chassis and a high-performance AXIe frequency reference module for use with its signal sources. Available within each product family are a number of options allowing customers to select specialized capabilities, features and functions. The end-user markets for these products can be divided into three segments: RADAR Target Generation, Threat Emulation and Surveillance. These instruments are used in the design, evaluation and calibration of RADAR, Electronic Countermeasures (ECM) and Direction Finding (DF) systems.

 

Microsource

 

Our Microsource segment develops and manufactures a broad line of YIG tuned oscillators, filters, filter components, and microwave synthesizers, which are used by its customers in operational applications and in manufacturing a wide variety of microwave instruments or devices. Microsource’s two largest customers are prime contractors for which it develops and manufactures YIG RADAR filters used in fighter jet aircraft.

 

Sources and Availability of Raw Materials and Components

 

Substantially all the components required by Giga-tronics to make its assemblies are available from more than one source. We occasionally use sole source arrangements to obtain leading-edge technology or favorable pricing or supply terms, but not in any material volume. In our opinion, the loss of any sole source arrangement we have would not be material to our operations. Some suppliers are also competitors of Giga-tronics. In the event a competitor-supplier chooses not sell its products to us, production delays could occur as we seek new suppliers or re-design components to our products.

 

Although extended delays in receipt of components from our suppliers could result in longer product delivery schedules for us, we believe that our protection against this possibility stems from our practices of dealing with well-established suppliers and maintaining good relationships with such suppliers.

 

Patents and Licenses

 

Our competitive position is largely dependent upon our ability to provide performance specifications for our instruments and systems that (a) are easy to use and effectively and reliably meet customers’ needs and (b) selectively surpass competitors’ specifications in competing products. Patents may occasionally provide some short-term protection of proprietary designs. However, because of the rapid progress of technological development in our industry, such protection is most often, although not always, short-lived. Therefore, although we occasionally pursue patent coverage, we place major emphasis on the development of new products with superior performance specifications and the upgrading of existing products toward this same end.

 

Our products are based on our own designs, which are derived from our own engineering abilities. If our new product engineering efforts fall behind, our competitive position weakens. Conversely, effective product development greatly enhances our competitive status.

 

We presently hold 31 patents. Capitalized costs relating to these patents were both incurred and fully amortized prior to March 27, 2011. Accordingly, these patents have no recorded value included in our consolidated financial statements for the fiscal years ended March 25, 2017 (“fiscal 2017”) and March 26, 2016 (“fiscal 2016”).

 

We are not dependent on trademarks, licenses or franchises. We utilize certain software licenses in certain functional aspects for some of our products. Such licenses are readily available, non-exclusive and are obtained at either no cost or for a relatively small fee.

 

 
4

 

 

In September 2015, we entered a software development agreement with a major aerospace and defense company whereby the aerospace company developed and licensed its simulation software to us. The simulation software (also called Open Loop Simulator or OLS technology) is the aerospace company’s intellectual property. The OLS technology generates threat simulations and enables various hardware to generate signals for performing threat analysis on systems under test. We license the OLS software as a bundled or integrated solution with our ASG system.

 

Seasonal Nature of Business

 

Our business is not seasonal.

 

Working Capital Practices

 

We generally strive to maintain adequate levels of inventory and we generally sell to customers on 30-day payment terms in the U.S. and generally allow more time for overseas payments. Typically, we receive payment terms of 30 days from our suppliers. We believe that these practices are consistent with typical industry practices.

 

Importance of Limited Number of Customers

 

We are a supplier of microwave and RF test instruments to various United States (U.S.) government defense agencies, as well as to their prime contractors. Management anticipates sales to U.S. government agencies and their prime contractors will remain significant in fiscal 2018. U.S. and international defense-related agencies accounted for 78% of net sales in fiscal 2017 and 73% of net sales in fiscal 2016. Commercial business accounted for the remaining 22% of net sales in fiscal 2017 and 27% of net sales in fiscal 2016.

 

At the Giga-tronics Division, U.S. defense agencies and their prime contractors accounted for 58% and 42% of net sales in fiscal 2017 and 56% and 40% of net sales in fiscal 2016, respectively. Microsource reported 97% and 98% of net sales to prime contractors of U.S. defense agencies in fiscal 2017 and fiscal 2016, respectively.

 

During fiscal 2017, the Boeing Company accounted for 33% of our consolidated revenues and was included in the Microsource reporting segment. A second customer, CSRA LLC (CSRA acted as Prime Contractor for the United States Navy) accounted for 20% of our consolidated revenues during fiscal 2017 and was included in the Giga-tronics Division reporting segment.

 

During fiscal 2016, the Boeing Company accounted for 32% of our consolidated revenues and was included in the Microsource reporting segment. A second customer, Defense Finance and Accounting Services (DFAS) accounted for 11% of our consolidated revenues during fiscal 2016 and was included in the Giga-tronics Division reporting segment.

 

In management’s opinion, we could experience a material adverse effect on our financial stability if there was a significant loss of either our defense or commercial customers.

 

Our Giga-tronics Division products are largely capital investments for our customers, and our belief is that our customers have economic cycles in which capital investment budgets for the kinds of products that we produce expand and contract. We therefore, expect that a major Giga-tronics Division customer in one year will often not be a major customer in the following year. Accordingly, our net sales and earnings will decline if we are unable to find new customers or increase our business with other existing customers to replace declining net sales from the previous year’s major customers. A substantial decline in net sales to the U.S. government defense agencies and their prime contractors would also have a material adverse effect on our net sales and results of operations unless replaced by net sales in the commercial sector.

 

Backlog of Orders

 

On March 25, 2017, our backlog of unfilled orders was approximately $11.4 million compared to approximately $14.6 million at March 26, 2016. As of March 25, 2017, there were approximately $5.7 million of orders scheduled for shipment beyond one year, compared to $8.6 million at March 26, 2016. Orders for our products include program orders from prime contractors with extended delivery dates. Accordingly, the backlog of orders may vary substantially from year to year and the backlog entering any single quarter may not be indicative of sales for any period.

 

 
5

 

 

Backlog includes only those customer orders for which binding agreement exists, a delivery schedule has been agreed upon between us and our customer and, in the case of U.S. government orders, for which funding has been appropriated.

 

Competition

 

Giga-tronics serves two very different markets.

 

The first is the electronic test equipment market with applications in complex RF signal simulation used in the evaluation of military RADAR and Electronic Warfare systems. These applications represent niche segments within the broader test equipment market and their unique requirements allow Giga-tronics to win against a variety of larger competitors, such as Agilent/Keysight, Rohde & Schwarz and Anritsu, by focusing our limited resources squarely on the specific features needed. We do not attempt to compete ‘across the board’, but selectively based upon our strengths, the competitors’ perceived limitations, the customer’s needs and market opportunities. To maintain our position against competitors that have greater resources in research, development and manufacturing with substantially broader product lines and channels, we (a) place strong emphasis on maintaining a high degree of technical competence as it relates to the development of new products, (b) are highly selective in establishing technological objectives and (c) focus sales and marketing activities in the selected niche areas that are weakly served or underserved. Other competitors are of comparable size or have small product divisions with more limited product lines, such as Racal Instrument (a division of Astronics), VTI Instruments (a division of AMETEK), ELCOM (a division of Frequency Electronics Inc.), COMSTRON (a division of Cobham Plc) and EWST (a division of Ultra Electronics Plc).

 

The second is the aftermarket for operational hardware associated with the US Government’s RADAR Modernization Program (RMP) for prior generation fighter aircraft. The F/A-18E, the F-15D and F-16 jets are receiving new RADARs to extend their useful lives. Giga-tronics’ Microsource business unit supplies YIG filters specifically designed for military aircraft to solve interference problems. The prime contractors responsible for integrating the new RADARs have flight qualified our filters at considerable expense. Only a few companies possess the technical know-how to design and manufacture filters of this nature, such as Teledyne and Micro-Lambda Wireless, but the expense of requalifying a new component is prohibitive to the point where the integrator would only undertake such an effort when insurmountable technical deficiencies arose, which do not exist in this case. Microsource is the sole-source supplier of these filters and presently does not have any competition for this business. Microsource routinely maintains a “gold supplier” rating from its customers and received the Supplier of the Year award from one of the integrators. Microsource must maintain the Aerospace Industry’s AS9100C certification for its Quality Management System which it currently holds.

 

Sales and Marketing

 

Giga-tronics and Microsource sell their products primarily direct to end customers and prime contractors.

 

Product Development

 

Products of the type manufactured by Giga-tronics historically have had relatively long product life cycles. However, the electronics industry is subject to rapid technological changes at the component level. Our future success is dependent on our ability to steadily incorporate advancements in component technologies into our new products. In fiscal 2017 and fiscal 2016, product development expenses totaled approximately $2.3 million and $2.8 million, respectively.

 

Recent activities have focused primarily on the development of the ASG product. It is our intention to maintain product development at levels required to sustain our competitive position. Our product development activities are funded internally, through product line sales, or through outside equity investment and debt financing. Product development activities are expensed as incurred, except software development costs associated with the ASG.

 

We expect to continue to make significant investments in research and development. There can be no assurance that future technologies, processes or product developments will not render our current product offerings obsolete or that we will be able to develop and introduce new products or enhancements to existing products that satisfy customer needs in a timely manner or achieve market acceptance. Failure to do so could adversely affect our business.

 

 
6

 

 

Manufacturing

 

The assembly and testing of Giga-tronics Division and Microsource’s products are done at our Dublin facility.

 

Environment

 

To the best of our knowledge, we are in compliance with all Federal, state and local laws and regulations involving the protection of the environment.

 

Employees

 

As of March 25, 2017, and March 26, 2016, we employed 57 and 63 individuals on a full-time basis, respectively. We believe that our future success depends on our ability to attract and retain skilled personnel. None of our employees are represented by a labor union, and we consider our employee relations to be good.

 

Information about Foreign Operations

 

We sell to our international customers through a network of foreign technical sales representative organizations. All transactions between us and our international customers are in U.S. dollars.

 

Geographic Distribution of Net Sales

                               

(Dollars in thousands)

 

Fiscal

2017

   

Fiscal

2016

   

Fiscal

2017

   

Fiscal

2016

 

Domestic

  $ 15,938     $ 13,998       98 %     96 %

International

    329       598       2 %     4 %

Total

  $ 16,267     $ 14,596       100 %     100 %

 

See Item 8, (Note 12, Significant Customers and Industry Segment Information) of the consolidated financial statements for further breakdown of international sales for the last two fiscal years.

 

ITEM 1A. RISK FACTORS

 

Future liquidity is uncertain

 

We incurred net losses of $1.5 million in fiscal 2017, and $4.1 million in fiscal 2016. These losses have contributed to an accumulated deficit of $25.6 million as of March 25, 2017.

 

Beginning in fiscal 2012, we invested substantially in the research and development of our new product line, ASG. We anticipate long-term revenue growth and improved gross margins from the ASG platform, but delays in completing it have contributed to our losses. We also experienced delays in the development of features, orders, and shipments for the new ASG. These delays have significantly contributed to a decrease in working capital from $1.8 million at March 26, 2016, to $620,000 at March 25, 2017. The Advanced Signal Generator product has now shipped to several customers, but potential delays in the refinement of features, longer than anticipated sales cycles, or the ability to continue shipments in volume quantities, could significantly contribute to additional future losses.

 

These matters raise substantial doubt as to our ability to continue as a going concern.

 

To address these matters, our management has taken several actions to provide additional liquidity and reduce costs and expenses going forward. These actions are described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in the “Notes to the Consolidated Financial Statements” (Note 2, Going Concern and Management’s Plan).

 

Customer orders and production of new product platform

 

We invested heavily in the development of our new ASG product platform but delays in completing it have contributed to our losses. Longer than anticipated sales cycles in future fiscal years, or delays in production and shipping volume quantities, could significantly contribute to additional losses.

 

 
7

 

 

Ability to stay listed for trading on The NASDAQ Capital Market

 

On May 4, 2017, we received a notification letter from The NASDAQ Stock Market (“NASDAQ”) advising the Company that it has initiated proceedings to delist the Company from NASDAQ for the Company’s failure to comply with NASDAQ’s bid price rule. As previously reported on November 1, 2016, NASDAQ notified the Company that the bid price of its listed security had closed at less than $1 per share over the previous 30 consecutive business days, and, thus, did not comply with Listing Rule 5550(a)(2) (the “Rule”).

  

The Company was provided 180 calendar days, or until May 1, 2017, to regain compliance with the Rule. 

  

Additionally, the Company reported on February 8, 2017, that it received a notification letter from NASDAQ advising the Company of its failure to comply with the required minimum of either $2,500,000 in shareholders’ equity, $35,000,000 market value of listed securities or $500,000 net income from continuing operations for continued listing on The Nasdaq Capital Market, pursuant to NASDAQ listing rule 5550(b). NASDAQ listing rules provided the Company with 45 calendar days in which to submit a plan to regain compliance. The Company submitted a plan on March 24, 2017, and NASDAQ notified the Company on April 20, 2017 of NASDAQ’s acceptance of the plan and the granting of an extension through August 7, 2017; however, because the Company was not able to comply with the Rule, NASDAQ has determined that the Company is not eligible for a second 180 calendar day extension to comply with the Rule.

  

The Company may request an appeal of this determination or be scheduled for delisting; the Company appealed the determination before the NASDAQ deadline and attended a hearing on June 15, 2017. The Company is awaiting a determination from the hearing.

  

There can be no assurance that the Company’s plans to comply with the required bid price, minimum shareholders’ equity, market value of listed securities or net income from continuing operations will be successful. There can also be no assurance that the Company’s appeal of the determination would be successful. If the Company’s Common Stock ceases to be listed for trading on the Nasdaq Capital Market, the Company expects that its Common Stock would be traded on the Over-the-Counter Bulletin Board on or about the same day.

 

Giga-tronics’ sales are substantially dependent on the defense industry

 

We have a significant number of defense-related orders. If the defense market demand decreases, actual shipments could be less than projected shipments with a resulting decline in sales. Our product backlog has a number of risks and uncertainties such as the cancellation or deferral of orders, dispute over performance and our ability to collect amounts due under these orders. If any of these events occur, actual shipments could be lower than projected shipments and revenues could decline which would have an adverse effect on our operating results and liquidity.

 

Giga-tronics’ markets involve rapidly changing technology and standards

 

The market for electronics equipment is characterized by rapidly changing technology and evolving industry standards. We believe that our future success will depend in part upon our ability to develop and commercialize our existing products, and in part on our ability to develop, manufacture and successfully introduce new products and product lines with improved capabilities, and to continue to enhance existing products. There can be no assurance that we will successfully complete the development of current or future products, or that such products will achieve market acceptance. The inability to develop new products in a timely manner could have a material adverse impact on our operating performance and liquidity.

 

Giga-tronics’ common stock price is volatile

 

The market price of our common stock could be subject to significant fluctuations in response to variations in quarterly operating results, reduction in revenues or lower earnings or increased losses and reduced levels of liquidity when compared to previous quarterly periods, and other factors such as announcements of technological innovations or new products by us or by our competitors, government regulations or developments in patent or other proprietary rights. In addition, NASDAQ and other stock markets have experienced significant price fluctuations in recent years. Some of these fluctuations often have been unrelated to the reported operating performance of the specific companies whose stocks are traded. Broad market fluctuations, as well as general foreign and domestic economic conditions, may adversely affect the market price of our common stock.

 

Our stock at any time has historically traded on low volume on the NASDAQ Capital Market. Sales of a significant volume of stock could result in a decline of our share price.

 

 
8

 

 

Performance problems in Giga-tronics’ products or problems arising from the use of its products together with other vendors’ products may harm its business and reputation

 

Products as complex as those we produce may contain unknown and undetected defects or performance problems. For example, it is possible that a product might not comply with stipulated specifications under all circumstances. In addition, our customers generally use our products together with their own products and products from other vendors. As a result, when problems occur in a combined environment, it may be difficult to identify the source of the problem. A defect or performance problem could result in lost revenues, increased warranty costs, diversion of engineering and management time and effort, impaired customer relationships and injury to our reputation generally. To date, performance problems in our products or in other products used together with our products have not had a material adverse effect on our business. However, management cannot be certain that a material adverse impact will not occur in the future.

 

Giga-tronics’ competition has greater resources

 

Our instrument, oscillator and synthesizer products compete with Agilent/Keysight, Anritsu, and Rohde & Schwarz. All these companies have substantially greater research and development, manufacturing, marketing, financial, and technological personnel and managerial resources than us. These resources also make these competitors better able to withstand difficult market conditions than us. There can be no assurance that any products developed by the competitors will not gain greater market acceptance than any developed by us.

 

Our ASG product is complex and could have unknown defects or errors, which may increase our costs, harm our reputation with customers, give rise to costly litigation, or divert our resources from other purposes.

 

Our new advanced signal generator product is extremely complex. Despite testing, our product has contained defects and errors and may in the future contain defects, errors, or performance problems when first introduced, when new versions or enhancements are released, or even after these products have been used by our customers for a period of time. These problems could result in expensive and time-consuming design modifications or warranty charges, delays in the introduction of new products or enhancements, significant increases in our service and maintenance costs, diversion of our personnel’s attention from our product development efforts, exposure to liability for damages, damaged customer relationships, and harm to our reputation, any of which could materially harm our results of operations. In addition, increased development and warranty costs could be substantial and could reduce our operating margins.

 

We are dependent on our management team and development and operations personnel, and the loss of one or more key employees or groups could harm our business and prevent us from implementing our business plan in a timely manner.

 

Our success depends substantially upon the continued services of our executive officers and other key members of management. From time to time, there may be changes in our executive management team resulting from the hiring or departure of executives. Such changes in our executive management team may be disruptive to our business. We are also substantially dependent on the continued service of our existing development and operations personnel because of the complexity of our service and technologies. The loss of one or more of our key employees or groups could seriously harm our business.

 

Impairment Loss on Capitalized Software Development Costs

 

The Company has capitalized certain software development costs. These costs are amortized over the expected life of the product and evaluated each reporting period for impairment. The Company examines the possibility of recovering the book value of assets based on the future cash flow to be generated from the asset. It may be necessary to recognize impairment of such asset if insufficient cash flow is generated.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

ITEM 2. PROPERTIES

 

Our principal executive office and the marketing, sales and engineering offices and manufacturing facilities was previously in a 47,300 square feet facility in San Ramon, California, which we occupied under a lease agreement that expired April 30, 2017. On January 5, 2017, we entered into a seventy-seven-month commercial building lease agreement for a 23,873 square feet facility in Dublin, California which began on April 1, 2017. In April 2017, we completed our move from the San Ramon facility to the Dublin facility. We believe that our Dublin facility is adequate for our business activities.

 

 
9

 

 

ITEM 3. LEGAL PROCEEDINGS

 

From time to time, the Company is involved in various disputes and litigation matters that arise in the ordinary course of business.

 

The Company is party to an Asset Purchase Agreement dated November 25, 2015 with Spanawave Corporation under which Spanawave agreed to purchase certain product lines and associated business and assets from the Company. The Company and Spanawave have been engaged in a dispute over their respective rights and obligations under the agreement and have negotiated in an effort to resolve the dispute. The agreement provides for an aggregate purchase of $1,500,000 which includes six phases plus the value of inventory. To date, the Company has received $375,000, against a contract price of $750,000, plus certain inventory payment for phases 1 through 5 of the subject businesses. Because of the dispute, the status of phase 6 (legacy signal generators), which has a contract price of another $750,000 plus the value of inventory is uncertain. On August 19, 2016, Spanawave filed an action against the Company in Contra Costa Superior Court for alleged breach of contract and alleged breach of the implied covenant of good faith and fair dealing. The complaint seeks specific performance of the agreement and damages. Spanawave’s affiliate Liberty Test Equipment also filed an arbitration claim for $440,000 under a distribution agreement between the Company and Liberty. The Company has filed cross-complaints in both the litigation and arbitration asserting breach of the respective agreements by Spanawave and Liberty. The Company had previously asserted that the distribution agreement does not extend to the products with respect to which the claim has been made. Certain customers of the lines of business sold to Spanawave are also customers of the Company’s ongoing ASG business. Continued disruption of the phase 6 signal generator business could have an adverse effect on the ASG business. The parties have negotiated in an effort to settle the dispute notwithstanding the filings. The expenses and potential liability of negotiation, any settlement or continued litigation or arbitration could have a material adverse effect on the Company.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable

 

PART II

 

ITEM 5. MARKET FOR COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER REPURCHASES OF EQUITY SECURITIES

 

Common Stock Market Prices

 

Our common stock is traded on the Nasdaq Capital Market using the symbol ‘GIGA’. The number of record holders of our common stock as of March 25, 2017 was approximately 114. A significantly larger number of stockholders may be "street name" or beneficial holders, whose shares of record are held by banks, brokers and other financial institutions. The table below shows the high and low closing bid quotations for the common stock during the indicated fiscal periods. These quotations reflect inter-dealer prices without mark-ups, mark-downs, or commission and may not reflect actual transactions.

    

  Fiscal Quarter   Fiscal Quarter  
 

2017

 

High

   

Low

 

2016

 

High

   

Low

 

First Quarter

(3/27 - 6/25)

  $ 1.47     $ 1.06  

(3/29 - 6/27)

  $ 3.15     $ 1.43  

Second Quarter

(6/26 - 9/24)

    1.15       0.93  

(6/28 - 9/26)

    1.89       1.04  

Third Quarter

(9/25 - 12/24)

    0.95       0.63  

(9/27 - 12/26)

    3.85       0.86  

Fourth Quarter

(12/25 - 3/25)

    1.07       0.65  

(12/27 - 3/26)

    1.85       1.11  

 

We have not paid cash dividends in the past and have no current plans to do so in the future, believing the best use of our available capital is in the enhancement of our product position. In addition, in the absence of positive retained earnings, California law permits payment of cash dividends only to the extent total assets exceed the sum of total liabilities and the liquidation preference amounts of preferred securities. At March 25, 2017, the Company’s assets were less than this sum by $1.7 million.

 

 
10

 

 

Equity Compensation Plan Information

 

The following table provides information on options and other equity rights outstanding and available at March 25, 2017.

 

Equity Compensation Plan Information

                       
                   

No. of

 
                   

securities

 
                   

remaining

 
                   

available for

 
                   

future issuance

 
                   

under equity

 
   

No. of

           

compensation

 
   

securities to be

   

Weighted

   

plans

 
   

issued upon

   

average

   

(excluding

 
   

exercise of

   

exercise price

   

securities

 
   

outstanding

   

of outstanding

   

reflected in

 
   

options

   

options

   

column (a))

 

Plan Category

 

(a)

   

(b)

   

(c)

 

Equity compensation plans approved by security holders (1)

    1,104,500     $ 1.41       1,285,127  

Equity compensation plans not approved by security holders

                n/a  

Total

    1,104,500     $ 1.41       1,285,127  

 

 

(1)

Excludes warrants issued to purchasers of units consisting of stock and warrants in private placements, to a placement agent for services in connection with a private placement and to lenders in connection with debt financing.

 

Issuer Repurchases

 

We did not repurchase any of our equity securities during the fiscal year ended March 25, 2017.

 

ITEM 6. SELECTED FINANCIAL DATA

 

Pursuant to Item 301(c) of Regulation S-K., the Company, as a smaller reporting company, is not required to provide the information required by this item.

 

 
11

 

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS

 

Overview and Refocusing Giga-tronics

 

We produce sophisticated test and measurement equipment primarily used in the aerospace and defense markets. We also produce YIG (Yttrium, Iron, Garnet) RADAR filters used in fighter jet aircraft. We have two reporting segments: Giga-tronics Division and Microsource.

 

 

The Giga-tronics Division over the past thirty-five years has produced a broad line of test and measurement equipment used primarily for the design, production, repair and maintenance of products in aerospace, telecommunications, RADAR, and electronic warfare. Giga-tronics has recently completed a move within the test and measurement market from its legacy products to the newly developed ASG product. As part of this evolution certain legacy product lines were sold to raise additional capital. For example, we sold our SCPM product line to Teradyne in 2013, and in December of 2015, Giga-tronics sold its Power Meters, Amplifiers, and Legacy Signal Generators to Spanawave (see Note 10, Sale of Product Lines). In June of 2016, Giga-tronics sold its Switch product line to Astronics (see Note 10, Sale of Product Lines). With the sales of these legacy product lines, the Giga-tronics Division is solely focused on the ASG product in the test and measurement equipment market.

 

 

Microsource primarily develops and manufactures YIG RADAR filters used in fighter jet aircraft for two prime contractors. The Microsource YIG RADAR filters provide us with long term production and development contracts with strong gross margins.

 

The ASG has the potential to significantly grow our sales and achieve strong gross margins. However, we have experienced significant delays developing, manufacturing, and receiving ASG customer orders. The ASG is the most technically complex and advanced product Giga-tronics has developed and manufactured, and we have experienced delays in bringing the product to market and efficiently manufacturing it. It is also priced significantly higher than any other previous Giga-tronics product, and we have experienced longer than anticipated procurement cycles in the electronic warfare market it services. The delays in the refinement and manufacturing of the ASG, along with the longer than anticipated procurement cycles, have contributed to the increased operating losses in fiscal 2017 and prior years. Giga-tronics could continue to experience similar losses in the current fiscal year if there are further delays in ASG features currently being refined, manufacturing efficiencies are not achieved, and customer orders are delayed. To bring the ASG to its full potential, Giga-tronics may be required to seek additional working capital; however, there are no assurances that such working capital will be available, or on terms acceptable to the Company.   

 

Significant Orders

 

Both the Giga-tronics Division and Microsource receive large customer orders each year. The timing of orders, and any associated milestones achievement, causes significant differences in orders received, backlog, sales, deferred revenue, inventory and cash flow when comparing one fiscal period to another. Below is a review of recently received significant orders:

 

In the first quarter of fiscal 2016, the Microsource business unit received a $3.0 million YIG RADAR filter order (Ongoing Production Order) associated with a fighter jet platform for which we have been manufacturing since fiscal 2014. We shipped all the $3.0 million order in fiscal 2016. In the first quarter of fiscal 2017, the Microsource business unit received a $4.5 million YIG RADAR filter order for the same fighter jet platform, representing a 50% year over year increase in the order size compared to the fiscal 2016 order. We shipped approximately $4.1 million of the fiscal 2017 order, and we expect to ship the remainder in the first quarter of fiscal 2018.

 

In June 2016, the Giga-tronics Division received a $3.3 million order from the United States Navy for our Real-Time Threat Emulation System (TEmS) which is a combination of the ASG hardware platform, along with software developed and licensed to the Company from a major Aerospace and Defense Company. The complete order included ASG blades, along with engineering services to integrate the Real-Time TEmS product with additional third party hardware and software for the customer. We fulfilled the order during the fourth quarter of the current fiscal year. An additional order for $542,000 was received in July 2016 from the United States Navy for our ASG hardware only platform. We fulfilled the $542,000 order in the second quarter of fiscal 2017.

 

In July 2016, Microsource received a $1.9 million non-recurring engineering order associated with redesigning a component of its high performance YIG filter used on an aircraft platform. Of this NRE service order, we delivered approximately $884,000 in services during the fiscal year ended March 25, 2017, and we expect to continue such services over the next nine to twelve months.

 

 
12

 

 

In December 2016, the Giga-tronics Division received a $764,000 Real-Time TEmS order from one of our customers. The order was fulfilled in the third quarter ended December 24, 2016.

 

In March 2017, Microsource received a $404,000 YIG RADAR filter order from one of our customers. We expect to fulfil this order in fiscal 2018.

 

In October 2015, the Giga-tronics Division received a $1.4 million order from a major prime contractor for our ASG. In January 2016, a $433,000 ASG follow-on order was received from the major prime contractor. We delivered these chassis and blades in December 2015 and April 2016, respectively.

 

Our Giga-tronics Division received a $1.5 million order in the first quarter of fiscal 2016 from the United States Navy for our legacy Model 8003 Precision Scalar Analyzers and associated accessories. We shipped all of the $1.5 million order in the first and second quarters of fiscal 2016. The Model 8003 was designed about 25 years ago, and Giga-tronics is no longer able to purchase key components and materials used to manufacture the Model 8003. The Navy orders marked the end of life of the Model 8003 and its associated accessories.

 

In fiscal 2015 Microsource received a $6.5 million order (“NRE Order”) for non-recurring engineering and for delivery of a limited number of flight-qualified prototype hardware from a second prime defense contractor to develop a variant of our high performance fast tuning YIG RADAR filters for an aircraft platform. We completed the final milestone for the NRE Order in the second quarter of fiscal 2017. In fiscal 2016 our Microsource business unit also finalized an associated multiyear $10.0 million YIG production order (“YIG Production Order”). We started shipping a portion of the YIG Production Order in the second quarter of fiscal 2017, and we expect to continue shipping the balance through fiscal 2020.

 

Most of the deliverables under the Microsource NRE Order occurred in fiscal 2015 and early fiscal 2016. We started delivering the flight-qualified prototype hardware in the second quarter of fiscal 2017.

 

Results of Operations

 

New orders by reporting segment are as follows for the fiscal years ended:

 

New orders

                 

% change

 

(Dollars in thousands)

  2017    

2016

   

2017

vs.

2016

   

2016

vs.

2015

 

Giga-tronics Division

  $ 7,527     $ 9,668       (22 )%     7 %

Microsource

    7,567       13,739       (45 )%     63 %

Total

  $ 15,094     $ 23,427       (36 )%     34 %

 

New orders received in fiscal 2017 decreased by 36% to $15.1 million from the $23.4 million received in fiscal 2016. The Giga-tronics Division saw a 22% decrease in orders primarily due to the decreasing orders for the legacy and switch products which the Company no longer manufactures. The Microsource business unit saw a 45% decrease in fiscal 2017 primarily due to the receipt of a $4.5 million order for YIG RADAR filters and the receipt of a $1.9 million non-recurring engineering order in comparison to the larger $10.0 million YIG Production Order and the $3.0 million Ongoing Production Order received in fiscal 2016. 

 

New orders received in fiscal 2016 increased 34% to $23.4 million from the $17.5 million received in fiscal 2015. The increase in orders was primarily due to Microsource’s receipt of the $10.0 million YIG Production Order and the $3.0 million Ongoing Production Order in fiscal 2016, compared to the $6.5 million NRE order in fiscal 2015. The increase in the Giga-tronics Division was primarily due to the $2.3 million increase of orders for the ASG, partially offset by the decrease in the Navy 8003 order, and by decreasing orders for legacy products being sold to Spanawave Corporation (See Note 10, Sale of Product Lines).

 

 
13

 

 

The following table shows order backlog and related information at fiscal year-end:

 

Backlog                   % change  
                   

2017

vs.

   

2016

vs.

 

(Dollars in thousands)

 

2017

   

2016

   

2016

   

2015

 

Backlog of unfilled orders

  $ 11,364     $ 14,560       (22 )%     154 %

Backlog of unfilled orders shippable within one year

    5,680       5,984       (5 )%     15 %

Backlog of unfilled orders shippable after one year

    5,684       8,576       (34 )%     1546 %

 

 

Backlog at the end of fiscal 2017 decreased 22% compared to the end of fiscal 2016. The decrease in backlog is primarily due to the completion of the NRE order for the Microsource reporting segment as well as the fulfillment of ASG orders for the Giga-tronics division. Backlog also decreased due to the fulfillment of the legacy and switch product lines as the Company sold these products lines in fiscal 2017.

 

The allocation of net sales by reporting segment was as follows for the fiscal years shown:

 

Allocation of Net Sales                   % change  
                   

2017

vs.

   

2016

vs.

 

(Dollars in thousands)

 

2017

   

2016

   

2016

   

2015

 

Giga-tronics Division

  $ 8,021     $ 8,679       (8 )%     (5 )%

Microsource

    8,246       5,917       39 %     (37 )%

Total

  $ 16,267     $ 14,596       11 %     (21 )%

 

Net sales for the fiscal year ended March 25, 2017 were $16.3 million, an increase of 11%, compared to $14.6 million for the fiscal year ended March 26, 2016. Microsource saw an increase of approximately $2.3 million in net sales, from $5.9 million in fiscal 2016 to $8.2 million in fiscal 2017. The increase in net sales for Microsource over the prior fiscal year was primarily due to an increase in YIG RADAR filter shipments and completion of certain related nonrecurring engineering (NRE) services.

 

The Giga-tronics division saw a decrease of approximately $700,000 in net sales, from $8.7 million in fiscal 2016 to $8.0 million in fiscal 2017. The decrease in net sales for the Giga-tronics division over the prior fiscal year was primarily due to lower legacy product sales mainly due to recent product line divestitures which was partially offset by an increase in the ASG product shipments. In fiscal 2017, the Company recorded $5.2 million of sales associated with the ASG product compared to $1.8 million recorded in fiscal 2016.

 

Net sales in fiscal 2016 were $14.6 million, a 21% decrease from $18.5 million in fiscal 2015. Sales for the Giga-tronics Division decreased 5%, or $444,000, primarily due to the $1.2 million decrease in the legacy products sold to Spanawave Corporation (See Note 10, Sale of Product Lines), the $905,000 decrease in the size of the Navy 8003 order in fiscal 2016, which were partially offset by a $1.3 million increase in ASG shipments and a $383,000 increase in 4600 Switch product shipments. Net sales for Microsource decreased 37% primarily due to the winding down of the NRE Order.

 

The allocation of gross margins by reporting segment was as follows for the fiscal years shown:

 

Gross Margin                   % change  
                   

2017

vs.

   

2016

vs.

 

(Dollars in thousands)

 

2017

   

2016

   

2016

   

2015

 

Giga-tronics Division

  $ 1,512     $ 2,360       (36 )%     (33 )%

Microsource

    3,039       2,261       34 %     (50 )%

Total

  $ 4,551     $ 4,621       (2 )%     (42 )%

 

Gross margin remained relatively flat year over year. The Giga-tronics gross margin was negatively impacted by inventory parts which were transferred to Astronics and Spanawave at cost, non-cash charges totaling approximately $477,000 associated with the amortization of capitalized software costs as the Company started shipping its ASG TEmS units in fiscal 2017 and unabsorbed factory overhead variances. The increase in Microsource gross margin was primarily due to the increase in net sales.

 

 
14

 

 

Gross margin decreased in fiscal 2016 to $4.6 million from $8.0 million for fiscal 2015. The decrease in Giga-tronics gross margin was due to rework associated with the initial pilot manufacturing run of the ASG, and overhead being absorbed by fewer shipments. The decrease in Microsource was primarily due to the decrease in net sales associated with the NRE Order, which had a lower cost of sales compared to product sales and overhead being absorbed by fewer shipments.

 

Operating expenses were as follows for the fiscal years shown:

 

Operating Expenses

                 

% change

 

(Dollars in thousands)

 

2017

   

2016

   

2017

vs.

2016

   

2016

vs.

2015

 

Engineering

  $ 2,254     $ 2,806       (20 )%     (13 )%

Selling, general and administrative

    4,641       5,522       (16 )%     15 %

Total

  $ 6,895     $ 8,328       (17 )%     44 %

 

Operating expenses decreased 17%, or $1.4 million in fiscal 2017 compared to fiscal 2016. Engineering expenses decreased $552,000 during fiscal 2017 when compared to fiscal 2017 primarily due to a decrease in personnel related expenses as a result of the sale of the Switch and Legacy product lines. Engineering expenses were also lower in fiscal 2017 due to certain engineers having been assigned to a Microsource nonrecurring engineering project that is recorded as cost of sales. Selling, general and administrative expenses decreased 16% or $881,000 primarily due to a decrease of $631,000 associated with the non-cash stock based compensation (primarily in connection with director compensation); a decrease in outside services related to management consulting, and a decrease in bonuses and commissions as a result of the sale of the legacy products to Astronics and Spanawave.

 

Operating expenses increased 4%, or $335,000 in fiscal 2016 compared to fiscal 2015. Engineering expenses decreased $404,000 during fiscal 2016 when compared to fiscal 2015 primarily due to development costs incurred in fiscal 2015 associated with the Switch product. Selling, general and administrative expenses increased 15% or $739,000 primarily due to a $200,000 increase in outside services related to financial services and management consulting, a $167,000 increase in sales and marketing efforts associated with our new ASG, a $155,000 increase in officer salaries, and a $113,000 increase in non-cash stock based compensation.

 

Derivative Liability

 

In fiscal 2017, we recorded a gain of $131,000 related to revaluation of the derivative liability, associated with warrants issued with the PFG Loan. In fiscal 2016, we recorded a loss of $12,000 related to revaluation of the derivative liability, associated with warrants issued with the PFG Loan (see Note 8, Term Loan, Revolving Line of Credit and Warrants).

 

Gain on Sale of Product Line

 

On June 20, 2016, the Company entered into an Asset Purchase agreement for the sale of its Switch product line to Astronics. Upon signing the agreement, Astronics paid $850,000 to the Company for the intellectual property of the product line. The Company recognized a net gain of $802,000 in the first quarter ended June 25, 2016 after related expenses were subtracted from the sales price. The gain is included in the accompanying consolidated financial statements (see Note 10, Sale of Product Lines).

 

Net Interest Expense

 

Net interest expense in fiscal 2017 was $133,000 a decrease of $250,000 over fiscal 2016. Interest expense decreased in fiscal 2017 over fiscal 2016 primarily due to the lower principal balances on the PFG loan. For fiscal 2017, interest expense includes $22,000 of accretion of discounts on the PFG Loan and Warrant Debt compared to $165,000 recorded in fiscal 2016 (see Note 8, Term Loan, Revolving Line of Credit and Warrants).

 

Net Loss

 

Net loss was $1.5 million in fiscal 2017, compared to a net loss of $4.1 million in fiscal 2016. The lower net loss recorded in fiscal 2017 was primarily due to increased revenues as well as lower operating expenses discussed above. Net loss was also lower due to the $802,000 gain recorded associated with the sale of the Switch product line in the first quarter of fiscal 2017 as discussed above.

 

 
15

 

 

Net Inventories 

 

Inventories consisted of the following:

 

Net Inventories

                 

% change

 
   

March 25,

   

March 26,

   

2017

vs.

 

(Dollars in thousands)

 

2017

   

2016

   

2016

 

Raw materials

  $ 1,775     $ 3,489       (49 )%

Work-in-progress

    2,155       2,156        

Finished goods

    473       2       2355 %

Demonstration inventory

    408       47       768 %

Total

  $ 4,811     $ 5,694       (16 )%

 

Net inventories decreased by $883,000 from March 26, 2016 to March 25, 2017. Raw materials inventory decreased primarily due to the sale of the legacy and switch product lines. The increase in finished goods inventory is primarily driven by the timing of YIG filter production, demonstration inventory increased due to the addition of demo units to support ASG sales efforts.

 

Financial Condition and Liquidity

 

As of March 25, 2017, Giga-tronics had $1.4 million in cash and cash-equivalents, compared to $1.3 million as of March 26, 2016. Working capital at the end of fiscal year 2017 was $620,000 as compared to $1.8 million at the end of fiscal year 2016. The current ratio (current assets divided by current liabilities) at March 25, 2017 was 1.09 as compared to 1.23 at March 26, 2016. The fiscal 2017 decrease in working capital was primarily attributable to our net losses.

 

Cash used in operating activities was $56,000 in fiscal 2017. Cash used in operating activities is primarily attributable to our net loss, a decrease of $1.2 million in accounts receivable, a decrease of $817,000 in accounts payable, a decrease of $883,000 in inventory and a decrease of $810,000 in deferred revenue. These were partially offset by non-cash charges of $286,000 for stock based compensation and $827,000 for depreciation and amortization. Cash used in operating activities was $3.0 million in fiscal 2016. Cash used in operating activities was primarily due to the net loss of $4.1 million, partially offset by non-cash charges of $925,000 for stock based compensation, $321,000 for depreciation and amortization, and $165,000 for accretion of discounts on loan and warrant debt.

 

Cash provided by investing activities was $809,000. Cash provided by investing activities in fiscal 2017 resulted primarily from a cash payment from Astronics of $850,000 pertaining to the sale of our Switch product line, as well as a cash payment from Spanawave of $750,000 pertaining to the sale of our legacy product lines. The Company and Spanawave have been engaged in a dispute as to whether the Company has fulfilled all the requirements to close phases one through five and to the application of $375,000 related to the proposed commencement of phase 6 which was received during the first quarter of fiscal 2017. The parties are attempting to resolve this dispute, and the Company returned the $375,000 to Spanawave on July 28, 2016. The cash payments were partially offset by additions to property and equipment of $41,000. Cash provided by investing activities was $183,000 and included $375,000 received from Spanawave for the initiation of data transfer pertaining to the sale of our legacy product lines as well as additions to property and equipment of $192,000 in fiscal 2016 compared to $16,000 in fiscal 2015. The additions in both fiscal 2017 and fiscal 2016 were associated with equipment required to manufacture the ASG.

 

Cash used in financing activities in fiscal year 2017 was $663,000, primarily due to the repayment of the Company’s term loan with PFG and a portion of the line of credit with Bridge Bank. Cash provided by financing activities in fiscal year 2016 was $3.0 million, primarily due to $3.1 million in net proceeds from a Private Placement completed in the fourth quarter of fiscal 2016.

 

On January 29, 2016, we consummated the sale of 2,787,872 Units, each consisting of one share of common stock and a warrant to purchase 0.75 shares of common stock, to approximately 20 private investors pursuant to a Securities Purchase Agreement dated as of January 19, 2016. The purchase price for each Unit was $1.24375. Gross proceeds were approximately $3.5 million. Net proceeds to the Company after fees were approximately $3.1 million. The portion of the purchase price attributable to the common shares included in each Unit was $1.15, the consolidated closing bid price for the Company’s common stock on January 15, 2016. The warrant price was $.09375 per Unit (equivalent to $0.125 per whole warrant share), with an exercise price of $1.15 per share. The term of the warrants is five years from the date of completion of the transaction.

 

 
16

 

 

Emerging Growth Equities, Ltd also received warrants to purchase 292,727 shares of common stock as part of its consideration for serving as placement agent in connection with the private placement.

 

We incurred net losses of $1.5 million for fiscal 2017, which have contributed to an accumulated deficit of $25.6 million as of March 25, 2017.

 

We experienced delays in the development of features, orders, and shipments for the new ASG. These delays have significantly contributed to a decrease in working capital from $1.8 million on March 26, 2016, to $620,000 on March 25, 2017. The new ASG product has now shipped to several customers, but potential delays in the refinement of features, longer than anticipated sales cycles, or the ability to efficiently manufacture the ASG, could significantly contribute to additional future losses and decreases in working capital.

 

To help fund operations, we rely on advances under the line of credit with Bridge Bank. The line of credit which expired on May 7, 2017, was renewed through May 6, 2019 (see Note 20, Subsequent Events). The agreement includes a subjective acceleration clause, which allows for amounts due under the facility to become immediately due in the event of a material adverse change in our business condition (financial or otherwise), operations, properties or prospects, or ability to repay the credit based on the lender’s judgement. As of March 25, 2017, outstanding borrowings and additional borrowing capacity under the line of credit were $582,000 and $234,000, respectively.

 

These matters raise substantial doubt as to our ability to continue as a going concern.

 

To address these matters, our management has taken several actions to provide additional liquidity and reduce costs and expenses going forward. These actions are described in the following paragraphs:

 

In July 2016, Microsource received a $1.9 million non-recurring engineering order associated with redesigning a component of its high performance YIG filter used on an aircraft platform. The Company delivered NRE services for approximately $884,000 during fiscal 2017 and we expect to continue such services over the next nine to twelve months.

   

On April 27, 2017, we entered into a loan agreement with Partners For Growth V, L.P. (“PFG”). Under the terms of the agreement, PFG made a term loan to the Company in the principal amount of $1,500,000, with funding occurring on April 28, 2017. The loan has a two-year term, with interest only payments for the term of the loan (see Note 20, Subsequent Events).

   

With the elimination of Giga-tronics Switch, Power Meter, Amplifier, and Signal Generator legacy product lines resulting from the Asset Purchase Agreements with Spanawave and Astronics, (see Note 10, Sale of Product Lines), we have been able to reduce the number of employees from 71 in fiscal 2016 to 57 in fiscal 2017, while providing additional cash for operations from the proceeds of the sales. We are also anticipating reductions in overhead costs by relocating our operations into a smaller facility beginning in fiscal 2018.

   

In May 2017, we renewed our accounts receivable line of credit with Bridge Bank through May 6, 2019.

   

In the first quarter of fiscal 2016, the Company’s Microsource business unit also finalized a multiyear $10.0 million YIG Production Order. We started shipping the YIG Production Order in the second quarter of fiscal 2017, and we expect to ship the remainder through fiscal 2020.

   

To assist with the upfront purchases of inventory required for future product deliveries, the Company entered into advance payment arrangements with certain customers, whereby the customers reimburse the Company for raw material purchases prior to the shipment of the finished products. The Company will continue to seek similar terms in future agreements with these customers and other customers.

 

Management will continue to review all aspects of the business in an effort to improve cash flow and reduce costs and expenses, while continuing to invest, to the extent possible, in new product development for future revenue streams.

 

 
17

 

 

Management will also continue to seek additional working capital through product line sales, debt, or possible equity financing. However, there are no assurances that such financings or sales will be available at all, or on terms acceptable to the Company.

 

Our historical operating results and forecasting uncertainties indicate that substantial doubt exists related to our ability to continue as a going concern. Management believes that through the actions to date and possible future actions described above, we should have the necessary liquidity to continue operations at least twelve months from the issuance of the financial statements. However, we cannot predict, with certainty, the outcome of our actions to generate liquidity, including the availability of additional financing, or whether such actions would generate the expected liquidity as currently planned. Forecasting uncertainties also exist with respect to the ASG product line due to the potential longer than anticipated sales cycles, as well as with potential delays in the refinement of certain features, and/or our ability to efficiently manufacture it in a timely manner.

 

Therefore, the accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern; however, the above conditions raise substantial doubt about the Company’s ability to do so. The accompanying Consolidated Financial Statements do not include any adjustments that might result if we were unable to do so.

 

Contractual Obligations

 

We leased our San Ramon facility under an operating lease that expired in April 2017. On January 5, 2017, we entered a seventy-seven-month commercial building lease agreement for a 23,873 square feet facility in Dublin, California. The new lease began on April 1, 2017. We also lease certain equipment under operating leases. Total future minimum lease payments under these leases amount to approximately $2.9 million, of which $421,000 is scheduled to be paid in fiscal 2018.

 

We lease equipment under capital leases that expire through September 2020. The future minimum lease payments under these leases are approximately $202,000.

 

We are committed to purchase certain inventory under non-cancelable purchase orders. As of March 25, 2017, total non– cancelable purchase orders were approximately $541,000 and are scheduled to be delivered to the Company at various dates through March 2018.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and the results of operations are based upon the consolidated financial statements included in this report and the data used to prepare them. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and management is required to make judgments, estimates and assumptions in the course of such preparation. The Summary of Significant Accounting Policies included with the consolidated financial statements describes the significant accounting policies and methods used in the preparation of the consolidated financial statements. On an ongoing basis, we re-evaluate our judgments, estimates and assumptions. We base our judgment and estimates on historical experience, knowledge of current conditions, and our beliefs of what could occur in the future considering available information. Actual results may differ from these estimates under different assumptions or conditions. We have identified the following as our critical accounting policies:

 

Revenue Recognition

 

Revenues are recognized when there is evidence of an arrangement, delivery has occurred, the price is fixed or determinable, and collectability is reasonably assured. This generally occurs when products are shipped and the risk of loss has passed. Revenue related to products shipped subject to customers’ evaluation is recognized upon final acceptance. Revenue recognized under the milestone method is recognized once milestones are met. Determining whether a milestone is substantive is a matter of judgment and that assessment is performed only at the inception of the arrangement. The consideration earned from the achievement of a milestone must meet all of the following for the milestone to be considered substantive:

 

 

a.

It is commensurate with either of the following:

 

1.

Our performance to achieve the milestone

 

2.

The enhancement of the value of the delivered item or items as a result of a specific outcome resulting from our performance to achieve the milestone.

 

b.

It relates solely to past performance.

 

c.

It is reasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement.

 

 
18

 

 

Milestones for revenue recognition are agreed upon with the customer prior to the start of the contract and some milestones will be tied to product shipping while others will be tied to design review.

 

On certain contracts with one of our significant customers we receive payments in advance of manufacturing. Advanced payments are recorded as deferred revenue until the revenue recognition criteria described above have been met.

 

Product Warranties

 

Our warranty policy generally provides one to three years of coverage depending on the product. We record a liability for estimated warranty obligations at the date products are sold. The estimated cost of warranty coverage is based on our actual historical experience with our current products or similar products. For new products, the required reserve is based on historical experience of similar products until sufficient historical data has been collected on the new product. Adjustments are made as new information becomes available.

 

Accounts Receivable and Allowance for Doubtful Accounts

 

Accounts receivable are stated at their net realizable values. We have estimated an allowance for uncollectible accounts based on our analysis of specifically identified problem accounts, outstanding receivables, consideration of the age of those receivables, our historical collection experience, and adjustments for other factors management believes are necessary based on perceived credit risk.

 

Inventory

 

Inventories are stated at the lower of cost or market. Cost is determined on a first-in, first-out basis. We periodically review inventory on hand to identify and write down excess and obsolete inventory based on estimated product demand.

 

Income Taxes

 

Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Future tax benefits are subject to a valuation allowance when management is unable to conclude that its deferred tax assets will more likely than not be realized. The ultimate realization of deferred tax assets is dependent upon generation of future taxable income during the periods in which those temporary differences become deductible. Management considers both positive and negative evidence and tax planning strategies in making this assessment.

 

We consider all tax positions recognized in the consolidated financial statements for the likelihood of realization. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the positions taken or the amounts of the positions that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above, if any, would be reflected as unrecognized tax benefits, as applicable, in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. We also recognize accrued interest and penalties, if any, related to unrecognized tax benefits as a component of the provision for income taxes in the consolidated statements of operations.

 

 
19

 

 

Share Based Compensation

 

We have a stock incentive plan that provides for the issuance of stock options and restricted stock to employees and directors. We calculate share based compensation expense for stock options using a Black-Scholes-Merton option pricing model and record the fair value of stock option and restricted stock awards expected to vest over the requisite service period. In so doing, we make certain key assumptions in making estimates used in the model. We believe the estimates used, which are presented in the Notes to Consolidated Financial Statements, are appropriate and reasonable.

 

Going Concern

 

We evaluate our relevant conditions and events that are known and reasonably knowable at the date that our financial statements are issued. This includes Management’s preparation and review of a forecasting process that evaluates a twelve-month horizon period post issuance of the consolidated financial statements. Management responds to the known and reasonably knowable circumstances that give rise to our initial doubt as a going concern by implementing plans that are reasonably sufficient to overcome the conditions that give rise to our ability to continue as a going concern. Our Consolidated Financial Statements have been prepared assuming we will continue as a going concern and do not include any adjustments that might result if we were unable to do so.

 

Software Development Costs

 

We expense development costs included in the research and development of new products and enhancements to existing products as incurred, until technological feasibility in the form of a working model has been established. Development costs of computer software to be sold, leased, or otherwise marketed are subject to capitalization beginning when our product’s technological feasibility has been established and ending when the product is available for general release to our customers.

 

Discontinued Operations 

 

We review reporting and presentation requirements for discontinued operations in accordance with the guidance provided by ASC 205-20 as we move to newer technology within the test and measurement market from legacy products to the newly developed Advanced Signal Generator. The disposal of these product line sales represent an evolution of the Company’s Giga-tronics Division to a more sophisticated product offered to the same customer base. The Company has evaluated the sales of product lines (see Note 10, Sale of Product Lines) concluding that each product line does not meet the definition of a “component of an entity” as defined by ASC 205-20.We are able to distinguish revenue and gross margin information as disclosed in Note 10, Sale of Product Lines to the accompanying financial statements; however, operations and cash flow information is not clearly distinguishable and the company is unable to present meaningful information about results of operations and cash flows from those product lines.

 

 
20

 

 

Off-Balance-Sheet Arrangements

 

We have no other off-balance-sheet arrangements (including standby letters of credit, guaranties, contingent interests in transferred assets, contingent obligations indexed to its own stock or any obligation arising out of a variable interest in an unconsolidated entity that provides credit or other support to the Company), that have or are likely to have a material effect on its financial conditions, changes in financial conditions, revenue, expense, results of operations, liquidity, capital expenditures or capital resources.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Pursuant to Item 305 of Regulation S-K, the Company, as a smaller reporting company, is not required to provide the information required by this item.

 

 
21

 

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

INDEX TO FINANCIAL STATEMENTS AND SCHEDULES

 

 

Financial Statements

Page

   

Consolidated Balance Sheets - As of March 25, 2017 and March 26, 2016 

23

   

Consolidated Statements of Operations - Years ended March 25, 2017 and March 26, 2016 

24

   

Consolidated Statements of Shareholders’ Equity - Years ended March 25, 2017 and March 26, 2016 

25

   

Consolidated Statements of Cash Flows - Years ended March 25, 2017 and March 26, 2016 

26

   

Notes to Consolidated Financial Statements

27-46

   

Report of Independent Registered Public Accounting Firm

47

 

 
22

 

 

GIGA-TRONICS INCORPORATED

CONSOLIDATED BALANCE SHEETS

 

(In thousands except share data)

 

March 25,

2017

   

March 26,

2016

 

Assets

               

Current assets:

               

Cash and cash-equivalents

  $ 1,421     $ 1,331  

Trade accounts receivable, net of allowance of $45, respectively

    954       2,129  

Inventories, net

    4,811       5,694  

Prepaid expenses and other current assets

    452       318  

Total current assets

    7,638       9,472  

Property and equipment, net

    528       837  

Other long term assets

    175       8  

Capitalized software development costs, net

    733       876  

Total assets

  $ 9,074     $ 11,193  

Liabilities and shareholders' equity

               

Current liabilities:

               

Line of credit

  $ 582     $ 800  

Current portion of long term debt, net of discount

          370  

Accounts payable

    1,107       1,924  

Accrued payroll and benefits

    583       647  

Deferred revenue

    3,614       2,804  

Deferred rent

          110  

Capital lease obligations

    50       44  

Deferred Liability related to asset sale

    375       375  

Other current liabilities

    707       621  

Total current liabilities

    7,018       7,695  

Warrant liability, at estimated fair value

    222       353  

Long term obligations - capital lease

    114       165  

Total liabilities

    7,354       8,213  

Commitments and contingencies

               

Shareholders' equity:

               

Convertible preferred stock of no par value; Authorized - 1,000,000 shares

               

Series A - designated 250,000 shares; no shares at March 25, 2017 and March 26, 2016 issued and outstanding

           

Series B, C, D- designated 19,500 shares; 18,533.51 shares at March 25, 2017 and March 26, 2016 issued and outstanding; (liquidation preference of $3,540 at March 25, 2017 and March 26, 2016)

    2,911       2,911  

Common stock of no par value; Authorized - 40,000,000 shares; 9,594,203 shares at March 25, 2017 and 9,549,703 at March 26, 2016 issued and outstanding

    24,390       24,104  

Accumulated deficit

    (25,581 )     (24,035 )

Total shareholders' equity

    1,720       2,980  

Total liabilities and shareholders' equity

  $ 9,074     $ 11,193  

 

See Accompanying Notes to Consolidated Financial Statements

 

 
23

 

 

GIGA-TRONICS INCORPORATED

CONSOLIDATED STATEMENTS OF OPERATIONS

 

      Years Ended  
      March 25,       March 26,  
(In thousands except per share data)     2017       2016  
                 

Net sales

  $ 16,267     $ 14,596  

Cost of sales

    11,716       9,975  

Gross margin

    4,551       4,621  
                 

Operating expenses:

               

Engineering

    2,254       2,806  

Selling, general and administrative

    4,641       5,522  

Total operating expenses

    6,895       8,328  
                 

Operating loss

    (2,344 )     (3,707 )
                 

Gain/(loss) on adjustment of warrant liability to fair value

    131       (12 )

Other (expense) income (Gain on sale of product line)

    802        

Interest expense:

               

Interest expense, net

    (111 )     (218 )

Interest expense from accretion of loan discount

    (22 )     (165 )

Total interest expense, net

    (133 )     (383 )

Loss before income taxes

    (1,544 )     (4,102 )

Provision for income taxes

    2       2  

Net loss

  $ (1,546 )   $ (4,104 )
                 

Loss per common share - basic

  $ (0.16 )   $ (0.59 )

Loss per common share - diluted

  $ (0.16 )   $ (0.59 )
                 

Weighted average common shares used in per share calculation:

               

Basic

    9,550       6,941  

Diluted

    9,550       6,941  

 

See Accompanying Notes to Consolidated Financial Statements

 

 
24

 

 

GIGA-TRONICS INCORPORATED

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

 

   

Preferred Stock

   

Common Stock

   

Accumulated

         
(In thousands except share data)   Shares     Amount     Shares     Amount     Deficit     Total  

Balance at March 28, 2015

    18,534     $ 2,911       6,706,065     $ 19,975     $ (19,931 )   $ 2,955  

Net loss

                                    (4,104 )     (4,104 )

Option exercises

                    48,550       77               77  

Share based compensation

                            925               925  

Shares issued for net settlement of warrant

                    7,216                      

Proceeds from common offering, net of issuance cost

                    2,787,872       3,127               3,127  

Balance at March 26, 2016

    18,534       2,911       9,549,703       24,104       (24,035 )     2,980  

Net loss

                                    (1,546 )     (1,546 )

Restricted stock granted

                    44,500                        

Share based compensation

                            286               286  

Balance at March 25, 2017

    18,534     $ 2,911       9,594,203     $ 24,390     $ (25,581 )   $ 1,720  

 

See Accompanying Notes to Consolidated Financial Statements

 

 
25

 

 

GIGA-TRONICS INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(In thousands)

 

March 25,

2017

   

March 26,

2016

 

Cash flows from operating activities:

               

Net loss

  $ (1,546 )   $ (4,104 )

Adjustments to reconcile net loss to net cash used in operating activities:

               

Depreciation and amortization

    827       321  

Share based compensation

    286       925  

Accretion of discounts on debt and amortization of issuance costs

    30       165  

Adjustment of warrant liability to fair value

    (131 )     12  

Capitalized software development costs

    (334 )     (876 )

Change in other long term assets

    (167 )     66  

Gain on sale of product line

    (802 )      

Change in deferred rent

    (110 )     (128 )

Changes in operating assets and liabilities:

               

Trade accounts receivable

    1,175       225  

Inventories

    883       (2,329 )

Prepaid expenses and other assets

    (134 )     (3 )

Accounts payable

    (817 )     915  

Accrued payroll and benefits

    (64 )     (31 )

Deferred revenue

    810       1,677  

Other current liabilities

    38       120  

Net cash used in operating activities

    (56 )     (3,045 )
                 

Cash flows from investing activities:

               

Purchases of property and equipment

    (41 )     (192 )

Cash received from sale of product line

    1,225       375  

Cash returned related to sale of product line

    (375 )      

Net cash provided by investing activities

    809       183  
                 

Cash flows from financing activities:

               
                 

Proceeds from exercise of stock options

          77  

Payments on capital leases

    (45 )     (81 )

Proceeds from line of credit

          1,800  

Repayments of line of credit

    (218 )     (1,000 )

Repayments of debt

    (400 )     (900 )

Proceeds from issuance of common stock, net of issuance costs of $278

          3,127  

Net cash (used in) provided by financing activities

    (663 )     3,023  
                 

Increase in cash and cash-equivalents

    90       161  
                 

Beginning cash and cash-equivalents

    1,331       1,170  

Ending cash and cash-equivalents

  $ 1,421     $ 1,331  
                 

Supplementary disclosure of cash flow information:

               

Cash paid for income taxes

  $ 2     $ 2  

Cash paid for interest

  $ 77     $ 165  

Supplementary disclosure of noncash investing and financing activities:

               

Equipment acquired under capital lease

  $     $ 163  

Equipment acquired with reduction of other current asset

  $     $ 49  

Fully depreciated equipment disposal

  $ 174     $  

Equipment acquired with an increase in accounts payable

  $     $ 36  

 

See Accompanying Notes to Consolidated Financial Statements

 

 
26

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1

Summary of Significant Accounting Policies

 

The accompanying consolidated financial statements include the accounts of Giga-tronics Incorporated (“Giga-tronics”) and its wholly-owned subsidiary, Microsource Incorporated (“Microsource”), collectively the “Company”. The Company’s corporate office and manufacturing facilities are located in Dublin, California.

 

Giga-tronics Division designs, manufactures and markets the new Advanced Signal Generator (ASG) for the electronic warfare market. The Giga-tronics Division over the past thirty-five years has produced a broad line of test and measurement equipment used primarily for the design, production, repair and maintenance of products in aerospace, telecommunications, RADAR, and electronic warfare. Giga-tronics has recently completed a move within the test and measurement market from legacy products to the newly developed ASG. As part of this evolution certain legacy product lines were sold to raise additional capital. For example, we sold our SCPM line to Teradyne in 2013, and in December of 2015 we sold our Power Meters, Amplifiers, and Legacy Signal Generators to Spanawave Corporation (see Note 10, Sale of Product Lines). In June of 2016 we sold our Switch product line to Astronics (see Note 10, Sale of Product Lines). These transactions will allow us to increase our focus on the ASG and Microsource YIG RADAR filters. With the sales of these legacy product lines, the Giga-tronics Division is solely focused on the ASG product in the test and measurement equipment market.

 

Microsource develops and manufactures a broad line of YIG (Yttrium, Iron, Garnet) tuned oscillators, filters and microwave synthesizers, which are used by its customers in operational applications and in manufacturing a wide variety of microwave instruments and devices. Microsource’s two largest customers are prime contractors for which it develops and manufactures YIG RADAR filters used in fighter jet aircraft.

 

Principles of Consolidation The consolidated financial statements include the accounts of Giga-tronics and its wholly-owned subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.

 

Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Fiscal Year The Company’s financial reporting year consists of either a 52 week or 53 week period ending on the last Saturday of the month of March. Fiscal year 2017 ended on March 25, 2017 resulting in a 52 week year. Fiscal year 2016 ended on March 26, 2016, also resulting in a 52 week year. All references to years in the consolidated financial statements relate to fiscal years rather than calendar years.

 

Reclassifications Certain reclassifications, none of which affected the prior year’s net loss or shareholders’ equity, have been made to prior year balances in order to conform to the current year presentation.

 

Revenue Recognition and Deferred Revenue The Company records revenue when there is persuasive evidence of an arrangement, delivery has occurred, the price is fixed and determinable, and collectability is reasonably assured. This occurs when products are shipped or the customer accepts title transfer. If the arrangement involves acceptance terms, the Company defers revenue until product acceptance is received. On certain large development contracts, revenue is recognized upon achievement of substantive milestones. Determining whether a milestone is substantive is a matter of judgment and that assessment is performed only at the inception of the arrangement. The consideration earned from the achievement of a milestone must meet all of the following for the milestone to be considered substantive:

 

 

a.

It is commensurate with either of the following:

 

1.

The Company’s performance to achieve the milestone.

 

2.

The enhancement of the value of the delivered item or items as a result of a specific outcome resulting from the Company's performance to achieve the milestone.

 

b.

It relates solely to past performance.

 

c.

It is reasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement.

 

 
27

 

 

Milestones for revenue recognition are agreed upon with the customer prior to the start of the contract and some milestones are based on product shipping while others are based on design review. In fiscal 2015 the Company’s Microsource business unit received a $6.5 million order from a major aerospace company for non-recurring engineering services to develop a variant of its high performance fast tuning YIG filters for an aircraft platform and to deliver a limited number of flight-qualified prototype hardware units (the “NRE Order”) which is being accounted for on a milestone basis. The Company considered factors such as estimated completion dates and product acceptance of the order prior to accounting for the NRE Order as milestone revenue. During the fiscal years ended March 25, 2017 and March 26, 2016, revenue recognized on a milestone basis were $478,000 and $1.0 million, respectively.

 

On certain contracts with several of the Company’s significant customers the Company receives payments in advance of manufacturing. Advanced payments are recorded as deferred revenue until the revenue recognition criteria described above has been met.

 

Accounts receivable are stated at their net realizable value. The Company has estimated an allowance for uncollectable accounts based on analysis of specifically identified accounts, outstanding receivables, consideration of the age of those receivables, the Company’s historical collection experience, and adjustments for other factors management believes are necessary based on perceived credit risk.

 

The activity in the allowance account for doubtful accounts is as follows for the years ended March 25, 2017 and March 26, 2016:

 

(Dollars in thousands)

 

March 25,

2017

   

March 26,

2016

 

Beginning balance

  $ 45     $ 45  

Provisions for doubtful accounts

           

Write-off of doubtful accounts

           

Ending balance

  $ 45     $ 45  

 

Accrued Warranty The Company’s warranty policy generally provides one to three years of coverage depending on the product. The Company records a liability for estimated warranty obligations at the date products are sold. The estimated cost of warranty coverage is based on the Company’s actual historical experience with its current products or similar products. For new products, the required reserve is based on historical experience of similar products until such time as sufficient historical data has been collected on the new product. Adjustments are made as new information becomes available.

 

Inventories Inventories are stated at the lower of cost or fair value using full absorption and standard costing. Cost is determined on a first-in, first-out basis. Standard costing and overhead allocation rates are reviewed by management periodically, but not less than annually. Overhead rates are recorded to inventory based on capacity management expects for the period the inventory will be held. Reserves are recorded within cost of sales for impaired or obsolete inventory when the cost of inventory exceeds its estimated fair value. Management evaluates the need for inventory reserves based on its estimate of the amount realizable through projected sales including an evaluation of whether a product is reaching the end of its life cycle. When inventory is discarded it is written off against the inventory reserve, as inventory generally has already been fully reserved for at the time it is discarded.

 

Research and Development Research and development expenditures, which include the cost of materials consumed in research and development activities, salaries, wages and other costs of personnel engaged in research and development, costs of services performed by others for research and development on the Company’s behalf and indirect costs are expensed as operating expenses when incurred. Research and development costs totaled approximately $2.3 million and $2.8 million for the years ended March 25, 2017 and March 26, 2016, respectively.

 

Property and Equipment Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets, which range from three to ten years for machinery and equipment and office fixtures. Leasehold improvements and assets acquired under capital leases are amortized using the straight-line method over the shorter of the estimated useful lives of the respective assets or the lease term.

 

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If such review indicates that the carrying amount of an asset exceeds the sum of its expected future cash flows on an undiscounted basis, the asset’s carrying amount would be written down to fair value. Additionally, the Company reports long-lived assets to be disposed of at the lower of carrying amount or fair value less cost to sell. As of March 25, 2017, and March 26, 2016, management believes there has been no impairment of the Company’s long-lived assets.

 

Derivatives The Company accounts for certain of its warrants as derivatives. Changes in fair values are reported in earnings as gain or loss on adjustment of warrant liability to fair value.

 

 
28

 

 

Deferred Rent Rent expense is recognized in an amount equal to the guaranteed base rent plus contractual future minimum rental increases amortized on the straight-line basis over the terms of the leases, including free rent periods.

 

Income Taxes Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Future tax benefits are subject to a valuation allowance when management is unable to conclude that its deferred tax assets will more likely than not be realized. The ultimate realization of deferred tax assets is dependent upon generation of future taxable income during the periods in which those temporary differences become deductible. Management considers both positive and negative evidence and tax planning strategies in making this assessment.

 

The Company considers all tax positions recognized in its financial statements for the likelihood of realization. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the positions taken or the amounts of the positions that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above, if any, would be reflected as unrecognized tax benefits, as applicable, in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company recognizes accrued interest and penalties, if any, related to unrecognized tax benefits as a component of the provision for income taxes in the consolidated statements of operations.

 

Product Development Costs The Company incurs pre-production costs on certain long-term supply arrangements. The costs, which represent non-recurring engineering and tooling costs, are capitalized as other assets and amortized over their useful life when reimbursable by the customer. All other product development costs are charged to operations as incurred. Capitalized pre-production costs included in inventory were immaterial as of March 25, 2017 and March 26, 2016.

 

Software Development Costs Development costs included in the research and development of new software products and enhancements to existing software products are expensed as incurred, until technological feasibility in the form of a working model has been established. Capitalized development costs are amortized over the expected life of the product and evaluated each reporting period for impairment. During the fourth quarter of fiscal 2017, the Company revised its estimates in accounting for the amortization of the capitalized software costs due to the long procurement cycle associated with the product. The Company had previously elected to amortize the capitalized software costs on a straight-line basis over a three year period, however, the Company revised its estimates based on the percentage of revenue associated with the current period revenues. This change in estimate increased the Company’s cost of sales by $342,000 in fiscal 2017. As of March 25, 2017, and March 26, 2016, capitalized software development costs were $733,000 and $876,000 respectively. As of March 25, 2017, amortization of capitalized software was $476,000. There was no amortization for the fiscal year ended March, 26, 2016 as the Company released the ASG product to its customers in the third quarter of fiscal 2017.

 

Discontinued Operations The Company reviews its reporting and presentation requirements for discontinued operations as it moves to newer technology within the test and measurement market from legacy products to the newly developed Advanced Signal Generator. The disposal of these product line sales represents an evolution of the Company’s Giga-tronics Division to a more sophisticated product offered to the same customer base. The Company has evaluated the sales of product lines (see Note 10, Sale of Product Lines) concluding that each product line does not meet the definition of a “component of an entity” as defined by ASC 205-20.The Company is able to distinguish revenue and gross margin information as disclosed in Note 10, Sale of Product Lines to the accompanying financial statements; however, operations and cash flow information is not clearly distinguishable and the company is unable to present meaningful information about results of operations and cash flows from those product lines.

 

Share-based Compensation The Company has established the 2005 Equity Incentive Plan, which provides for the granting of options for up to 2,850,000 shares of Common Stock. In 2014, the term of the 2005 Equity Incentive Plan was extended to 2025. The Company records share-based compensation expense for the fair value of all stock options and restricted stock that are ultimately expected to vest as the requisite service is rendered.

 

 
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The cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) are classified as cash flows from financing in the statements of cash flows. These excess tax benefits were not significant for the Company for the fiscal years ended March 25, 2017 or March 26, 2016.

 

In calculating compensation related to stock option grants, the fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option-pricing model. The computation of expected volatility used in the Black-Scholes- Merton option-pricing model is based on the historical volatility of Giga-tronics’ share price. The expected term is estimated based on a review of historical employee exercise behavior with respect to option grants. The risk free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. Expected dividend yield was not considered in the option pricing formula since the Company has not paid dividends and has no current plans to do so in the future.

 

The fair value of restricted stock awards is based on the fair value of the underlying shares at the date of the grant. Management makes estimates regarding pre-vesting forfeitures that will impact timing of compensation expense recognized for stock option and restricted stock awards.

 

Earnings or Loss Per Common Share Basic earnings or loss per common share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share incorporate the incremental shares issuable upon the assumed exercise of stock options and warrants using the treasury stock method. Anti-dilutive options are not included in the computation of diluted earnings per share. Non-vested shares of restricted stock have non-forfeitable dividend rights and are considered participating securities for the purpose of calculating basic and diluted earnings per share under the two-class method.

 

Comprehensive Income or Loss There are no items of comprehensive income or loss other than net income or loss.

 

Financial Instruments and Concentration of Credit Risk Financial instruments that potentially subject the Company to credit risk consist of cash, cash-equivalents and trade accounts receivable. The Company’s cash-equivalents consist of overnight deposits with federally insured financial institutions. Concentration of credit risk in trade accounts receivable results primarily from sales to major customers. The Company individually evaluates the creditworthiness of its customers and generally does not require collateral or other security. At March 25, 2017, three customers combined accounted for 67% of consolidated gross accounts receivable. At March 26, 2016, three customers combined accounted for 52% and 65% of consolidated gross accounts receivable.

 

Fair Value of Financial Instruments and Fair Value Measurements The Company’s financial instruments consist principally of cash and cash-equivalents, line of credit, term debt, and warrant derivative liability. The fair value of a financial instrument is the amount at which the instrument could be exchanged in an orderly transaction between market participants to sell the asset or transfer the liability. The Company uses fair value measurements based on quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity can access as of the measurement date (Level 1), significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data (Level 2), or significant unobservable inputs reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability (Level 3), depending on the nature of the item being valued.

 

Recently Issued Accounting Standards

 

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. ASU 2014-15 provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements. The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if “conditions or events raise substantial doubt about the entity’s ability to continue as a going concern.” The ASU applies to all entities and is effective for annual periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. The Company adopted this accounting standard as of March 25,2017.

 

 
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In April 2015, the FASB issued ASU 2015-03, “Interest - Imputation of Interest (Subtopic 835-30) – Simplifying the Presentation of Debt Issuance Costs,” or ASU 2015-03. ASU 2015-03 simplifies the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct reduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by this ASU. The amendments in this ASU are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The adoption of this ASU by the Company, changed the presentation of certain debt issuance costs, which are reported as a direct offset to the applicable debt on the balance sheet.

 

In August 2015, the FASB issued ASU 2015-15 – “ Interest—Imputation of Interest (Subtopic 835-30) - Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements”, Previously, on April 7, 2015, the FASB issued ASU 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs , which required entities to present debt issuance costs related to a recognized debt liability as a direct deduction from the carrying amount of that debt liability. The guidance in ASU 2015-03 (see paragraph 835-30-45-1A) does not address presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements. Given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line-of-credit arrangements, the SEC staff stated that they would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. For public business entities, the guidance in the ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company’s adoption of ASU 2015-15 in fiscal 2017 did not have a material impact on its financial statements.

 

In November 2015, the FASB issued ASU 2015-17 – Income Taxes (Topic 740): “Balance Sheet Classification of Deferred Taxes”. Topic 740 is effective for public business entities for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. For all other entities, the amendments are effective for financial statements issued for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. The amendments may be applied prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The amendments in ASU 2015-17 eliminates the current requirement for organizations to present deferred tax liabilities and assets as current and noncurrent in a classified balance sheet. Instead, organizations will be required to classify all deferred tax assets and liabilities as noncurrent. The Company is currently evaluating the impact this accounting standard update may have on its financial statements.

 

In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-04 (“ASU 2017-04”), Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. ASU 2017-04 amends the guidance to simplify the subsequent measurement of goodwill by removing Step 2 of the goodwill impairment test. Instead, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value. ASU 2017-04 is effective for annual reporting periods beginning after December 15, 2019, with early adoption permitted. The Company does not expect the standard will have a material impact on its Consolidated Financial Statements.

 

In August 2016, the FASB issued ASU 2016-15 (“ASU 2016-15”), Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The objective of ASU 2016-15 is to reduce existing diversity in practice by addressing eight specific cash flow issues related to how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. If early adopted, an entity must adopt all the amendments in the same period. The Company is currently evaluating the impact of the new guidance and timing of adoption, but does not expect that the standard will have a material impact on its Consolidated Financial Statements.

 

In February 2016, the FASB issued ASU 2016-02 (“ASU 2016-02”), Leases. ASU 2016-02 requires that lessees recognize assets and liabilities for the rights and obligations for leases with a lease term of more than one year. The amendments in this ASU are effective for annual periods ending after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact of the adoption of ASU 2016-02 on its consolidated financial statements.

 

In May 2014, the FASB issued ASU 2014-09 (“ASU 2014-09”), Revenue from Contracts with Customers. ASU 2014-09 establishes a broad principle that would require an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve this principle, an entity identifies the contract with a customer, identifies the separate performance obligations in the contract, determines the transaction price, allocates the transaction price to the separate performance obligations and recognizes revenue when each separate performance obligation is satisfied. ASU 2014-09 was further updated in March, April, May, and December 2016 to provide clarification on a number of specific issues as well as requiring additional disclosures. ASU 2014-09 may be applied either retrospectively or through the use of a modified-retrospective method. The full retrospective method requires companies to recast each prior reporting period presented as if the new guidance had always existed. Under the modified retrospective method, companies would recognize the cumulative effect of initially applying the standard as an adjustment to opening retained earnings at the date of initial application. On July 9, 2015, the FASB approved a one year deferral of the effective date of ASU 2014-09 to annual reporting periods beginning after December 15, 2017. The Company has not yet completed its evaluation of the impact of ASU 2014-09 on its past and future revenue recognition and related disclosure.

 

 
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2

Going Concern and Management’s Plan

 

The Company incurred net losses of $1.5 million and $4.1 million in the fiscal years ended March 25, 2017 and March 26, 2016, respectively. These losses have contributed to an accumulated deficit of $25.6 million as of March 25, 2017.

 

The Company has experienced delays in the development of features, orders, and shipments for the new ASG. These delays have significantly contributed to a decrease in working capital from $1.8 million on March 26, 2016, to $620,000 on March 25, 2017. The new ASG product has now shipped to several customers, but potential delays in the refinement of features, longer than anticipated sales cycles, or the ability to efficiently manufacture the ASG, could significantly contribute to additional future losses and decreases in working capital.

 

To help fund operations, the Company relies on advances under the line of credit with Bridge Bank. The line of credit which expired on May 7, 2017, was renewed through May 6, 2019 (see Note 20, Subsequent Events). The agreement includes a subjective acceleration clause, which allows for amounts due under the facility to become immediately due in the event of a material adverse change in the Company’s business condition (financial or otherwise), operations, properties or prospects, or ability to repay the credit based on the lender’s judgement. As of March 25, 2017, the line of credit had a balance of $582,000, and additional borrowing capacity of $234,000, respectively.

 

These matters raise substantial doubt as to the Company’s ability to continue as a going concern.

 

To address these matters, the Company’s management has taken several actions to provide additional liquidity and reduce costs and expenses going forward. These actions are described in the following paragraphs.

 

In July 2016, Microsource received a $1.9 million non-recurring engineering order associated with redesigning a component of its high performance YIG filter used on an aircraft platform. The Company delivered NRE services for approximately $884,000 during fiscal 2017 and we expect to continue such services over the next nine to twelve months.

   

On April 27, 2017, the Company entered into a new loan agreement with PFG. Under the terms of the agreement, PFG made a term loan to the Company in the principal amount of $1,500,000, with funding occurring on April 28, 2017. The loan has a two-year term, with interest only payments for the term of the loan (see Note 20, Subsequent Events).

 

 

With the elimination of Giga-tronics Switch, Power Meter, Amplifier, and Signal Generator legacy product lines resulting from the Asset Purchase Agreements with Spanawave and Astronics, (see Note 10, Sale of Product Lines), the Company has been able to reduce the number of employees from 71 in fiscal 2016 to 57 in fiscal 2017, while providing additional cash for operations from the proceeds of the sales. We are also anticipating reductions in overhead costs by relocating our operations into a smaller facility beginning in fiscal 2018.

   
In May 2017, the Company renewed its accounts receivable line of credit with Bridge Bank through May 6, 2019.
   

In the first quarter of fiscal 2016, the Company’s Microsource business unit also finalized a multiyear $10.0 million YIG Production Order. The Company started shipping the YIG Production Order in the second quarter of fiscal 2017, and we expect to ship the remainder through fiscal 2020.

   

To assist with the upfront purchases of inventory required for future product deliveries, the Company entered into advance payment arrangements with certain customers, whereby the customers reimburse the Company for raw material purchases prior to the shipment of the finished products. The Company will continue to seek similar terms in future agreements with these customers and other customers.

 

 
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Management will continue to review all aspects of the business in an effort to improve cash flow and reduce costs and expenses, while continuing to invest, to the extent possible, in new product development for future revenue streams.

 

Management will also continue to seek additional working capital through debt, equity financing or possible product line sales, however there are no assurances that such financings or sales will be available at all, or on terms acceptable to the Company.

 

The Company’s historical operating results and forecasting uncertainties indicate that substantial doubt exists related to the Company’s ability to continue as a going concern. Forecasting uncertainties exist with respect to the ASG product line due to the potential longer than anticipated sales cycles as well as with potential delays in the refinement of certain features, and/or the Company’s ability to efficiently manufacture it in a timely manner.

 

The accompanying Consolidated Financial Statements have been prepared assuming that the Company will continue as a going concern and do not include any adjustments that might result if the Company were unable to do so.

 

3

Cash and Cash-Equivalents

 

Cash and cash-equivalents of $1.4 million and $1.3 million at March 25, 2017 and March 26, 2016, respectively, consisted of demand deposits with a financial institution that is a member of the Federal Deposit Insurance Corporation (FDIC). At March 25, 2017, $1.1 million of the Company’s demand deposits exceeded FDIC insurance limits.

 

4

Inventories

 

Inventories, net of reserves, consisted of the following:

 

 

(Dollars in thousands)

 

March 25,

2017

   

March 26,

2016

 

Raw materials

  $ 1,775     $ 3,489  

Work-in-progress

    2,155       2,156  

Finished goods

    473       2  

Demonstration inventory

    408       47  

Total

  $ 4,811     $ 5,694  

 

5

Property, Plant and Equipment, net

 

Property, plant and equipment, net is comprised of the following:

 

(Dollars in thousands)

 

March 25,

2017

   

March 26,

2016

 

Leasehold improvements

  $ 327       327  

Machinery and equipment

    4,330       4,604  

Computer and software

    678       647  

Furniture and office equipment

    231       121  
      5,566       5,699  

Less: accumulated depreciation and amortization

    (5,038 )     (4,862 )

Total

  $ 528     $ 837  

 

6

Software Development Costs

 

On September 3, 2015, the Company entered into a software development agreement with a major aerospace and defense company whereby the aerospace company developed and licensed its simulation software to the Company. The simulation software (also called Open Loop Simulator or OLS technology) is currently the aerospace company’s intellectual property. The OLS technology generates threat simulations and enables various hardware to generate signals for performing threat analysis on systems under test. The Company licenses the OLS software as a bundled or integrated solution with its Advanced Signal Generator system.

 

 
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The Company paid the aerospace company software development costs and fees for OLS of $1.2 million in the aggregate (this includes an amendment to the software development agreement for additional features and functionality), which was paid in monthly installments as the work was performed by the aerospace company through the third quarter of fiscal 2017. The OLS technology is a perpetual license agreement that may be terminated by the Company at any time as long as the Company provides a notice to the aerospace company and pays for the development costs incurred through the notice termination date. The Company is also obligated to pay royalties to the aerospace company on net sales of its Advanced Signal Generator product sold with the OLS software equal to seven percent of net sales price of each ASG system sold and subject to certain minimums. The Company expenses research and development costs as they are incurred. Development costs of computer software to be sold, leased, or otherwise marketed are subject to capitalization beginning when a product’s technological feasibility has been established and ending when a product is available for general release to customers.

 

As of March 25, 2017, and March 26, 2016, capitalized software costs were $733,000 and $876,000, respectively. The Company began amortizing the costs of capitalized software to cost of sales in fiscal 2017 using the percentage of revenue approach. During the fourth quarter of fiscal 2017, the Company revised its estimates in accounting for the amortization of the capitalized software costs due to the long procurement cycle associated with the product. The Company had previously elected to amortize the capitalized software costs on a straight-line basis over a three year period, however, the Company revised its estimates based on the percentage of revenue associated with the current period revenues. This change in estimate increased the Company’s cost of sales by $342,000 in fiscal 2017. Amortization of capitalized software costs recorded were $476,000 during fiscal 2017. There was no amortization recorded in fiscal 2016 as the Company had not yet released its ASG TEmS units in fiscal 2016.

 

7

Accounts Receivable Line of Credit

 

On June 1, 2015, the Company entered a $2.5 million Revolving Accounts Receivable Line of Credit agreement with Bridge Bank. The credit facility agreement replaced the line of credit with Silicon Valley Bank which expired April 15, 2015. The agreement provides for a maximum borrowing capacity of $2.5 million of which $2.0 million is subject to a borrowing base calculation and $500,000 is non-formula based.

 

The loan is secured by all assets of the Company including intellectual property and general intangibles and provides for a borrowing capacity equal to 80% of eligible accounts receivable. The loan matured on May 6, 2017 but was renewed through May, 6, 2019 (see Note 20, Subsequent Event) and bears an interest rate equal to 1.5% over the bank’s prime rate of interest (which was 3.75% March 25, 2017 resulting in an interest rate of 5.25%). Interest is payable monthly with principal due upon maturity. The Company paid a commitment fee of $12,500. The loan agreement contains financial and non-financial covenants that are customary for this type of lending and includes a covenant to maintain an asset coverage ratio of at least 135% (defined as unrestricted cash and cash equivalents maintained with Bridge Bank, plus eligible accounts receivable aged less than 90 days from the invoice date, divided by the total amount of outstanding principal of all obligations under the loan agreement).

 

As of March 25, 2017, the Company was in compliance with all the financial covenants under the agreement. The line of credit requires a lockbox arrangement, which provides for receipts to be swept daily to reduce borrowings outstanding at the discretion of Bridge Bank. This arrangement, combined with the existence of the subjective acceleration clause in the line of credit agreement, necessitates the line of credit be classified as a current liability on the balance sheet. The acceleration clause allows for amounts due under the facility to become immediately due in the event of a material adverse change in the Company’s business condition (financial or otherwise), operations, properties or prospects, or ability to repay the credit based on the lender's judgment. As of March 25, 2017, the Company’s total outstanding borrowings and remaining borrowing capacity under the Bridge Bank line of credit were $582,000 and $234,000, respectively.

 

8

Term Loan, Revolving Line of Credit and Warrants

 

On March 13, 2014, the Company entered into a three year, $2.0 million term loan agreement with PFG under which the Company received $1.0 million on March 14, 2014.

 

On June 16, 2014, the Company amended its loan agreement with PFG (the “Amendment”). Under the terms of the Amendment, PFG made a revolving credit line available to Giga-tronics in the amount of $500,000, and the Company borrowed the entire amount on June 17, 2014. The revolving line had a thirty-three month term. The Amendment reduced the future amount potentially available for the Company to borrow under the PFG Loan agreement from $1.0 million to $500,000. The interest on the PFG revolving credit line was fixed, calculated on a daily basis at a rate of 12.50% per annum. The Company was allowed to prepay the loan at any time prior to its March 13, 2017 maturity date without a penalty.

 

 
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On June 3, 2015, the Company further amended its loan agreement with PFG (the “Second Amendment”). The Second Amendment cancelled the Company’s $500,000 of borrowing availability under the June 2014 Amendment and required the Company to pay PFG $150,000 towards its existing $500,000 outstanding balance under the revolving line of credit, which the Company paid in July 2015. The Company also agreed to pay PFG an additional $10,000 per month towards its remaining credit line balance until repaid, followed by like payments towards its term loan balance until repaid. As of March 26, 2016, the $500,000 borrowed with the June 2014 Amendment had been fully repaid.

 

Interest on the initial $1.0 million term loan was fixed at 9.75% and required monthly interest only payments during the first six months of the agreement followed by monthly principal and interest payments over the remaining thirty months. The Company may prepay the loan at any time prior to maturity by paying all future scheduled principal and interest payments. As of March 25, 2017, the debt was fully repaid.

 

The PFG Loan was secured by all the assets of the Company under a lien that is junior to the Bridge Bank debt described in Note 7, and limits borrowing under the Bridge Bank credit line limit to $2.5 million. The Company paid a loan fee of $30,000 upon the initial draw (“First Draw”) and $15,000 for the June 2014 Amendment. The loan fees paid were recorded as prepaid expenses and amortized to interest expense over the term of the PFG amended loan agreement.

 

The loan agreement contained financial covenants associated with the Company achieving minimum quarterly net sales and maintaining a minimum monthly shareholders’ equity. In the event of default by the Company, all or any part of the Company’s obligation to PFG could become immediately due. As of March 25, 2017, the Company was in compliance with all the financial covenants under the agreement.

 

The loan agreement also provided for the issuance of warrants convertible into 300,000 shares of the Company’s common stock, of which 180,000 were exercisable upon receipt of the initial $1.0 million from the First Draw, 80,000 became exercisable with the First Amendment and 40,000 were cancelled as a result of the Second Amendment. Each warrant issued under the loan agreement has a term of five years and an exercise price of $1.42 which was equal to the average NASDAQ closing price of the Company’s common stock for the ten trading days prior to the First Draw.

 

If the warrants are not exercised before expiration on March 13, 2019, the Company would be required to pay PFG $150,000 and $67,000 as settlement for warrants associated with the First Draw and the Amendment, respectively. The warrants could be settled for cash at an earlier date in the event of any acquisition or other change in control of the Company, future public issuance of Company securities or liquidation (or substantially similar event) of the Company. The Company currently has no definitive plans for any of the aforementioned events, and as a result, the cash payment date is estimated to be the expiration date unless warrants are exercised before then. The warrants have the characteristics of both debt and equity and are accounted for as a derivative liability measured at fair value each reporting period with the change in fair value recorded in earnings.

 

As of March 25, 2017, the estimated fair values of the derivative liabilities associated with the warrants issued in connection with the First Draw and Amendment were $133,000 and $89,000, respectively, for a combined value of $222,000. As of March 26, 2016, the estimated fair value of the derivative liability associated with the warrant issued in connection with the First Draw and Amendment was $212,000 and $141,000, respectively for a combined value of $353,000. The change in the fair value of the warrant liability totaled $131,000 for the fiscal year ended March 25, 2017 and is reported in the accompanying statement of operations as a gain on adjustment of derivative liability to fair value. The change in the fair of the warrant liability totaled $12,000 for the fiscal year ended March 26, 2016 and is reported as a loss on adjustment of derivative liability to fair value.

 

 
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The initial $1.0 million in proceeds under the term loan agreement were allocated between the PFG Loan and the warrants based on their relative fair values on the date of issuance which resulted in initial carrying values of $822,000 and $178,000, respectively. The resulting discount of $178,000 on the PFG Loan was accreted to interest expense under the effective interest method over the term of the PFG Loan, and as of March 25, 2017 had been fully accreted since the $1.0 million had been fully repaid.

 

The proceeds from the $500,000 credit line issued in connection with the Amendment were allocated between the PFG Loan and the warrants based on their relative fair values on the date of issuance which resulted in initial carrying values of $365,000 and $135,000, respectively. The resulting discount of $135,000 on the PFG Loan was accreted to interest expense under the effective interest method over the of the PFG Loan, and as of March 26,2016 had been fully accreted since the $500,000 from the Amendment had been fully repaid.

 

For the fiscal years ended March 25, 2017 and March 26, 2016, the Company recorded accretion of discount expense associated with the warrants issued with the PFG Loan of $22,000 and $165,000, respectively.

 

On April 27, 2017, the Company entered into a new loan agreement with PFG. Under the terms of the agreement, PFG made a term loan to the Company in the principal amount of $1,500,000, with funding occurring on April 28, 2017. The loan has a two-year term, with interest only payments for the term of the loan (see Note 20, Subsequent Events).

 

9

Fair Value

 

Pursuant to the accounting guidance for fair value measurement and its subsequent updates, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. The accounting guidance establishes a hierarchy for inputs used in measuring fair value that minimizes the use of unobservable inputs by requiring the use of observable market data when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on active market data. Unobservable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.

 

The fair value hierarchy is broken down into the three input levels summarized below:

 

 

Level 1 —Valuations are based on quoted prices in active markets for identical assets or liabilities and readily accessible by us at the reporting date. Examples of assets and liabilities utilizing Level 1 inputs are certain money market funds, U.S. Treasuries and trading securities with quoted prices on active markets.

 

 

Level 2 —Valuations based on inputs other than the quoted prices in active markets that are observable either directly or indirectly in active markets. Examples of assets and liabilities utilizing Level 2 inputs are U.S. government agency bonds, corporate bonds, commercial paper, certificates of deposit and over-the- counter derivatives.

 

 

Level 3 —Valuations based on unobservable inputs in which there are little or no market data, which require us to develop our own assumptions.

 

The carrying amounts of the Company’s cash and cash-equivalents and line of credit approximate their fair values at each balance sheet date due to the short-term maturity of these financial instruments, and generally result in inputs categorized as Level 1 within the fair value hierarchy. The fair values of term debt are based on the present value of expected future cash flows and assumptions about current interest rates and the creditworthiness of the Company, and generally result in inputs categorized as Level 3 within the fair value hierarchy.

 

At March 25, 2017 and March 26, 2016, the carrying amounts of the Company’s term debt was zero and $379,000, respectively. The estimated fair value totaled $384,000 at March 26, 2016, the fair value at March 25, 2017 was zero as the loan was paid in full in fiscal 2017. The fair value at March 26, 2016 was calculated using a discounted cash flow model and utilized a 20% discount rate. The rate was commensurate with market rates given the remaining term, principal repayment schedule, the Company’s creditworthiness and outstanding loan balance.

 

The Company’s derivative warrant liability is measured at fair value on a recurring basis and is categorized as Level 3 in the fair value hierarchy. The derivative warrant liability is valued using a Monte Carlo simulation model, which used the following assumptions as of March 25, 2017: (i) the remaining expected life of 2.0 years, (ii) the Company’s historical volatility rate of 101.1%, (iii) risk-free interest rate of 1.26%, and (iv) a discount rate of twenty four percent.

 

 
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The aforementioned derivative warrant liability is the Company’s only asset and liability recognized and measured at fair value on a recurring or non-recurring basis and was follows:

 

Fair Value Measurements as of Mar. 25, 2017

(In Thousands):

                 
   

Level 1

   

Level 2

   

Level 3

 

Warrant Liability

  $           $ 222  

Total

  $           $ 222  

 

Fair Value Measurements as of March 26, 2016

(In Thousands):

                 
   

Level 1

   

Level 2

   

Level 3

 

Warrant Liability

  $           $ 353  

Total

  $     $     $ 353  

 

There were no transfers between Level 1, Level 2 or Level 3 for the fiscal years ended March 25, 2017 and March 26, 2016.

 

The table below summarizes changes in gains and losses recorded in earnings for Level 3 assets and liabilities that are still held at March 25, 2017:

 

    Years Ended  

(In thousands)

 

Mar. 25,

2017

   

Mar. 26,

2016

 

Warrant liability at beginning of year

  $ 353     $ 341  

Gains on adjustment of warrant liability to fair value

    (136 )      

Losses on adjustment of warrant liability to fair value

    5       12  

Warrant liability at end of period

  $ 222     $ 353  

 

There were no assets measured at fair value on a recurring basis and there were no assets or liabilities measured on a non- recurring basis at March 25, 2017 and March 26, 2016.

 

The following table presents quantitative information about recurring Level 3 fair value measurements at March 25, 2017 and March 26, 2016:

 

March 25, 2017

 

Valuation Technique(s)

 

Unobservable Input

 

Warrant liability

  Monte Carlo   Discount rate 24%
           

March 26, 2016

 

Valuation Techniques(s)

 

Unobservable Input

 

Warrant liability

  Monte Carlo   Discount rate 20%

 

The discount rate of twenty four percent is management’s estimate of the cost of capital given the Company’s credit worthiness. A significant increase in the discount rate would significantly decrease the fair value, but the magnitude of this decrease would be less significant in a scenario where the Company’s stock price is significantly higher than the exercise price since the holder’s option to take a cash payment at maturity represents a smaller component of the total fair value when the Company’s stock price is higher.

 

The Monte Carlo simulation model simulated the Company’s stock price through the maturity date of March 31, 2019. At the end of the simulated period, the value of the warrant was determined based on the greater of (1) the net share settlement value, (2) the net exercise value, or (3) the fixed cash put value.

 

 
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10

Sale of Product Lines

 

On June 20, 2016, the Company entered into an Asset Purchase Agreement for the sale of its Switch product line to Astronics Test Systems Inc. (Astronics). Upon signing the agreement, Astronics paid $850,000 for the intellectual property of the product line. The Company recognized a net gain of $802,000 in the first quarter of fiscal 2017 after related expenses were subtracted from the sales price. The following table presents the breakdown of the gain recognized related to the asset sale:

  

(In thousands)

  

  

  

  

Cash received from Astronics

  

$

850

  

Cash paid to buy out future commission obligation

  

  

(170

)

Employee severance

  

  

(97

)

Legal fees

  

  

(13

)

Commissions

  

  

(46

)

Warranty Liability released

  

  

278

  

Net gain recognized

  

$

802

  

    

In calculating the gain included in the accompanying consolidated financial statements, the Company released $278,000 of deferred warranty obligations related to the Switch asset. Pursuant to the terms of the agreement, Astronics assumed all the warranty obligations for the Switch product line, including the products sold prior to the asset being transferred to Astronics. The deferred warranty obligation was previously included in other current liabilities in the consolidated financial statements. The Company also had an existing agreement with a consultant supporting the Switch product line which included a three percent commission on the sales of the Switch product line for a period of 4 years ending in January 2020. The agreement allowed for a buyout of future commissions associated with the Switch product which the Company exercised in connection with the Astronics transaction in June 2016 resulting in a payment of $170,000 by the Company.

  

During fiscal 2017, the Switch product line accounted for $2.1 million in product revenue. Gross margins for the Switch product line for the fiscal year ended March, 25, 2017 was $437,000. During fiscal 2016, the Switch product line accounted for $2.7 million in product revenue. Gross margins for the Switch product line for the fiscal year ended March, 26, 2016 was $958,000. While the Company is able to distinguish revenue and gross margin information related to the sale of the Switch product line to Astronics, the Company is unable to present meaningful information about results of operation and cash flows from the Switch product line.

  

On December 15, 2015, the Company entered into an Asset Purchase Agreement with Spanawave Corporation, whereby Spanawave agreed to purchase the Giga-tronics’ Division product lines for its Power Meters, Amplifiers, and Legacy Signal Generators for $1.5 million. The agreement provided for the transfer of these product lines to Spanawave sequentially in six phases beginning with certain sensor and amplifier products. During the second quarter ended September 24, 2016, the Company and Spanawave became engaged in a dispute, including litigation initiated by Spanawave and an arbitration proceeding initiated by Spanawave’s affiliate Liberty Test Equipment, Inc., as to whether the Company has fulfilled all the requirements to close phases one through five and become entitled to the $375,000 received during the first quarter of fiscal 2017.

  

The complaint seeks specific performance of the agreement and damages. Spanawave’s affiliate Liberty Test Equipment also filed an arbitration claim for $440,000 under a distribution agreement between the Company and Liberty. The Company has filed cross-complaints in both the litigation and arbitration asserting breach of the respective agreements by Spanawave and Liberty. The Company had previously asserted that the distribution agreement does not extend to the products with respect to which the claim has been made. Certain customers of the lines of business sold to Spanawave are also customers of the Company’s ongoing Advance Signal Generator business. Continued disruption of the phase 6 signal generator business could have an adverse effect on the ASG business. The parties have negotiated in an effort to settle the dispute notwithstanding the filings. The expenses and potential liability of negotiation, any settlement or continued litigation or arbitration could have a material adverse effect on the Company.

  

During fiscal 2017, the Company had received $750,000 from Spanawave under the agreement. Of this amount, the Company returned $375,000 to Spanawave on July 28, 2016 resulting from the dispute regarding the status of phases one through five. The remaining $375,000 is included in deferred liability related to asset sales in the consolidated balance sheet. In addition, in June 2016, the Company received approximately $275,000 in exchange for raw material purchases. The purchase price of the raw materials approximated its carrying value, therefore no gain or loss was recognized. The parties are currently attempting to resolve this dispute. No gain has been recognized in connection with this product line sale because of the aforementioned dispute. These product lines accounted for approximately $592,000 and $2.7 million in revenue during the fiscal year ended March 25, 2017, and March 26, 2016, respectively. There was no margin associated with the revenue derived in fiscal 2017 as the revenues were primarily related to inventory transfer at book value. For the fiscal year ended March 26, 2016, gross margin was $240,000. While the Company is able to distinguish revenue and gross margin information related to the sale of these product lines, the Company is unable to present meaningful information about results of operation and cash flows from these product lines.

  

 
38

 

 

11

Selling and Advertising Expenses

 

Selling expenses consist primarily of salaries to employees and commissions paid to various sales representatives and marketing agencies. Commission expense totaled $121,000 and $172,000 for fiscal 2017 and 2016, respectively. Advertising costs, which are expensed as incurred, totaled $58,000 and $123,000 for fiscal 2017 and 2016, respectively.

 

12

Significant Customers and Industry Segment Information

 

The Company has two reportable segments: Giga-tronics Division and Microsource. Giga-tronics Division produces a broad line of test and measurement equipment used in the development, test and maintenance of wireless communications products and systems, flight navigational equipment, electronic defense systems and automatic testing systems and designs, manufactures, and markets a line of switching devices that link together many specific purpose instruments that comprise automatic test systems. Microsource develops and manufactures a broad line of Yttrium, Iron and Garnet (YIG) tuned oscillators, filters and microwave synthesizers, which are used in a wide variety of microwave instruments or devices.

 

The accounting policies for the segments are the same as those described in the "Summary of Significant Accounting Policies". The Company evaluates the performance of its segments and allocates resources to them based on earnings before income taxes. Segment net sales include sales to external customers. Inter-segment activities are eliminated in consolidation. Assets include accounts receivable, inventories, equipment, cash, deferred income taxes, prepaid expenses and other long- term assets. The Company accounts for inter-segment sales and transfers at terms that allow a reasonable profit to the seller. During the periods reported there were no significant inter-segment sales or transfers.

 

The Company's reportable operating segments are strategic business units that offer different products and services. They are managed separately because each business utilizes different technology and requires different accounting systems. The Company’s chief operating decision maker is considered to be the Company’s Chief Executive Officer (“CEO”). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues and pre-tax income or loss by operating segment.

 

The tables below present information for the fiscal years ended in 2017 and 2016.

 

March 25, 2017 (Dollars in thousands)

 

Giga-tronics

Division

   

Microsource

   

Total

 

Revenue

  $ 8,021     $ 8,246     $ 16,267  

Interest expense, net

    133             133  

Depreciation and amortization

    820       7       827  

Capital expenditures

    41             41  

Income/(Loss) before income taxes

    (2,702 )     1,158       (1,544 )

Assets

    6,433       2,641       9,074  

 

 
39

 

 

March 26, 2016 (Dollars in thousands)

 

Giga-tronics

Division

   

Microsource

   

Total

 

Revenue

  $ 8,679     $ 5,917     $ 14,596  

Interest expense, net

    383             383  

Depreciation and amortization

    301       20       321  

Capital expenditures

    192             192  

Income/(Loss) before income taxes

    (4,119 )     17       (4,102 )

Assets

    8,059       3,134       11,193  

 

 

The Company’s Giga-tronics Division and Microsource segments sell to agencies of the U.S. government and U.S. defense- related customers. In fiscal 2017 and 2016, U.S. government and U.S. defense-related customers accounted for 78% and 71% of sales, respectively. During fiscal 2017, the Boeing Company accounted for 33% of the Company’s consolidated revenues at March 25, 2017 and was included in the Microsource segment. A second customer, CSRA LLC (CSRA acted as Prime Contractor for the United States Navy) accounted for 20% of the Company’s consolidated revenues at March 25, 2017 was included in the Giga-tronics Division reporting segment. A third customer, Lockheed Martin accounted for 14% of the Company’s revenue and was included in the Microsource segment.

 

During fiscal 2016, the Boeing Company accounted for 32% of the Company’s consolidated revenues at March 26, 2016 and was included in the Microsource segment. A second customer, DFAS accounted for 11% of the Company’s consolidated revenues at March 26, 2016 was included in the Giga-tronics Division reporting segment.

 

Export sales accounted for 2% and 4% of the Company’s sales in fiscal 2017 and 2016, respectively. Export sales by geographical area for these fiscal years are shown below:

 

(Dollars in thousands)

 

March 25,

2017

   

March 26,

2016

 

Americas

  $     $ 10  

Europe

    249       326  

Asia

    15       140  

Rest of world

    64       122  

Total

  $ 328     $ 598  

 

13   Loss per Common Share

 

Net loss and common shares used in per share computations for the fiscal years ended March 25, 2017 and March 26, 2016 are as follows:

 

(In thousands except per-share data)  

March 25,

2017

   

March 26,

2016

 
             
Net loss   $ (1,546 )   $ (4,104 )
                 

Weighted average: Common shares outstanding

    9,550       6,941  
Potential common shares            

Common shares assuming dilution

    9,550       6,941  

Loss per common share – basic

  $ (0.16 )   $ (0.59 )

Loss per common share – diluted

  $ (0.16 )   $ (0.59 )

Stock options not included in computation that could potentially dilute EPS in the future

    1,105       1,592  

Restricted stock awards not included in computation that could potentially dilute EPS in the future

           

Convertible preferred stock not included in computation that could potentially dilute EPS in the future

    1,853       1,853  

Warrants not included in computation that could potentially dilute EPS in the future

    3,737       3,737  

 

 
40

 

 

The stock options, restricted stock, convertible preferred stocks and warrants not included in the computation of diluted earnings per share (EPS) for the fiscal years ended March 25, 2017 and March 26, 2016 is a result of the Company’s net loss and, therefore, the effect of these instruments would be anti-dilutive.

 

14   Income Taxes

 

Following are the components of the provision for income taxes:

 

Fiscal years ended  

March 25,

   

March 26,

 

(in thousands)

 

2017

   

2016

 
             

Current

               

Federal

  $     $  

State

    2       2  
Total Current     2       2  

Deferred

               

Federal

    (496 )     (1,297 )

State

    (6 )     215  
Total Deferred     (502 )     (1,082 )
                 

Change in liability for uncertain tax positions

    14       13