GIGA TRONICS INC - Annual Report: 2019 (Form 10-K)

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 Incorporated and its wholly owned subsidiary.

FORWARD-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 consists of two business segments, those of our wholly-owned subsidiary, Microsource Inc. (“Microsource”) and those of our Giga-tronics Division (“Giga-tronics”). Our Microsource operation designs and manufactures Microwave Integrated Components (MICs) for military airborne applications while Giga-tronics designs and manufactures real time solutions for RADAR / Electronic Warfare (EW) test and deployment in a laboratory setting.

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

The Company’s principal executive offices are located at 5990 Gleason Drive, Dublin, California and our telephone number at that location is (925) 328-4650. Our website address is http://www.gigatronics.com.

Reporting Segments

Our business has two reporting segments: Microsource and the Giga-tronics Division.

Microsource

Microsource develops and manufactures MICs for operational use in airborne military applications. Microsource’s two largest customers are prime contractors for which we develop and manufacture RADAR filters used in fighter jet aircrafts. Revenues from Microsource comprised the majority of our revenues for the fiscal years ended March 30, 2019 and March 31, 2018.

Giga-tronics Division

Our Giga-tronics Division designs, manufactures and markets a family of functional test products and integrates those test products along with third party hardware and software to create full test solutions for the RADAR/EW segment of the defense electronics market. Our RADAR/EW test solutions are used to evaluate and improve the performance of RADAR and EW systems. Giga-tronics Division customers include major defense prime contractors, the United States armed services and research institutes.

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, Note 10, Significant Customers and Industry Segment Information.”

Products and Markets

Microsource

Microsource’s primary business is the design of custom Microwave Integrated Components as well as the production of MIC components using chip and wire assembly methods. Microsource offers a line of tunable, synthesized Band Reject Filters (“BRF”) for solving interference problems in RADAR/EW applications. Self-protection systems onboard high performance military aircraft often require RADAR filters to block electromagnetic interference generated by other onboard electronic systems, particularly the aircraft’s main RADAR. Our high-speed, tunable notch filters can quickly block interference from both continuous wave and wide bandwidth emissions. Using proprietary driver and phase lock technology, these filters offer tuning speeds that are up to ten times faster than traditional filter designs. We design these filters specifically for each application.

While our RADAR filter technology may be used in a variety of operational applications and as components in microwave instruments and devices, Microsource’s two largest customers are prime contractors for whom we develop and manufacture RADAR filters used in fighter aircrafts. Microsource serves the aftermarket for operational hardware associated with the United States Government’s RADAR Modernization Program for prior generation fighter aircraft (i.e., the F/A-18E, F-15D and F-16 jets) to extend their useful lives. These RADAR filters are designed to withstand the rigors of operating under extreme conditions. They must be able to operate while exposed to the shock, vibration, high altitudes and temperature extremes experienced during jet flight without any cooling or heating from the aircraft.

Our customers require that Microsource be certified to the stringent AS9100D aerospace quality standard. Microsource routinely maintains a top rating from its customers and over the years has received a “Supplier of the Year” award, as well as multiple “Gold Supplier” awards from one of our prime customers. We received our most recent customer award in April of 2019 for delivering consistent product quality and on-time shipments during 2018.

Microsource’s revenues have grown as prime contractors began upgrading additional aircraft. Initially Microsource supplied filters for one fighter jet, the F/A-18E. During our 2014 fiscal year, the prime contractor added a second aircraft, the F-15. Additionally, during our 2017 fiscal year, a second prime contractor added a third aircraft, the F-16. As a result, Microsource’s revenue has climbed to over $9 million in fiscal 2019, which ended March 30, 2019. Microsource is a sole-source supplier of filters for these three fighter jets and we expect that the business will continue to be a significant source of our future revenue.

Giga-tronics Division

Our Giga-tronics Division designs, manufactures and markets a family of functional test products for the RADAR/EW segment of the defense electronics market. Our RADAR/EW test products are used in a laboratory setting to evaluate and improve the performance of RADAR/EW systems. Giga-tronics Division customers include major prime defense contractors, the armed services (primarily in the U.S.) and research institutes.

Our goal is to be the leading supplier of solutions for evaluating RADAR and EW systems and we believe our Advanced Signal Generation and Analysis (“ASGA”) functional test platform, which we have been developing since 2012, will allow us to accomplish this goal. The same digital technology that has revolutionized commercial communications and automotive electronics is now being applied to advanced RADAR and EW systems. This shift in technology limits the effectiveness of traditional test solutions, which are unable to properly stimulate and actively interact with the RADAR and EW systems being tested. The Giga-tronics ASGA platform, however, has control capabilities and real-time behavior built into the fabric of its architecture. This architecture enables test solutions with real time responses and closed loop behavior that we believe is unavailable from any competitor.

Technology Shift in RADAR Technology

Historically, U.S. defense electronic systems have embodied the most advanced capabilities available. Major investments in integrated circuits, computing technology and signal processing algorithms, made by the U.S. Defense Department during the 1960s, through the 1980s, gave the U.S. its edge in defensive capability. However, these technologies slowly found their way into consumer products and services, such as desktop computers, music players, smartphones and the world-wide-web. The rapid acceleration and global proliferation of these technologies by commercial companies has allowed U.S. allies and potential adversaries alike to take a significant leap forward in RADAR and EW technology.

The democratization of these advanced technologies has permitted potential adversaries to “catch-up” and in many cases surpass U.S. military dominance in the air and at sea. The U.S. Defense Department recognizes these threats and has requested that Congress divert substantial resources from other programs to fund development of the next generation of RADAR and EW systems. These new systems may employ machine learning and artificial intelligence technologies that will require new approaches for test and evaluation. We believe the market for these new test technologies will remain robust even through typical business cycles.

Traditional open loop test techniques will also no longer be adequate to exercise the new cognitive systems through all their modes nor will they be able to interact in a closed loop manner to evaluate machine learning algorithms in real-time. We believe that prime contractors and government test facilities will require hardware-in-the-loop (“HWIL”) testing. HWIL testing calls for building a realistic simulation of the environment the new devices will experience when deployed. This means the new test solutions must stimulate the system under test (SUT) with high-fidelity signals and then modify its stimulation in real-time in response to the evolving behavior of the SUT. We believe our ASGA platform is the first to offer this closed-loop test functionality. Traditional test solutions that use synthesizers, modulators and spectrum analyzers are poorly suited to the task and this shift has provided a market opportunity for Giga-tronics. We believe, therefore, that competitors seeking to develop competing closed-loop test functionality face significant barriers because developing close-loop test systems requires a completely new investment from the ground up.

Giga-tronics’ Solution

Giga-tronics took the approach to develop a HWIL test platform similar to a RADAR or EW system in order to be prepared for the new challenges, but with the added difficult requirement of being broadband with real-time control of Frequency, Phase, and Amplitude. Giga-tronics limited its investment to the microwave portion of a RADAR or EW system’s architecture and has leveraged third party hardware partners to acquire the digital portion of the test solutions. Instead of building a traditional synthesizer, Giga-tronics developed a broad-band up-converter. Instead of building a spectrum analyzer, Giga-tronics invented a down-converter which uses a similar internal control structure as the up-converter. Consequently, we believe that Giga-tronics is the only solution provider able to offer a real-time closed loop RADAR emulator.

We developed our ASGA test systems to address three primary goals:

We developed our ASGA solution in three phases. First, building on our microwave RADAR component expertise, we developed a microwave up-converter, a down-converter, and a power amplifier. By using identical architecture and components as in the up-converter, for the down-converter, superior Radio Frequency (“RF”) performance is achieved, including:

Second, we provided a microwave sub-system which includes individual calibrated transmit channels called the Advanced Signal Generator (ASG) and individual calibrated receive channels called the Advanced Signal Analyzer (ASA). A System Reference Module (SRM100A) shared between the ASG and ASA modules along with an industry standard AXIe chassis completes the platform. The platform’s architecture facilitates building test systems with reduced size, weight and cost compared with traditional solutions, especially when the test system is required to have multiple transmitters and receivers.

Third, we developed complete custom test solutions. Some examples of test solutions integrated by Giga-tronics are our Real-Time Threat Emulation System (TEmS) and the Multi-Ship RADAR Signal Generator sold to the US Navy at its Naval Air Station in Pt. Mugu, California.

By architecting a RADAR/EW test solution similarly to the way a RADAR system is architected, we have developed a disruptive product test platform which addresses the new adaptive/cognitive RADAR/EW test requirements.

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 materially adverse to our operations. Some suppliers are also competitors of Giga-tronics. In the event a competitor-supplier chooses not to 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.

Proprietary Technology and Intellectual Property

Our competitive position is largely dependent upon our ability to provide performance specifications for our instruments and systems that (a) 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 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 primarily 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 have maintained four non-provisional patents related to our legacy 2500B parametric signal generator product line, which was not among the legacy product lines that have been sold to date. These patents describe advanced synthesis techniques and potentially can be extended for use with the Giga-tronics ASGA system and to a number of Microsource synthesizer components. Additionally, we filed a provisional U.S. patent relating to the ASGA system in June of 2016 and subsequently filed a non-provisional application in June of 2017. The patent application describes the internal design of the ASG and ASA along with the architecture of how all the components work together to facilitate building multi-channel test systems with reduced size, weight and cost as compared to present solutions. The application for the non-provisional patent is currently pending before the U.S. patent office.

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.

In September 2015, we entered into 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), which is owned by the aerospace company and licensed to us, allows our ASGA system to coordinate with various third-party hardware elements to generate the signals for testing RADAR/EW equipment. We license the OLS software as a bundled or integrated solution with our TEmS product. We paid over $1.2 million in connection with the development of this software and, in addition, we incur a license fee of over $20,000 per system sold that incorporate this software.

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 RADAR filters for fighter jet aircrafts and RADAR/EW testing solutions 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 a significant portion of all of our sale in fiscal 2020. U.S. and international defense-related agencies accounted for 98% of net sales in fiscal 2019 and 93% of net sales in fiscal 2018. Commercial business accounted for the remaining 2% of net sales in fiscal 2019 and 7% of net sales in fiscal 2018.

At the Giga-tronics Division, U.S. defense agencies and their prime contractors accounted for 90% and 10% of net sales in fiscal 2019 and 76% and 24% of net sales in fiscal 2018, respectively. Microsource reported 100% and 99% of net sales to prime contractors of U.S. defense agencies in fiscal 2019 and fiscal 2018, respectively.

During fiscal 2019, the Boeing Company accounted for 57% of our consolidated revenues and was included in the Microsource reporting segment. A second customer, Lockheed Martin accounted for 26% of our consolidated revenues during fiscal 2019 and was also included in the Microsource reporting segment.

During fiscal 2018, the Boeing Company accounted for 29% 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 17% of our consolidated revenues during fiscal 2018 and was included in the Giga-tronics Division reporting segment.

We could experience a material adverse effect on our financial stability if there was a significant loss of either our defense or commercial customers.

Both Microsource and our Giga-tronics Division products are largely dependent on U.S. defense spending and budgets and are subject to expansion and contraction between fiscal year periods. Revenues from Microsource products and services often times span several years with deliveries varying between both interim and annual fiscal year periods. Additionally, the Giga-tronics Division’s ASGA system is a relatively new product platform with fewer targeted customers and significantly longer sales cycles and greater average selling prices when compared to its prior general-purpose test & measurement equipment product lines. We therefore expect that a major customer in one year may not be a major customer in the following year. Accordingly, our net sales and earnings may vary significantly from one period to the next and 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.

Backlog of Orders

On March 30, 2019, our backlog of unfilled orders was approximately $6.7 million compared to approximately $11.2 million at March 31, 2018. As of March 30, 2019, there were approximately $2.2 million of orders scheduled for shipment beyond one year, compared to $3.8 million at March 31, 2018. 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 fiscal quarter may not be indicative of sales for any period. In addition, the Company now recognizes revenue for certain contracts as it incurs costs, as opposed to when units are delivered. This change in fiscal 2019 has resulted in a decrease in backlog as of March 30, 2019 as compared to the legacy method for those contracts in the prior years.

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

The Company primarily competes in two different products markets: Microsource’s RADAR filters and Giga-tronics RADAR/EW test systems.

Microsource is a sole source supplier serving the aftermarket for operational hardware associated with the U.S. Government’s RADAR Modernization Program (RMP) for certain prior generation fighter jet aircrafts (F/A-18E, F-15D and F-16 jets) to extend their useful lives. Our Microsource division supplies RADAR filters specifically designed for military aircrafts to solve an interference problem created when newer, more powerful RADARs are installed on older aircrafts. Over the years, the prime contractors responsible for integrating the new RADARs have flight qualified our filters at considerable expense. Only a few other companies possess the technical know-how to design and manufacture filters of this nature, such as Teledyne and Micro-Lambda Wireless, but we believe the expense of developing and requalifying a new component for these aircraft is prohibitive to the point where the prime contractor would only undertake such an effort if major issues were to arise such as, significant technical deficiencies or if Microsource were unable to deliver products on time.

Microsource has received multiply supplier of the year awards including in April 2019 “The Gold Supplier” award from Boeing, so we believe our sole source position is secure.

The Giga-tronics Division serves the defense electronics market with a microwave test platform used in the evaluation of military RADAR/EW systems. These applications represent niche segments within the broader test equipment market. While the niche market segments of RADAR/EW are large enough to be meaningful to Giga-tronics, we believe they are too small to attract larger competitors, such as Agilent/Keysight, Rohde & Schwarz and National Instruments who, to our knowledge, do not approach these markets with new dedicated solutions.

We have developed a unique HWIL approach to address the RADAR/EW test requirements that are adaptive/cognitive. Testing these new RADAR and jamming (i.e. interference) signals is best solved by a real time, closed loop, dynamic simulation system. We believe our Giga-tronics RADAR/EW solutions present a paradigm shift providing a closed loop test capability that is currently unavailable elsewhere. Our competitors often have greater resources in research, development and manufacturing and substantially broader product lines and channels. To compete, we place strong emphasis on maintaining a high degree of technical competence as it relates to the development of new microwave products, are highly selective in establishing technological objectives and focus sales and marketing activities in the selected niche areas that are weakly served or underserved by our competitors. Competitors that make alternative equipment to the Giga-tronics Advanced Signal Generation and Analysis (ASGA) system include ELCOM (a division of Frequency Electronics Inc.), COMSTRON (a division of Cobham Plc) and EWST (a division of Ultra Electronics Plc). Compared to Giga-tronics, these competitors are of comparable size or have small product divisions with more limited product lines. Two larger companies, Northrop Grumman/Amherst and Textron/AAI sell open loop test equipment that competes with the Giga-tronics ASGA solutions, albeit at a much higher selling price. We do not believe that either of these suppliers are in a position to offer an adaptive closed loop testing system due to the analog nature of their systems’ architectures. Compared to our ASGA system, the test systems from Northrup Grumman and Textron have long delivery schedules, represent expensive capital investments to the customers and typically are shared among a large number of users generally limiting access to their testing capabilities. Giga-tronics’ ASGA solution can complement these larger test systems by addressing the new closed loop test requirements for the next generation RADAR/EW devices and by offering smaller, lower cost and more flexible testing solutions that can be delivered more quickly, which greatly increases a user’s access to systems test capability and reduces the risk of program failure.

Sales and Marketing

Microsource and the Giga-tronics Division sell their products primarily direct to U.S. defense agencies and their prime defense contractors. While the Company primarily relies on its internal sales teams to identify leads and complete sales, it may engage independent sales representatives who are perceived to have expertise with targeted markets or customers.  The Company changed its sales approach and sales team in fiscal 2019 and we believe that we are beginning to see the benefits of these changes with the recent $4.0 million purchase order for our ASGA product platform. 

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 new functionality and advancements in component technologies into our new products. In fiscal 2019 and fiscal 2018, product development expenses totaled approximately $1.3 million and $1.8 million, respectively.

Our product development activities have historically been funded internally, through product line sales, or through outside equity investment and debt financing. Product development activities are expensed as incurred.

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.

Manufacturing

The Company assembles and tests Microsource and Giga-tronics Division products at its Dublin facility. Microsource develops and manufactures RADAR filters used in fighter jet aircrafts. Our Giga-tronics Division manufactures a family of functional test products and integrates those test products along with third party hardware and software to create full test solutions for the RADAR/EW segment of the defense electronics market.

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 30, 2019 and March 31, 2018, we employed 39 and 43 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.

See Part II-Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements, Note 10, Significant Customers and Industry Segment Information for further breakdown of international sales for the last two fiscal years.

ITEM 1A. RISK FACTORS

If we do not generate sufficient net cash flow from our operations and if we are unable to raise additional capital as needed, our financial condition would be adversely affected, we may not to be able to execute our growth strategy and we could become insolvent.

We cannot assure that we will generate cash from operations or other potential sources to fund our future working capital needs.

We incurred net losses of $1.0 million in fiscal 2019, and $3.1 million in fiscal 2018. These losses have contributed to an accumulated deficit of $28.5 million as of March 31, 2019. Beginning in fiscal 2012, we invested primarily in the development of our ASGA product platform for EW test and emulation applications, which we believe possesses greater long-term opportunities for revenue growth and improved gross margins compared to our previous general-purpose test and measurement product lines, the substantial majority of which have been sold as of March 31, 2018. Through March 31, 2019, the Company has spent approximately $20 million towards the development of the ASGA system product platform.  Although we have shipped ASGA system products to several customers, potential delays in the refinement of further features, longer than anticipated sales cycles, or the ability to generate shipments in significant quantities, could significantly contribute to additional future losses.

The lack of adequate working capital from any inability to generate cash flow from operations or to raise equity or debt financing could force us to discontinue or suspend product lines, business segments or otherwise substantially curtail or cease operations and would, therefore, have an adverse effect on our business and financial condition. Furthermore, we cannot assure that any necessary financing, if available, would be available on attractive terms or that they would not have a significantly dilutive effect on our existing shareholders. If our financial condition were to worsen and we become unable to attract additional equity or debt financing or enter into other strategic transactions, we could become insolvent or be forced to declare bankruptcy, and we would not be able to execute our growth strategy. 

Our recent losses and limited liquidity during most of Fiscal 2019 and prior fiscal years caused us to reduce product development expenditures and headcount.

Our recent losses and limited liquidity caused us to reduce our R&D expenditures and headcount in fiscal 2019 and prior years. This prolonged reduction of R&D spending caused us to delay the development of certain features of our ASGA product platform. As a result of the Company’s improved operating performance in fiscal 2019, due in part to the receipt of a $4.0 million ASGA product order in February 2019, the receipt of $2.5 million in gross proceeds from the sale of 6.0% Series E Senior Convertible Voting Perpetual Preferred Stock (“Series E Shares”) between March 2018 and March 2019, and a projected increase in ASGA product sales in fiscal 2020, the Company anticipates hiring additional R&D personnel and incurring additional R&D expenditures during fiscal 2020 compared to fiscal 2019. Any delays in the receipt of future orders for our ASGA or other products would adversely impact our quarterly operating results during the second half of calendar 2020 and subsequent periods.

We face risks related to production delays, delays of customer orders and higher selling price of a new product platform.

Our ASGA product platform has been our primarily product development focus during the past seven years, however, delays in completing its development, together with early design and manufacturing issues and longer than anticipated sales cycles have contributed to our losses and increased accumulated deficit as of March 30, 2019. Additionally, the average selling price of our new ASGA products is considerably higher that our prior general-purpose test and measurement products, which in turn, requires additional internal approvals on the part of the purchaser and generally leads to longer sales cycles. Our financial condition may also cause potential customers to delay, postpone or decide against placing orders for our products. Continued longer than anticipated sales cycles in future fiscal years, or delays in production and shipping volume quantities, could significantly contribute to additional losses.

Our sales are substantially dependent on the defense industry and a limited number of customers.

All of our current product and service offerings are directed towards the defense marketplace which has a limited number of customers. If the defense market demand decreases, actual shipments could be less than projected shipments with a resulting decline in sales. Additionally, the loss of any one customer may have a material adverse effect on future operating results and financial condition. Our product backlog also has a number of risks and uncertainties such as the cancellation or deferral of orders, dispute over performance of our products 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.

Our 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.

Performance problems in our products or problems arising from the use of our products together with other vendors’ products may harm our 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 equipment 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.

Our Advanced Signal Generation and Analysis system product platform 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 ASGA system products are extremely complex. Despite testing, our initial products contained defects and errors and may in the future contain defects, errors, or performance problems following its sale or 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 have a material adverse impact on our results of operations. In addition, increased development and warranty costs could be substantial and could reduce our operating margins.

Our products contain components produced by suppliers which may be discontinued or no longer available in future periods which could lead to production delays and adversely impact our operating results and financial condition.

Certain components produced by our suppliers may be discontinued or no longer available to us to produce our products. Such discontinuations would require us to seek replacement components that may take longer than expected to procure and lead to delays in product sales. To date, procurement of replacement products has not had a significant adverse impact on our operating results, however, such occurrences in the future may adversely impact our business operations and financial condition.

If we fail to maintain satisfactory compliance with quality certifications and classified processing and control standards, product deliveries may be delayed or cancelled which would adversely impact our business, operating result and financial condition.

Certain of our customer contracts require that we maintain quality certifications and classified processing and control standards. If we were unable to maintain such certifications and standards, our product shipments may be delayed or cancelled which would cause us to lose business or brand reputation, resulting in a material adverse effect on our business operating results and financial condition.

Our operating results may fluctuate from quarter to quarter, making it difficult to predict future performance.

Our revenue, expenses and operating results have fluctuated, and may in the future continue to fluctuate significantly from quarter to quarter due to a number of factors. Factors that may contribute to these fluctuations include our dependence on the defense industry and a limited number of customers, the nature and length of our sales cycles for our products and services, the duration and delivery schedules within our customer contracts, our ability to timely develop and produce our products, as well as other factors described elsewhere in this Form 10-K.

There is a limited trading market for our common stock.

Although our common stock trades on the OTCQB Market, the trading volumes are generally low. As a result, there is limited liquidity for our common stock and it could be more difficult for investors to purchase or sell shares of our common stock compared to other publicly traded companies. In addition, because of the limited volume of trading in our common stock, a sale of a significant number of shares of our common stock in the open market could cause our stock price to decline significantly.

Our 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, receipt or cancellation of significant orders, 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, the OTCQB Market 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.

We may issue additional shares of common or preferred stock in the future, which could dilute a shareholder’s ownership of common stock.

Our articles of incorporation authorize our board of directors, generally without shareholder approval, to, among other things, issue additional shares of common or preferred stock. The issuance of any additional shares of common or preferred stock could be dilutive to a shareholder’s ownership of our common stock. The issuance of preferred stock could impair the voting, dividend and liquidation rights of common shareholders without their approval. To the extent that we issue options or warrants to purchase common stock in the future and the options or warrants are exercised, our shareholders may experience further dilution. Holders of shares of our common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, shareholders may not be permitted to invest in future issuances of our common or preferred stock.

We have a significant number of outstanding warrants, options and shares of convertible preferred stock, which may cause significant dilution to our shareholders, adversely impact the market price of our common stock and make it more difficult for us to raise funds through future equity offerings.

As of March 30, 2019, we had 11,360,511 shares of common stock outstanding. In addition, as of that date we had outstanding warrants to acquire 3,452,000 shares of common stock, options to acquire 2,735,000 shares of common stock and shares of convertible preferred stock convertible into an aggregate of 11,213,000 shares of common stock. The issuance of shares of common stock upon the exercise of warrants or options or conversion of preferred stock would dilute the percentage ownership interest of all holders of our common stock, might dilute the book value per share of our common stock and would increase the number of our publicly traded shares, which could depress the market price of our common stock.

The fact that our shareholders, warrant holders and option holders can sell substantial amounts of our common stock in the public market, whether or not sales have occurred or are occurring, could make it more difficult for us to raise additional funds through the sale of equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate, or at all.

Holders of our outstanding preferred stock have rights that are preferential to and may conflict with the rights and interests of holders of our common stock.

As of March 30, 2019, we had 116,934 shares of convertible preferred stock outstanding with aggregate liquidation preferences of $7.2 million. In addition, we must obtain the approval of the holders of our Series E Shares to complete certain types of transactions. For example, the Certificate of Determination for our Series E Shares prohibits us from issuing any shares having preferences that are superior to or on parity with our Series E Shares and the Investor Rights Agreement with the holders of our Series E Shares require that we obtain the approval of holders representing 66.6% of the Series E Shares to incur any additional indebtedness, other than commercial bank debt or trade debt.

These preferences and restrictions could make it more difficult to raise capital through sales of common stock, a new series of preferred stock or debt without the approval of the holders of our Series E Shares or other preferred shares, who interests may be different than those of our other shareholders who are not entitled to similar preferences or approval rights.

Our competition has greater resources.

Several of our competitors including, among others, Agilent/Keysight, Rohde & Schwarz and National Instruments 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.

We may incur substantial costs enforcing our intellectual property rights or defending against third-party claims as a result of litigation or other proceedings.

In connection with the potential enforcement of our own intellectual property rights or disputes related to the validity or alleged infringement of third-party intellectual property rights, including patent rights, we may in the future be subject to claims, negotiations or complex, protracted litigation. Intellectual property disputes and litigation may be costly and can be disruptive to our business operations by diverting attention and energies of management and key technical personnel, and by increasing our costs of doing business. Additionally, we may not prevail in any future litigation and disputes, which could adversely affect our results of operations and financial condition.

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. Staffing due to the loss of one or more of our key employees or groups can be expensive, divert our attention from executing our business plan and could seriously harm our business. Furthermore, possible shortages of key personnel, including engineers, in the area surrounding our facilities could require us to pay more to hire and retain key personnel, thereby increasing our costs.

If we experience a significant cybersecurity attack or disruption in our IT systems, our business, reputation, and operating results could be adversely affected.

We rely on an internal IT system monitored by certain internal employees and third-party service providers to maintain our IT systems; maintain financial records; retain sensitive data, such as intellectual property, proprietary business information, and data related to customers, and suppliers; process orders; manage inventory; process shipments to customers; and operate other critical functions. The ongoing maintenance and security of this information is critical to the classified processing and control standards that our suppliers require us to maintain and the success of our business operations and our strategic goals.

Despite our implementation of network security measures, our network may be vulnerable to cybersecurity attacks, computer viruses, break-ins and similar disruptions. Our network security measures include, but are not limited to, the implementation of firewalls, antivirus protection, patches, log monitors, routine backups, offsite storage, network audits, and routine updates and modifications. Despite our efforts to create these security barriers, we may not be able to keep pace as new threats emerge and it is virtually impossible for us to entirely eliminate this risk. Cybersecurity attacks are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and corruption of data. Any such event could have a material adverse effect on our business, reputation, operating results and financial condition, and no assurance can be given that our efforts to reduce the risk of such attacks will be successful.

In addition, our IT systems may be susceptible to damage, disruptions or shutdowns due to power outages, hardware failures, telecommunication failures, user errors, catastrophes or other unforeseen events. Such events could result in the disruption of business processes, network degradation and system downtime, along with the potential that a third party will exploit our critical assets such as intellectual property, proprietary business information and data related to our customers, suppliers and business partners. To the extent that such disruptions occur, our customers and suppliers may lose confidence in our solutions and we may lose business or brand reputation, resulting in a material and adverse effect on our business operating results and financial condition.

Business interruptions could delay or prevent our business activities, which could have a material adverse effect on our business, financial condition and results of operations.

Our primary facility and headquarters is located in the San Francisco Bay Area near known earthquake fault zones and is vulnerable to significant damage from earthquakes. We are also vulnerable to other natural disasters and other events that could disrupt our operations that may be beyond our control. We do not carry insurance for earthquakes and we may not carry sufficient business interruption insurance to compensate us for losses that may occur. Any losses or damages we incur could have a material adverse effect on our operating results, cash flows, and success as an overall business.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2. PROPERTIES

Our principal executive offices along with our marketing, sales, and engineering offices and manufacturing facilities are located in a 23,873 square foot facility in Dublin, California, which we leased on January 5, 2017 and began occupying in April 2017 under a lease agreement which expires in March 2023. We previously occupied a 47,300 square foot facility in nearby San Ramon, California under a lease agreement which expired on April 30, 2017.

We added a second engineering office located in a 1,200 square foot facility in Nashua, New Hampshire, which we leased on February 1, 2019 under a lease agreement which expires on January 31, 2022.

We believe that our Dublin and New Hampshire facilities are adequate for our business activities.

ITEM 3. LEGAL PROCEEDINGS

As of March 30, 2019, the Company had no material pending legal proceedings.

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 OTCQB market using the symbol “GIGA”. The number of record holders of our common stock as of March 30, 2019 was approximately 114. A significantly larger number of shareholders 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.

We have not paid cash dividends on our common stock in the past and have no current plans to do so in the future, believing our available capital is best used to fund our operations, including product development and enhancements. In addition, in the absence of positive retained earnings, California law permits payment of cash dividends on our common stock only to the extent total assets exceed the sum of total liabilities and the liquidation preference amounts of preferred securities. At March 30, 2019, the Company’s assets were less than this sum by $5.4 million. Our shares of Series E preferred stock provide for semi-annual 6% cumulative cash dividends based on the original purchase price of $25.00 per share, however we may exercise our right to pay any such dividends in shares of our common stock instead of cash.

Equity Compensation Plan Information

The following table provides information on options and other equity rights outstanding and available under the Company equity compensation plans at March 30, 2019.

Issuer Repurchases

We did not repurchase any of our equity securities during the fiscal year ended March 30, 2019.

Recent Sales of Unregistered Securities

On September 21, 2018, the Company issued and sold 1,260 additional Series E Shares to approximately three accredited investors in a private placement pursuant to a Securities Purchase Agreement. The purchase price for each Series E Share was $25.00, resulting in total gross proceeds of $31,500. Emerging Growth Equities, Ltd. served as the Company’s exclusive placement agent in connection with the private placement. Fees payable to Emerging Growth Equities, Ltd. at completion of the transaction were 2.5% of gross proceeds, plus warrants to purchase 2.5% of the number of common shares into which the Series E shares can be converted (100 common shares) at an exercise price of $0.25 per share, or 126,000 shares of common stock.

On September 28, 2018, the Company issued and sold 400 additional Series E Shares to one accredited investor in a private placement pursuant to a Securities Purchase Agreement. The purchase price for each Series E Share was $25.00, resulting in total gross proceeds of $10,000. Emerging Growth Equities, Ltd. served as the Company’s exclusive placement agent in connection with the private placement. Fees payable to Emerging Growth Equities, Ltd. at completion of the transaction were 2.5% of gross proceeds, plus warrants to purchase 2.5% of the number of common shares into which the Series E shares can be converted (100 common shares) at an exercise price of $0.25 per share, or 40,000 shares of common stock.

During the six-month period beginning September 30, 2018 and ending March 30, 2019, the Company sold an aggregate of 30,000 additional Series E Shares in a private placement to nine accredited investors at the price of $25.00 per share for gross proceeds of $750,000. Each Series E share is convertible into shares of common stock at a price of $0.25 per share (i.e., 100 shares of common stock per share of Series E) at the option of the holder. Emerging Growth Equities, Ltd. served as the Company’s exclusive placement agent in connection with the private placement. Fees payable to Emerging Growth Equities, Ltd. at completion of the transactions were 5% of gross proceeds. The following table provides additional information about these sales.

The Company issued the foregoing securities in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933 based on the fact that the sales were made to a limited number of accredited investors in a private placement. The Company expects to use the proceeds for working capital and general corporate purposes.

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.

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

Overview and Refocusing of Giga-tronics

We manufacture specialized electronics equipment for use in both military test and airborne operational applications. Our operations consist of two business segments, those of our wholly-owned subsidiary, Microsource, and those of our Giga-tronics Division.

Microsource’s revenues have grown as prime contractors began upgrading additional aircraft. Initially Microsource supplied filters for one fighter jet, the F/A-18E. During our 2014 fiscal year, the prime contractor added a second aircraft, the F-15. Additionally, during our 2017 fiscal year, a second prime contractor added a third aircraft, the F-16. As a result, Microsource’s revenue has climbed to over $9.0 million during our 2019 fiscal year, which ended March 30, 2019. Microsource is a sole-source supplier of filters for the three fighter jets and we expect that the business will continue to be a significant source of our future revenue.

The Company believes that customer spending for EW systems, including test and emulation, will grow in future years due to more complex RADAR signals and foreign investment in new technology, which will require customers to have greater access to more sophisticated test and emulation equipment.

The Company believes it can become a leading supplier of solutions for evaluating RADAR and EW systems due to the investment the Company has made since 2012 in its ASGA functional test platform. The same digital technology that has revolutionized commercial communications and automotive electronics is now being applied to advanced RADAR and EW systems. This shift in technology limits the effectiveness of currently available test solutions due to the inability of these solutions to properly stimulate and actively interact with the RADAR and EW systems being tested. The Giga-tronics ASGA platform, however, does have the needed sophisticated control and real-time behavior built into the fabric of its architecture. This architecture allows for delivering test solutions with real time responses and closed loop behavior not available from any competitor.

Significant Orders

Both Microsource and the Giga-tronics Division have historically received large customer orders periodically. The timing of orders is sporadic and difficult to predict, and any achievement of associated milestones, can cause 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:

Microsource

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

In July 2016, Microsource received a $1.9 million non-recurring engineering services order associated with redesigning a component of its high performance YIG filter used on a fighter jet aircraft platform. Of this NRE service order, we delivered services of approximately $884,000 and $816,000 in fiscal years 2017 and 2018, respectively, and completed delivery of the remaining services during fiscal 2019.

In September 2017, Microsource received a $4.8 million order for continuing the YIG RADAR filter for a fighter jet platform. The Company began initial shipments of these filters in the fourth quarter of fiscal 2018 and recognized revenue on the majority of the order in fiscal 2019.

In February 2018, Microsource received a $1.6 million YIG RADAR filter order from one of our customers. The Company recognized $1.1 million of revenue in fiscal 2019 and expects to recognize the remainder of revenue in fiscal 2020.

In November 2018, Microsource received a $4.5 million YIG RADAR filter order from one of our customers.  The Company recognized $1.1 million of revenue in fiscal 2019 and expects to recognize the majority of the remaining revenue in fiscal year 2020.

Giga-tronics Division

In February 2019, the Giga-tronics Division received a $4.0 million order from the United States Navy for our Real-Time Threat Emulation System (TEmS) which is a combination of the Advanced Signal Generator Hardware platform, along with software developed and licensed to the Company from a major aerospace and defense company. The order is comprised of two TEmS units of equal value along with approximately $671,000 of engineering services to support and upgrade currently installed systems. The Company fulfilled the first TEmS unit order in the March 2019 quarter, the Company’s fourth quarter of fiscal 2019. The second TEmS unit order was fulfilled during the June 2019 quarter, the Company’s first quarter of fiscal 2020. The engineering services are expected to occur during the next twelve months.

Results of Operations

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

Total new orders received in fiscal 2019 were $9.4 million which was consistent with the $9.6 million received in fiscal 2018. Although the new orders were consistent year over year, the product mix of new orders of higher Giga-tronics Division product orders ($2.0 million or 99%) was due mainly to the Company’s recent receipt in February 2019 of its $4.0 million ASGA product order from the U.S. Navy. The Microsource business unit saw a $2.2 million or 29% decrease in fiscal 2019 primarily due to the impact of the timing of large, multi-year RADAR filter production orders. The timing of receipt of expected large RADAR filter contracts varies from period to period.

Total new orders received in fiscal 2018 were $9.6 million which was $5.5 million or 36% lower than the $15.1 million received in fiscal 2017. The decrease was primarily the result of lower Giga-tronics Division product orders ($5.5 million or 73%) due mainly to the Company’s recent divestures of legacy test and measurement product lines and a decrease in ASGA product orders of $3.0 million due to a longer than anticipated sales cycle.

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

Backlog at the end of fiscal 2019 versus the prior year decreased by 40% primarily due to the impact of the adoption of ASC 606 on April 1, 2018. The Giga-tronics ASGA backlog at March 30, 2019 compared to March 31, 2018 increased $2.2 million primarily due to a large U.S. Navy order received in fiscal 2019.

Backlog at the end of fiscal 2018 decreased by $199,000 or 1.8% compared to the end of fiscal 2017. The decrease in backlog was primarily due to a longer than anticipated sales cycle for ASGA products for the Giga-tronics Division offset by an increase in RADAR filter products for Microsource.

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

Net sales for the fiscal year ended March 30, 2019 were $11.1 million, an increase of 14%, compared to $9.8 million for the fiscal year ended March 31, 2018. The majority of the sales increase in fiscal 2019 was attributable to Microsource which was higher by $2.2 million or 30% partially offset by a $445,000 or 20% decrease in ASGA sales, and a $357,000 or 67% decrease in legacy product sales due to the Company’s recent legacy product line divestitures. The increase in net sales for Microsource was primarily due to higher RADAR filters product including the impact of the adoption of ASC 606, which was significantly offset by the lower sales of our Giga-tronics Division sales compared to the prior year. Effective April 1, 2018, the Company adopted the required Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, as amended (commonly referred to as ASC 606), which changed the way the Company recognizes revenue for certain contracts.

Net sales for the fiscal year ended March 31, 2018 were $9.8 million, a decrease of 40%, compared to $16.3 million for the fiscal year ended March 25, 2017. The majority of the sales decrease in fiscal 2018 was attributable to the Giga-tronics Division which was lower by $5.3 million or 66% primarily due to a $3.1 million or 58% decrease in ASGA product sales due to longer than anticipated sales cycles and, in part, by the Company’s reduced focus on selling complete EW test solutions in fiscal 2018, and a $2.2 million or 81% decrease in legacy product sales due to the Company’s recent legacy product line divestitures. Microsource sales decreased in fiscal 2018 by $1.2 million or 14% compared to fiscal 2017 due to lower scheduled RADAR filter shipments in fiscal 2018 and the completion of certain related nonrecurring engineering (NRE) services in fiscal 2017.

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

Gross profit increased in fiscal 2019 to $4.7 million from $2.7 million for fiscal 2018. The higher gross profit was primarily due to a decrease in cost of sales of 9% and an increase in sales of 14%.

Overall gross profit decreased in fiscal 2018 to $2.7 million from $4.6 million for fiscal 2017. Gross profit in fiscal 2018 was negatively impacted by the higher cost of ASGA product line sales in fiscal 2018 compared to fiscal 2017 due to the costs related to rework, and refinement of features, the adverse impact of fixed manufacturing overhead upon lower production volume in fiscal 2018 and the increase in non-cash charges associated with the impact of a change in estimate of capitalized software development costs and amortizing the remaining cost thereof during fiscal 2018.

Operating expenses were as follows for the fiscal years shown:

Operating expenses decreased 15% or $859,000 in fiscal 2019 compared to fiscal 2018. Engineering expenses decreased $490,000 during fiscal 2019 when compared to fiscal 2018 primarily due to a decrease in personnel related expenses due to lower headcount. Selling, general and administrative expenses decreased 9% or $369,000 primarily due to a decrease in headcount and personnel related expenses, and a decrease in bonuses and commissions.

Operating expenses decreased 15% or $1.0 million in fiscal 2018 compared to fiscal 2017. Engineering expenses decreased $460,000 during fiscal 2018 when compared to fiscal 2017 primarily due to a decrease in personnel related expenses due to lower headcount. Engineering expenses were also lower in fiscal 2018 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 12% or $565,000 primarily due to a decrease in headcount and personnel related expenses, a decrease in outside services related to management consulting, a decrease in bonuses and commissions as a result of the sale of the legacy products to Astronics and Spanawave, and lower lease and facilities costs as a result of the Company’s relocation to a smaller facility in Dublin, California during May 2017.

Our recent losses and limited liquidity caused us to reduce our R&D expenditures and headcount in fiscal 2019 and prior years. With the Company’s improved operating performance in fiscal 2019 and a projected increase in ASGA product sales in fiscal 2020, the Company anticipates hiring additional R&D personnel and incurring additional R&D expenditures during fiscal 2020 compared to fiscal 2019.

Net Interest Expense

Net interest expense in fiscal 2019 was $713,000 an increase of $252,000 over fiscal 2018. Interest expense increased primarily due to the loan modification with PFG effective March 26, 2018, as well as additional interest accrued as a result of the Company’s issuance of Series E Shares in March of 2018 and throughout fiscal 2019. For fiscal 2019, interest expense includes $223,000 of accretion of discounts on the PFG loan compared to $127,000 recorded in fiscal 2018.

Net interest expense in fiscal 2018 was $461,000 an increase of $328,000 over fiscal 2017. The increased net interest expense in fiscal 2018 was primarily due to the additional interest as a result of non-compliance with certain covenants on the PFG loan and higher loan balances in fiscal 2018.

Net Loss

Net loss was $1.0 million in fiscal 2019, compared to a net loss of $3.1 million in fiscal 2018. The decrease in net loss for fiscal 2019 was primarily due to significantly improved gross margins of 42% in fiscal 2019 compared to 28% in fiscal 2018 due to the change in revenue mix described above (including the impact of the adoption of ASC 606) as well as a decrease in operating expenses of 15% or $859,000 in fiscal 2019 over fiscal 2018. Engineering expenses decreased primarily due to a decrease in personnel related expenses due to lower headcount. Selling, general and administrative expenses decreased primarily due a decrease in headcount and personnel related expenses as well as a decrease in bonuses and commissions.

Net loss was $3.1 million in fiscal 2018, compared to a net loss of $1.5 million in fiscal 2017. The higher net loss recorded in fiscal 2018 was primarily due to decreased revenues as well as increases in cost of sales due to the impact of the change in estimate related to capitalized software development costs and interest expense discussed above. Net loss was also higher due to an $802,000 gain associated with the sale of the Switch product line in the first quarter of fiscal 2017.

Net Inventories

Inventories consisted of the following:

Net inventories decreased by $2.8 million at March 30, 2019 compared to March 31, 2018. The decrease was primarily the result of the impact of the adoption of ASC 606 as well as lower inventory due to the timing of RADAR filter production, the shipment of an ASGA system, and lower demonstration inventory.

Net inventories increased by $676,000 at March 25, 2018 compared to March 25, 2017. The increase was primarily the result of higher raw materials inventory due to the timing of RADAR filter production, and increased demonstration inventory to support ASGA sales efforts.

Financial Condition and Liquidity

As of March 30, 2019, Giga-tronics had $878,000 in cash and cash equivalents, compared to $1.5 million as of March 31, 2018. The Company had positive working capital of $1.6 million at March 30, 2019 compared to negative working capital of ($386,000) at March 31, 2018. The current ratio (current assets divided by current liabilities) at March 30, 2019 was 1.41 compared to 0.95 at March 31, 2018. The increase in working capital was primarily due to the acceleration of revenue of $671,000, and an increase in prepaids and other current assets of $1.3 million, offset by a decrease in deferred revenue of $3.4 million, and a decrease in inventories of $2.8 million, all of which resulted from the adoption of ASC 606 during fiscal 2019. 

Cash Flows

The following summary of our cash flows for the periods indicated has been derived from our consolidated financial statements included elsewhere in this filing:

Cash Flows from Operating Activities

We experienced negative cash flows from operating activities for fiscal years 2019 and 2018 due primarily to operating results.

Cash used by operating activities during the fiscal year ended March 30, 2019 of $1.3 million was primarily attributable to our net loss, and changes in our working capital accounts, partially offset by other non-cash charges of $264,000 for depreciation and amortization and $245,000 for share-based compensation. Cash flow from our operating assets and liabilities decreased by $1.2 million as a result of decreased inventories of $1.2 million, a $133,000 increase in accrued payroll and benefits, a $807,000 decrease in deferred revenue, a $1.1 million increase in prepaid expenses and other current assets, a $204,000 increase in accounts receivable, a decrease in accounts payable of $249,000, and a $20,000 decrease in other accrued liabilities.

Cash used by operating activities during the fiscal year ended March 31, 2018 of $1.6 million was primarily attributable to our net loss of $3.1 million and a gain on the sale of a product line of $324,000, offset by non-cash charges of $1.1 million for depreciation and amortization, $251,000 for share-based compensation and a $487,000 increase in deferred rent. Cash flow from our operating assets and liabilities decreased by $83,000 primarily as a result of increased inventories of $676,000, a decrease in accrued payroll and benefits and deferred revenue of $240,000 each, and a $111,000 decrease in accounts payable, offset by a $590,000 decrease in accounts receivable, a $365,000 decrease in prepaid expenses and other current assets and a $229,000 increase in other current liabilities.

We expect that cash flows from operating activities will fluctuate in future periods due to a number of factors including our sales, which fluctuate significantly from one period to another due to the timing of receipt of contracts, operating results, amounts of non-cash charges, and the timing of our billings, collections and disbursements.

Cash Flows from Investing Activities

Cash used in investing activities for the fiscal year ended March 30, 2019 was zero.

Cash used in investing activities for the fiscal year ended March 31, 2018 was $688,000 as a result of leasehold improvements in connection with the Company’s facility relocation to Dublin, California.

Cash Flows from Financing Activities

Cash provided by financing activities for the fiscal year ended March 30, 2019 was $700,000, primarily due to net proceeds of $1.2 million from the Company’s issuance of Series E Shares as well as proceeds from the exercise of warrants of $112,000, partially offset by a $552,000 decrease in our line of credit and a $52,000 decrease in our capital lease.

Cash provided by financing activities for the fiscal year ended March 31, 2018 was $2.4 million, primarily due to net proceeds of $1.5 million from a new term loan with PFG and net proceeds of $1.0 million from the Company’s issuance of Series E convertible preferred stock.

Liquidity and Capital Resources

The Company incurred a net loss of $1.0 million and $3.1 million in fiscal years 2019 and 2018, respectively. These losses have contributed to an accumulated deficit of $28.5 million as of March 30, 2019. The Company has also experienced delays in the development or refinement of features, receipt of orders, and shipments for our RADAR/EW test system products. These delays have contributed, in part, to the losses and decreases in working capital.

The RADAR/EW test system products have shipped to several customers, but potential delays in the development of features, longer than anticipated sales cycles, or uncertainty as to the Company’s ability to efficiently manufacture our EW test system products, 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 Western Alliance Bank (formerly Bridge Bank). On March 11, 2019, the Company entered into an Amended and Restated Business Financing Agreement (the “Restated Financing Agreement”) with Western Alliance Bank. The Restated Financing Agreement amends, restates and replaces the Company’s Business Financing Agreement with Western Alliance Bank (doing business as Bridge Bank) dated May 6, 2015 (as previously amended, the “Previous Financing Agreement”) in its entirety.

Under the Restated Financing Agreement, Western Alliance Bank may advance up to 85% of the amounts of invoices issued by the Company, up to a maximum of $2,500,000 in aggregate advances outstanding at any time. The Restated Financing Agreement eliminates a $500,000 non-formula borrowing base and an asset coverage ratio financial covenant (see Item 8. Financial Statements and Supplementary Data, – Notes to Consolidated Financial Statements, Note 5, Accounts Receivable Credit Line).

As of March 30, 2019 and March 31, 2018, the Company’s total outstanding borrowings under the Western Alliance Bank line of credit were zero and $552,000, respectively.

During April 2017, we entered into a $1.5 million loan agreement with Partners For Growth, V L.P. (“PFG”) to provide additional cash to fund our operations. As a result of experiencing continued delays in receiving RADAR/EW test system product orders in fiscal 2018, we were unable to maintain compliance with certain financial covenants required by the PFG loan and, as a result, were subject to a default interest rate between June 2017 and March 2018. On March 26, 2018, and concurrent with the execution of certain stock purchase agreements for the sale of new Series E Convertible Preferred Stock and conditional upon the sale of at least $1.0 million in gross proceeds thereof, the Company and PFG entered into a modification agreement which provided for the restructuring of certain terms of the PFG loan including resetting of the financial covenants for the remaining loan term (see Item 8. Financial Statements and Supplementary Data, Notes to Consolidated Financial Statements Note 6, Term Loan and Warrants).

In order to raise additional working capital and to restructure the PFG loan, on March 26, 2018, the Company entered into a Securities Purchase Agreement for the sale of 43,800 shares of a newly designated series of 6.0% Series E Senior Convertible Voting Perpetual Preferred Stock to approximately 15 private investors. The purchase price for each Series E Share was $25.00. Gross proceeds received by the Company were approximately $1.095 million (the “Private Placement”). Net proceeds to the Company after fees and expenses of the Private Placement was approximately $1.0 million. Each Series E Share is initially convertible at the option of the holder at the purchase price of $0.25 per share of common stock, which is 100 shares of the Company’s common stock per each Series E Share (see Item 8. Financial Statements and Supplementary Data, Note 19, Preferred Stock – Series E Senior Convertible Voting Preferred Stock).

In December 2018, the Company and PFG entered into an additional modification agreement which conditionally extended the maturity date of the loan from April 27, 2019 to November 1, 2019, required the Company to pay all accrued interest on May 1, 2019 and requires the Company to make monthly prepayments of principal of $75,000 and accrued interest beginning on May 1, 2019 until maturity. The effectiveness of the modification was conditioned on the Company raising $500,000 in additional capital. As of March 30, 2019, the Company had satisfied this condition.

On March 11, 2019, the Company and PFG agreed to further modify the 2017 Loan Agreement to extend the maturity date to March 1, 2020 and add financial covenants requiring the Company to maintain a minimum tangible net worth and minimum revenues described in the modified 2017 Loan Agreement (see Item 8. Financial Statements and Supplementary Data, Notes to Consolidated Financial Statements Note 6, Term Loan and Warrants).

In order to raise additional working capital for the fiscal year ended March 30, 2019, the Company issued an additional 56,200 Series E shares to both new and existing investors at a purchase price of $25.00 per share for total gross proceeds of $1,405,000. Each Series E Share is initially convertible (at the option of the holder) at a conversion price of $0.25 per share of common stock, representing 100 shares of the Company’s common stock per each Series E Share. As of March 30, 2019, 1,600 issued Series E Shares were converted at the option of the holders and the Company has issued an aggregate of 160,000 shares of common stock upon conversion (see Item 8. Financial Statements and Supplementary Data, Note 17, Preferred Stock and Warrants – Series E Senior Convertible Voting Perpetual Preferred Stock).

Additionally, 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 its business including, but not limited to, the contribution of its individual business segments 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 seeking additional working capital and liquidity through debt (including debt refinancing), or equity financings.

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.

Contractual Obligations

We lease our Dublin, California facility under an operating lease agreement which expires in March 2023. We also lease certain equipment under operating leases. Total future minimum lease payments under these leases amount to approximately $2.1 million, of which $450,000 is scheduled to be paid in fiscal 2020.

We lease our Nashua, New Hampshire facility under an operating lease agreement which expires January 31, 2022. Total future minimum lease payments under this lease amount to $49,500, of which $18,000 is scheduled to be paid in fiscal 2020.

We lease equipment under capital leases that expire through September 2020. The future minimum lease payments under these leases are approximately $69,000.

We are committed to purchase certain inventory under non-cancelable purchase orders. As of March 30, 2019, total non– cancelable purchase orders were approximately $1,260,000 and are scheduled to be delivered to the Company at various dates through March 2020.

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

Beginning April 1, 2018, the Company follows the provisions of ASU 2014-09 as subsequently amended by the Financial Accounting Standards Board (“FASB”) between 2015 and 2017 and collectively known as ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”). Amounts for prior periods are not adjusted and continue to be reported in accordance with the Company’s prior historic accounting practices. The guidance provides a unified model to determine how revenue is recognized. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

In determining the appropriate amount of revenue to be recognized as we fulfill our obligations under our agreements, we perform the following steps: (i) identify the promised goods or services in the contract; (ii) determine whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measure the transaction price, including the constraint on variable consideration; (iv) allocate the transaction price to the performance obligations based on estimated selling prices; and (v) recognize revenue when (or as) we satisfy each performance obligation.

We generate revenue through the design, manufacture, and sale of products used in the defense industry to major prime defense contractors, the armed services (primarily in the U.S.) and research institutes. There is generally one performance obligation in our contracts with our customers. For highly engineered products, the customer typically controls the work in process as evidenced either by contractual termination clauses or by our right to payment for costs incurred to date plus a reasonable profit for products or services that do not have an alternative use. In these circumstances, the performance obligation is the design and manufacturing service. As control transfers continuously over time on these contracts, revenue is recognized based on the extent of progress towards completion of the performance obligation using a cost-to-cost method. Engineering services are also satisfied over time and recognized on the cost-to-cost method. These types of revenue arrangements are typical for our defense contracts within the Microsource segment for its RADAR filter products used in fighter jet aircrafts.

For the sale of standard or minimally customized products, the performance obligation is the series of finished products which are recognized at the points in time the units are transferred to the control of the customer, typically upon shipment. This type of revenue arrangement is typical for our commercial contracts within the Giga-tronics segment for its Advanced Signal Generation and Analysis system products used for testing RADAR and Electronic Warfare (“RADAR/EW”) equipment.

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.

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.

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.

Off-Balance-Sheet Arrangements

We have no off-balance-sheet arrangements (including standby letters of credit, guarantees, 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.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO FINANCIAL STATEMENTS AND SCHEDULES

GIGA-TRONICS INCORPORATED

CONSOLIDATED BALANCE SHEETS

(In thousands except share data)

See Accompanying Notes to Consolidated Financial Statements

GIGA-TRONICS INCORPORATED

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands except per share data)

See Accompanying Notes to Consolidated Financial Statements

GIGA-TRONICS INCORPORATED

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(In thousands except share data)

See Accompanying Notes to Consolidated Financial Statements

GIGA-TRONICS INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

See Accompanying Notes to Consolidated Financial Statements

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS