GIGA TRONICS INC - Quarter Report: 2016 June (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

  OR  

Commission File No. 0-12719

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 Web site, 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).

Yes [    ]     No [ X ]

There were a total of 9,549,703 shares of the Registrant’s Common Stock outstanding as of July 31, 2016. 

INDEX

FORWARD-LOOKING STATEMENTS

This report on Form 10-Q contains forward-looking statements about Giga-tronics Incorporated (the “Company”) for which it claims the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or board of directors, including those relating to products, revenue or cost savings; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements.  Words such as "believes", "anticipates", "expects", "intends", "targeted", "projected", "continue", "remain", "will", "should", "may" and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

These forward-looking statements are based on Management’s current knowledge and belief and include information concerning the Company’s possible or assumed future financial condition and results of operations. A number of factors, some of which are beyond the Company’s ability to predict or control, could cause future results to differ materially from those contemplated. These factors include but are not limited to risks related to (1) the Company’s potential inability to obtain necessary capital to finance its operations; (2) the Company’s ability to develop competitive products in a market with rapidly changing technology and standards; (3) risks related to customers’ credit worthiness/profiles; (4) changes in the Company’s credit profile and its ability to borrow; (5) a potential decline in demand for certain of the Company’s products; (6) potential product liability claims; (7) the potential loss of key personnel; and (8) U.S. and international economic conditions. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. The reader is directed to the Company's annual report on Form 10-K for the year ended March 26, 2016 or further discussion of factors that could affect the Company's business and cause actual results to differ materially from those expressed in any forward-looking statement made in this report. The Company undertakes no obligation to update any forward-looking statements in this report.

PART I – FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1)          Organization and Significant Accounting Policies

The condensed consolidated financial statements included herein have been prepared by Giga-tronics Incorporated (the “Company”), pursuant to the rules and regulations of the Securities and Exchange Commission. The consolidated results of operations for the interim periods shown in this report are not necessarily indicative of results to be expected for the fiscal year. In the opinion of management, the information contained herein reflects all adjustments (consisting of normal recurring entries) necessary to make the consolidated results of operations for the interim periods a fair statement of such operations. For further information, refer to the consolidated financial statements and footnotes thereto, included in the Annual Report on Form 10-K, filed with the Securities and Exchange Commission for the year ended March 26, 2016.

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.

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.

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. 

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.

Discontinued Operations The Company reviews its reporting and presentation requirements for discontinued operations in accordance with the guidance provided by ASC 205-20 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 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 9, 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 9, 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.

New Accounting Standards In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. ASU 2016-10 addresses implementation issues identified under ASC Topic 606. The amendments in ASU 2016-10 affect the guidance in ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which is not yet effective. The effective date and transition requirements in ASU 2016-10 are the same as the effective date and transition requirements of ASU 2014-09. ASU 2015-14, Revenue from Contracts with Customers (Topic 606). The amendments in this ASU is effective for public business entities with annual reporting periods beginning after 15 December 2017, including interim reporting periods within that reporting period. The Company is currently evaluating the impact this accounting standard update may have on its financial statements.

(2)          Going Concern and Management’s Plan

The Company incurred net losses of $102,000 and $629,000 in the first quarter of fiscal 2017 and fiscal 2016, respectively. These losses have contributed to an accumulated deficit of $24.1 million as of June 25, 2016.

The Company has experienced delays in the development of features, orders, and shipments for the new Advanced Signal Generator (“ASG”). These delays have contributed, in part to a decrease in working capital from $1.8 million at March 26, 2016, to $1.4 million at June 25, 2016. The new ASG product has shipped to several customers, but potential delays in the development 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 expires on May 7, 2017. 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 June 25, 2016, the line of credit had a balance of $800,000, and additional borrowing capacity of $902,000.

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. 

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, or equity financing, however there are no assurances that such financings will be available at all, or on terms acceptable to the Company.

Cumulative losses have had a significant negative impact on the financial condition of the Company and raise substantial doubt about the Company’s ability to continue as a going concern. The Consolidated Financial Statements have been prepared assuming 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)         Revenue Recognition

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. The Company limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations or subject to customer-specified return or refund privileges. The Company evaluates each deliverable in an arrangement to determine whether they represent separate units of accounting. 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.

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. 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 three month periods ended June 25, 2016 and June 27, 2015, revenue recognized on a milestone basis were $145,000 and $692,000, 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 have 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 Company provides for estimated costs that may be incurred for product warranties at the time of shipment. The Company’s warranty policy generally provides twelve to eighteen months depending on the customer. 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.

(4)           Inventories

Inventories consisted of the following:

(5)          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 would develop and license 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 intends to license the OLS software as a bundled or integrated solution with its Advanced Signal Generator system. The Company is obligated to pay the aerospace company software development costs and fees for OLS of $919,000 in the aggregate, which is payable in monthly installments as the work is performed by the aerospace company through July 2016. 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 a percentage 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 the first quarter ended June 25, 2016 capitalized software costs were $1.2 million. The Company intends to begin amortizing the costs of capitalized software to cost of sales once the product is released to its customers. The Company signed an amendment to the software development agreement in July of 2016 for additional features and functionality at an estimated cost of $265,000 that would be payable in monthly installments as the work is performed by the aerospace company through the fall of 2016.

 (6)      Accounts Receivable Line of Credit

On June 1, 2015 the Company entered into a $2.5 million Revolving Accounts Receivable Line of Credit agreement with Bridge Bank. 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 matures on May 7, 2017 and bears an interest rate, equal to 1.5% over the bank’s prime rate of interest (which was 3.5% at June 25, 2016 resulting in an interest rate of 5.0%). Interest is payable monthly with principal due upon maturity. The Company paid a commitment fee of $12,500, and an additional $12,500 which was due in May 2016. 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 June 25, 2016, 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 June 25, 2016, the Company’s total outstanding borrowings and remaining borrowing capacity under the Bridge Bank line of credit were $800,000 and $902,000, respectively.

(7)        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 (Partners For Growth IV, L.P.) under which the Company received $1.0 million on March 14, 2014 (“First Draw”). Pursuant to the agreement, the Company had the ability to borrow an additional $1.0 million following the Company’s achievement of certain performance milestones which included achieving $7.5 million in net sales during the first half of fiscal 2015 and two consecutive quarters of net income greater than zero during fiscal 2015.

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.

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. The $500,000 borrowed with the June 2014 Amendment was fully repaid in March 2016.

Interest on the initial $1.0 million term loan is 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 June 25, 2016, the Company’s total outstanding debt associated with the initial PFG loan was $270,000.

The PFG Loan is secured by all of the assets of the Company under a lien that is junior to the Bridge Bank debt described in Note 6, 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, the loan fees paid are recorded as a direct reduction from the carrying amount of the debt liability and amortized to interest expense over the remaining term of the PFG loan agreement.

The loan agreement contains 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 June 25, 2016, the Company was in compliance with all the financial covenants under the agreement.

The loan agreement also initially 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. The initial fair value of the warrants associated with the First Draw and Amendment were $173,000 and $168,000, respectively.

As of June 25, 2016, the estimated fair values of the derivative liabilities associated with the warrants issued in connection with the First Draw and Amendment were $184,000 and $123,000, respectively, for a combined value of $307,000. 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 $46,000 for the first quarter ended June 25, 2016 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 value of the warrant liability totaled $63,000 for the first quarter ended June 27, 2015 and is reported in the accompanying statement of operations as a loss on adjustment of derivative liability to fair value.

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 is being accreted to interest expense under the effective interest method over the three-year term of the PFG Loan.  

For the quarter ended June 25, 2016 and June 27, 2015, the Company recorded accretion of discount expense associated with the warrants issued with the PFG Loan of $11,000 and $42,000, respectively. 

(8)        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:

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 June 25, 2016 and March 26, 2016, the carrying amounts of the Company’s term debt totaled $254,000 and $370,000, respectively and the estimated fair value totaled $268,000 and $393,000, respectively. The fair value was calculated using a discounted cash flow model and utilized a 20% discount rate. The rates are 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 June 25, 2016: (i) the remaining expected life of 2.8 years, (ii) the Company’s historical volatility rate of 117.8%, (iii) risk-free interest rate of 0.73%, and (iv) a discount rate of twenty percent.

There were no transfers between Level 1, Level 2 or Level 3 for the quarter ended June 25, 2016.  

The table below summarizes changes in gains and losses recorded in earnings for Level 3 assets and liabilities that are still held at June 25, 2016:

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 June 25, 2016 and March 26, 2016.

The following table presents quantitative information about recurring Level 3 fair value measurements at June 25, 2015 and March 26, 2016:

The discount rate of twenty 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.  

(9)        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 quarter ending June 25, 2016 after related expenses were subtracted from the sales price. The following table presents the breakdown of the gain recognized in the quarter related to the asset sale:

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 a previous 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 sales in June 2016 which resulted in a payment by the Company during June of $170,000. Astronics also agreed to purchase approximately $500,000 of related materials inventory from Giga-tronics between July and August of 2016. The Switch product line accounted for $1.1 million in revenue for the fiscal quarter ended June 25, 2016 and $489,000 for the fiscal quarter June 27, 2015. The Switch product line’s gross margin on these revenues was $437,000 for the fiscal quarter ended June 25, 2016 and $217,000 for the fiscal quarter June 27, 2015. While the Company is able to distinguish revenue and gross margin information related to the sale of the Switch product line, 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, 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. The final product line transfer (legacy Signal Generators) is currently estimated to be completed by December 2016. As of June 25, 2016, the Company had received $750,000 from Spanawave under the agreement (of which $375,000 was received during the quarter ended June 25, 2016), which is included in deferred liability related to asset sale in the consolidated balance sheet. In addition, the Company received approximately $275,000 in exchange for raw materials as of June 25, 2016. The purchase price of the raw materials approximated its carrying value, therefore no gain or loss was recognized. After the end of the reporting period, 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 become entitled to the $375,000 received during the first quarter of fiscal 2017. The parties are currently attempting to resolve this dispute. On July 28, 2016, as part of its effort to resolve the dispute, the Company returned the $375,000 received during the quarter to Spanawave. No gain has been recognized in connection with this product line sale as the Company had not fully completed the asset transfer as required by the provisions of the agreement and final acceptance by Spanawave was pending. The final installment of $1.1 million is expected to be paid in fiscal 2017. In addition, the Company will sell to Spanawave approximately $350,000 of existing inventory for the remaining phase. The Company has stopped manufacturing these product lines. These product lines accounted for $275,000 in revenue for the fiscal quarter ended June 25, 2016 and $780,000 for the fiscal quarter June 27, 2015.Gross margin on these revenue was zero for the fiscal quarter ended June 25, 2016 and $240,000 for the fiscal quarter June 27, 2015. 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.

(10)          Loss Per Share

Basic loss per share (EPS) is calculated by dividing net income or loss by the weighted average common shares outstanding during the period. Diluted EPS reflects the net incremental shares that would be issued if unvested restricted shares became vested and dilutive outstanding stock options were exercised, using the treasury stock method. In the case of a net loss, it is assumed that no incremental shares would be issued because they would be antidilutive. In addition, certain options are considered antidilutive because assumed proceeds from exercise price, related tax benefits and average future compensation was greater than the weighted average number of options outstanding multiplied by the average market price during the period. The shares used in per share computations are as follows: 

The stock options, restricted stock, convertible preferred stocks and warrants not included in the computation of diluted earnings per share (EPS) for the three month period ended June 25, 2016 and June 27, 2015 is a result of the Company’s net loss and, therefore, the effect of these instruments would be anti-dilutive.

(11)          Share Based Compensation

The Company has established the 2005 Equity Incentive Plan, which provide for the granting of options and restricted stock for up to 2,850,000 shares of common stock at 100% of fair market value at the date of grant, with each grant requiring approval by the Board of Directors of the Company. The 2005 Plan has been extended to be effective until 2025. Option grants under the 2000 Stock Option Plan are no longer available. Options granted generally vest in one or more installments in a four or five year period and must be exercised while the grantee is employed by the Company or within a certain period after termination of employment. Options granted to employees shall not have terms in excess of 10 years from the grant date. Holders of options may be granted stock appreciation rights (SARs), which entitle them to surrender outstanding awards for a cash distribution under certain changes in ownership of the Company, as defined in the stock option plan. As of June 25, 2016, no SAR’s have been granted under the option plan. As of June 25, 2016, the total number of shares of common stock available for issuance was 1,018,627. All outstanding options have a ten year life from the date of grant. The Company records compensation cost associated with share-based compensation equivalent to the estimated fair value of the awards over the requisite service period.

Stock Options

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 and the following weighted average assumptions: 

The computation of expected volatility used in the Black-Scholes-Merton option-pricing model is based on the historical volatility of the Company’s 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 is based on the U.S. Treasury rates with maturity similar to the expected term of the option on the date of grant.

A summary of the changes in stock options outstanding for the three month period ended June 25, 2016 and the year ended March 26, 2016 is as follows:   

As of June 25, 2016, there was $376,000 of total unrecognized compensation cost related to non-vested options. That cost is expected to be recognized over a weighted average period of 2.59 years and will be adjusted for subsequent changes in estimated forfeitures. There were 28,500 options that vested during the quarter ended June 25, 2016, and 38,500 options that vested during the quarter ended June 27, 2015. The total fair value of options vested during each of the quarters ended June 25, 2016 and June 27, 2015 was $1,000 and $13,000 respectively. There were no options exercised in the three month period ended June 25, 2016. Options for 12,500 shares of common stock were exercised in the three month period ended June 27, 2015. Share based compensation cost related to stock options recognized in operating results for the three months ended June 25, 2016 and June 27, 2015 totaled $72,000 and $114,000, respectively.

Restricted Stock

No restricted awards were granted during the first quarter of fiscal 2017 and fiscal 2016. No restricted awards vested during the first quarter of fiscal 2017. The Company granted 50,000 shares of restricted stock outside the 2005 Plan in fiscal 2013 that vested in the first quarter of fiscal 2016. The restricted stock awards are considered fixed awards as the number of shares and fair value at the grant date is amortized over the requisite service period net of estimated forfeitures. There was no compensation recognized for the restricted and unrestricted stock awards during the first quarter of fiscal 2017. Compensation cost recognized for the restricted and unrestricted stock awards during the first quarter of 2016 was $221,000.

A summary of the changes in non-vested restricted stock awards outstanding for the three month period ended June 25, 2016 and the fiscal year ended March 26, 2016 is as follows:

(12)           Significant Customer and Industry Segment Information

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

The tables below present information for the three month periods ended June 25, 2016 and June 27, 2015:

During the first quarter of fiscal 2017, one customer accounted for 30% of the Company’s consolidated revenues and was included in the Microsource segment. A second customer accounted for 22% and was included in the Giga-tronics Division. A third customer accounted for 17% of the Company’s consolidated revenue and was also included in the Giga-tronics Division. During the first quarter of fiscal 2016, one customer accounted for 31% of the Company’s consolidated revenues and was included in the Microsource segment. A second customer accounted for 16% and was also included in the Microsource segment. A third customer accounted for 13% of the Company’s consolidated revenue and was included in the Giga-tronics Division.

(13)          Income Taxes

The Company accounts for income taxes using the asset and liability method as codified in Topic 740. Under this 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 carry-forwards.

The Company recorded no tax expense for the three months ended June 25, 2016 and June 27, 2015. The effective tax rate for the three months ended June 25, 2016 and June 27, 2015 was 0% respectively, primarily due to a valuation allowance recorded against the net deferred tax asset balance.

As of June 25, 2016, the Company had recorded $106,000 for unrecognized tax benefits related to uncertain tax positions. The unrecognized tax benefit is netted against the non-current deferred tax asset on the Consolidated Balance Sheet. The Company does not expect the liability for unrecognized tax benefits to change materially within the next 12 months. The Company does have a California Franchise Tax Board audit that is currently in process. The Company is working with the California Franchise Tax Board to resolve all audit issues and does not believe any material taxes, penalties and fees are due. However, as a result of the on-going examination, the Company recorded an estimated associated tax liability of $45,000 in the first quarter of fiscal 2015.

(14)        Warranty Obligations

The Company records a liability in cost of sales for estimated warranty obligations at the date products are sold. Adjustments are made as new information becomes available. The following provides a reconciliation of changes in the Company’s warranty reserve. The Company provides no other guarantees.

 (15)       Series B, C, D Convertible Voting Perpetual Preferred Stock and Warrants

On November 10, 2011, the Company received $2,199,000 in cash proceeds from Alara Capital AVI II, LLC, a Delaware limited liability company (the “Investor”), an investment vehicle sponsored by Active Value Investors, LLC, under a Securities Purchase Agreement entered into on October 31, 2011. Under the terms of the Securities Purchase Agreement, the Company issued 9,997 shares of its Series B Convertible Voting Perpetual Preferred Stock (“Series B Preferred Stock”) to the Investor at a price of $220 per share. The Company has recorded $2.0 million as Series B Preferred Stock on the consolidated balance sheet which is net of stock offering costs of approximately $202,000 and represents the value attributable to both the convertible preferred stock and warrants issued to the Investor. After considering the value of the warrants, the effective conversion price of the preferred stock was greater than the common stock price on date of issue and therefore no beneficial conversion feature was present.

On February 19, 2013, the Company entered into a Securities Purchase Agreement pursuant to which it agreed to sell 3,424.65 shares of its Series C Convertible Voting Perpetual Preferred Stock (“Series C Preferred Stock”) to the Investor, for aggregate consideration of $500,000, which is approximately $146.00 per share. The Company has recorded $457,000 as Series C Preferred Stock on the consolidated balance sheet, which is net of stock offering costs of approximately $43,000. After considering the reduction in the value of the warrant, the effective conversion price of the preferred stock was greater than the common stock price on the date of issue and therefore no beneficial conversion feature was present.

On July 8, 2013 the Company received $817,000 in net cash proceeds from the Investor under a Securities Purchase Agreement. The Company sold to the Investor 5,111.86 shares of its Series D Convertible Voting Perpetual Preferred Stock (Series D Preferred Stock) and a warrant to purchase up to 511,186 additional shares of common stock at the price of $1.43 per share. The allocation of the $858,000 in gross proceeds from issuance of Series D Preferred Stock based on the relative fair values resulted in an allocation of $498,000 (which was recorded net of $41,000 of issuance costs) to Series D Preferred Stock and $360,000 to Common Stock.  In addition, because the effective conversion rate based on the $498,000 allocated to Series D Preferred Stock was $0.97 per common share which was less than the Company’s stock price on the date of issuance, a beneficial conversion feature was present at the issuance date. The beneficial conversion feature totaled $238,000 and was recorded as an increase of common stock and an increase to accumulated deficit. 

Each share of Series B, Series C and Series D Preferred Stock is convertible into one hundred shares of the Company’s common stock. The investor also held warrants to purchase 1,017,405 shares at an exercise price of $1.43 per share which were exercised in February and May 2015 as discussed in Note 17, Exercise of Series C and Series D Warrants.

The table below presents information as of June 25, 2016 and March 26, 2016.

Preferred Stock                        

As of June 25, 2016 and March 26, 2016 

(16)        Private Placement Offering

On January 19, 2016, the Company entered into a Securities Purchase Agreement for 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. The purchase price for each Unit was $1.24375. Gross proceeds were approximately $3.5 million. Net proceeds to the Company after fees was 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. Emerging Growth Equities, Ltd also received warrants to purchase 292,727 shares of common stock at an exercise price of $1.15 per share as part of its consideration for serving as placement agent in connection with the private placement.

(17)        Exercise of Series C and Series D Warrants

On February 16, 2015, the Company entered into a Securities Purchase Agreement and Warrant Agreement with Alara Capital AVI II, LLC in which the Company received total gross cash proceeds of approximately $1.5 million. Funds were received from Alara in separate closings dated February 16, 2015 and February 23, 2015 in which Alara exercised a total of 1,002,818 of its existing Series C and Series D warrants to purchase common shares, all of which had an exercise price of $1.43 per share for total cash proceeds of $1,434,000, which was recorded net of $42,000 of stock issuance costs. As part of the consideration for this exercise, the Company sold to Alara two new warrants (“new Warrants”) to purchase an additional 898,634 and 194,437 common shares at an exercise price of $1.78 and $1.76 per share, respectively, for a total purchase price of $137,000 or $0.125 per share, The new warrants have a term of five years and may be paid in cash or through a cashless net share settlement. The Company and Alara amended the remaining 14,587 warrants as part of the February closings. On May 14, 2015, Alara exercised the remaining 14,587 warrants by acquiring 7,216 of shares of the Company’s common stock through a cashless net share settlement. The Company recorded the issuance of the new Warrants using their estimated fair value on the date of issuance. The Company estimated the fair value of the new Warrants using the Black-Scholes option valuation model with the following assumptions: expected term of 5 years, a risk-free interest rate of 1.54%, expected volatility of 90% and 0% expected dividend yield. The resulting $1.2 million from the issuance of the new Warrants was recorded as a charge to other expense in the fourth quarter of fiscal 2015.

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The forward-looking statements included in this report including, without limitation, statements containing the words "believes", "anticipates", "estimates", "expects", "intends" and words of similar import, which reflect management’s best judgment based on factors currently known, involve risks and uncertainties. Actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including but not limited to those listed in Giga-tronics’ Annual Report on Form 10-K for the fiscal year ended March 26, 2016 Part I, under the heading “Risk Factors”, and Part II, under the heading “Management’s Discussion and Analysis of Financial Conditions and Results of Operations”.

Company Overview

We produce an Advanced Signal Generator (ASG) for the electronic warfare market and YIG (Yttrium, Iron, Garnet) RADAR filters used in fighter jet aircraft. We have two reporting segments: Giga-tronics Division and Microsource.

The ASG has the potential to significantly grow sales and achieve strong gross margins. However, Giga-tronics has 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 Giga-tronics product, and we have experienced longer than anticipated procurement cycles in the electronic warfare market it services. The delays in the development 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 experience similar losses in the current fiscal year if there are further delays in ASG features currently being developed, 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 June 2016, the Giga-tronics Division received a $3.3 million order from the United States Navy for our Real-Time 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 includes two ASG chassis and seven ASG blades, along with engineering services to integrate the Real-Time TEmS product with additional third party hardware and software for the customer. The Company expects to fulfill the order over the second half of the current fiscal year.

In July 2016, the Giga-tronics Division received a $542,000 from the United States Navy for our ASG hardware only platform. The Company expects to fulfill the order within the next few months. This order is not reflected in the orders and backlog numbers reported below since it was received after June 25, 2016.

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 expects to deliver the NRE services over the next twelve months. This order is not reflected in the orders and backlog numbers reported below since it was received after June 25, 2016.

In October 2015, the Giga-tronics Division received a $1.4 million 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. The combined order was for four chassis and thirteen ASG blades. Giga-tronics started delivering these chassis and blades in December 2015. As of June 25, 2016, one blade had yet to be delivered and the Company expects it to be delivered in the next few months.

Since the introduction of the ASG, the Company has received $7.2 million in associated ASG orders and shipped $3.0 million of associated ASG products through June 25, 2016. The $7.2 million in associated ASG orders includes the $542,000 order from the United States Navy received in July 2016.

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 (“8003”). We shipped all of the $1.5 million order in the first and second quarters of fiscal 2016. The 8003 was designed about 25 years ago, and Giga-tronics is no longer able to purchase key components and materials used to manufacture the 8003. The Navy orders marked the end of life of the 8003.

In May 2015, Microsource received a $3.0 million YIG RADAR filter order (Ongoing Production Order) associated with a fighter jet platform we have been manufacturing since fiscal 2014. We shipped all of the $3.0 million order in fiscal 2016. In April 2016, Microsource received a $4.5 million YIG RADAR filter order for the same fighter jet platform, representing a 50% year increase in the order size when comparing fiscal 2017 to fiscal 2016. We expect to ship this order throughout fiscal 2017.

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. In fiscal 2016 our Microsource business unit also finalized an associated multiyear $10.0 million YIG production order (“YIG Production Order”). The Company will start shipping the YIG Production Order in the second quarter of fiscal 2017, and will continue shipping it through fiscal 2020.

The majority of the deliverables under the Microsource NRE Order occurred in fiscal 2015 and early fiscal 2016. The Company will be delivering a limited number of flight-qualified prototype hardware in the second quarter of fiscal 2017 and other NRE deliverables associated with the YIG RADAR filters moving from the NRE Order to the YIG Production Order.

Critical Accounting Policies

Please refer to the section of the Company’s Annual Report on Form 10-K for the year ended March 26, 2016 entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations —Critical Accounting Policies” for a discussion of our critical accounting policies. During the three months ended June 25, 2016, there were no material changes to these policies other than as disclosed in Note 1 Organization and Significant Accounting Policies.

In preparing the consolidated financial statements, management is required to make estimates based on the information available that affect the reported amounts of assets and liabilities as of the balance sheet dates and revenues and expenses for the reporting periods. While we believe that these accounting policies and estimates are based on sound measurement criteria, actual future events can and often do result in outcomes that can be materially different from these estimates and forecasts.

Results of Operations

New orders received by segment are as follows:

New orders received in the first quarter of fiscal 2017 decreased by 44% to $9.3 million from the $16.6 million received in the first quarter of fiscal 2016. The Giga-tronics Division saw a 35% increase in orders in the first quarter of fiscal 2017 due to a $3.3 million order from the US Navy associated with the Company’s ASG. The remaining orders of $1.4 million were associated with the Switch Product Line sold to Astronics in June of 2016 (see Note 9, Sale of Product Lines). The $3.5 million of new orders in the first quarter of fiscal 2016 were all for legacy product the Company no longer manufactures, including the $1.5 million 8003 order from the United States Navy. The Microsource business unit saw a 65% decrease in the first quarter of fiscal 2017 due to the receipt of a $4.5 million YIG Order in comparison to the $10.0 million YIG Production Order and the $3.0 million Ongoing Production Order, received in the first quarter of fiscal 2016.

The following table shows order backlog and related information at the end of the respective periods:

Backlog at the end of the first quarter of fiscal 2017 increased 2% compared to the end of the same period last year. The Giga-tronics ASG backlog at June 25, 2016 was $3.68 million, a $3.3 million increase of ASG backlog since June 27, 2015. Microsource saw a 1% increase in backlog in the first quarter of fiscal 2017. The increase is primarily due to the receipt of a $4.5 million YIG production Order in the current period in comparison to the $3.0 million Order for the same platform in the prior year.

The allocation of net sales was as follows for the periods shown:

Fiscal 2017 first quarter net sales were $3.4 million, a 21% decrease from the $4.4 million in the first quarter of fiscal 2016. Sales at Microsource decreased 42% primarily due to a decrease of $547,000 of sales associated with the winding down of the NRE Order until other deliverables became due in July of 2017 as the YIG RADAR filter moves to production.  Net sales for the Company’s Giga-tronics business unit were $2.1 million for both quarters. Sales for the Company’s Advanced Signal Generator (“ASG”) were $674,000 in the first quarter of fiscal 2017 compared to none in the first quarter of fiscal 2016, this increase was offset by lower sales associated with the legacy product lines sold to Spanawave and Astronics. The Switch product line accounted for $1.1 million in revenue for the fiscal quarter ended June 25, 2016 and $489,000 for the fiscal quarter June 27, 2015. The Switch product line’s gross margin on these revenue was $437,000 for the fiscal quarter ended June 25, 2016 and $217,000 for the fiscal quarter June 27, 2015.

Gross margins was as follows for the periods shown:

Gross margin decreased in the first quarter of fiscal 2017 to $925,000 from $1.7 million for the first quarter of fiscal 2016. The decrease was due to the decrease in net sales, overhead being absorbed by fewer shipments and production variances associated with the ASG. The Switch product line’s gross margin was $437,000 for the fiscal quarter ended June 25, 2016 and $217,000 for the fiscal quarter June 27, 2015.

Operating expenses were as follows for the periods shown:

Operating expenses decreased 17% or $366,000 in the first quarter of fiscal 2017 over fiscal 2016. Engineering expenses decreased $216,000, primarily due to less development hours associated with ASG in comparison to the same period in the prior year. Selling, general and administrative decreased by $150,000 primarily due to a decrease of $263,000 associated with non-cash stock based compensation, partially offset by $100,000 of severance associated with an officer departing the Company.

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 ending June 25, 2016 after related expenses were subtracted from the sales price. The gain is included in the accompanying consolidated financial statements. During the three month periods ended June 25, 2016 and June 27, 2015, net Switch sales were $1.1 million and $498,000, respectively (see Note 9, Sale of Product Lines).

Derivative Liability

The Company recorded a gain of $46,000 in the first quarter of fiscal 2017 related to revaluation of the derivative liability associated with warrants issued with the PFG Loan (see Note 7, Term Loan, Revolving Line of Credit and Warrants). The Company recorded a loss of $63,000 in the first quarter of fiscal 2016 related to revaluation of the derivative liability associated with warrants issued with the PFG Loan.

Net Interest Expense

Net interest expense in the first quarter of fiscal 2017 was $40,000, a decrease of $53,000 over the first quarter of fiscal 2016. Interest expense decreased primarily due to the lower principal balance on the PFG loan. For the first quarter of fiscal 2017, interest expense includes $11,000 of accretion of discounts on the PFG Loan and Warrant Debt compared to $42,000 recorded in the first quarter of fiscal 2016.

Net Loss

Net loss was for the first quarter of fiscal 2017 was $102,000, compared to a net loss of $629,000 recorded in the first quarter of fiscal 2016. The decrease in net loss was primarily 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.

Financial Condition and Liquidity

As of June 25, 2016, Giga-tronics had $1.8 million in cash and cash equivalents, compared to $1.3 million as of March 26, 2016. Working capital was $1.4 million at June 25, 2016 compared to $1.8 million at March 26, 2016. The current ratio (current assets divided by current liabilities) at June 25, 2016 was 1.16 compared to 1.23 at March 28, 2015. The first quarter of fiscal 2017 decrease in working capital was primarily attributable to a $1.1 million increase in deferred revenue related to advance payment arrangements for raw materials for our customer, which was partially offset by a $553,000 increase in inventories associated with the advance payment arrangements for raw materials for our customer.

Cash used in operating activities was $589,000 for the three month period ended June 25, 2016. Cash used in operating activities in the first quarter of fiscal 2017 resulted primarily from our net loss of $102,000, an increase in inventories of $553,000, and partially offset by an increase in deferred revenue of $1.1 million due to advance payment arrangements for raw materials. These uses of cash were partially offset by a decrease to accounts payable of $173,000.

Cash used in operating activities was $492,000 for the three month period ended June 27, 2015. Cash used in operating activities in the first quarter of fiscal 2016 resulted primarily from the net loss of $629,000, an increase in inventories of $424,000, a decrease in deferred revenue of $307,000 due to the completion of milestones associated with Microsource ongoing production contracts, and an increase in accounts receivable of $266,000. These uses of cash were partially offset by an increase to accounts payable of $861,000, and $335,000 of non-cash share based compensation expense which is included in the net loss.

Cash provided by investing activities was $1.2 million for the three month period ended June 25, 2016. Cash provided by investing activities in the first quarter of 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 $375,000 pertaining to the sale of our legacy product lines. After the end of the reporting period, 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 become entitled to the $375,000 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 offset by additions to property and equipment of $30,000 in the first quarter of fiscal 2017 compared to $28,000 in the first quarter of fiscal 2016. The additions in both first quarter ended fiscal 2017 and fiscal 2016 were associated with equipment required to manufacture the ASG.

Cash used in by financing activities for the quarter ended June 25, 2016 was $141,000, primarily due to the repayment of the Company’s term loan with PFG.

Cash provided by financing activities for the quarter ended June 27, 2015 was $354,000, primarily due to $500,000 in proceeds from the accounts receivable line of credit with Bridge Bank (see Note 6, Accounts Receivable Line of Credit). These proceeds were partially offset by a $141,000 repayment of the Company’s term loan with PFG.

The Company incurred a net loss of $102,000 for the first three months of fiscal 2017, which contributed to an increase in our accumulated deficit of $24.1 million as of June 25, 2016.

The Company has experienced delays in the development of features, orders, and shipments for the new ASG. These delays have contributed, in part, to a decrease in working capital from $1.8 million at March 26, 2016, to $1.4 million at June 25, 2016. The new ASG product has shipped to several customers, but potential delays in the development 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 expires on May 7, 2017. 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 June 25, 2016, the line of credit had a balance of $800,000, and additional borrowing capacity of $902,000.

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. 

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 and equity financing, however there are no assurances that such financings will be available at all, or on terms acceptable to the Company.

Cumulative losses have had a significant negative impact on the financial condition of the Company and raise substantial doubt about the Company’s ability to continue as a going concern. The Consolidated Financial Statements have been prepared assuming 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.

ITEM 3 – QUANTITATI VE 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.

ITEM 4 – CONTROLS AND PROCEDURES

The Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to provide reasonable assurances that (i) the information the Company is required to disclose in the reports it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period required by the Commission’s rules and forms, and (ii) such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

There were no significant changes in the Company's internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

Based on the above described procedures and actions taken, the Company’s management, including its Chief Executive Officer and its Chief Financial Officer have concluded that as of June 25, 2016, the Company’s internal control over financial reporting was effective based on the criteria described in the “COSO Internal Control – Integrated Framework.”

II - OTHER INFORMATION

ITEM 1 – LEGAL PROCEEDINGS 

As of June 25, 2016, the Company has no material pending legal proceedings. From time to time, the Company is involved in various disputes and litigation matters that arise in the ordinary course of business.

On December 15, 2015, the Company entered into an Asset Purchase Agreement with Spanawave, whereby Spanawave agreed to purchase the Giga-tronics’ Division product lines for its Power Meters, Amplifiers and Legacy Signal Generators for $1.5 million (see Note 9, Sale of Product Lines). As of June 25, 2016, the Company had received $750,000 from Spanawave under the agreement. After the end of the reporting period, 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 become entitled to the $375,000 which was received during the first quarter of fiscal 2017. The parties are attempting to resolve this dispute, and the Company has returned the $375,000 to Spanawave on July 28, 2016.

ITEM 1A – RISK FACTORS

There has been no material change in the risk factors disclosed in the registrant’s Annual Report on Form 10-K for the fiscal year ended March 26, 2016.

ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.           

ITEM 3 – DEFAULTS UPON SENIOR SECURITIES

None.          

ITEM 4 – MINE SAFETY DISCLOSURES

Not applicable.          

ITEM 5 – OTHER INFORMATION

None.

ITEM 6 – EXHIBITS

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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