GIGA TRONICS INC - Quarter Report: 2019 September (Form 10-Q)

 

   

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[ X ]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended	September 28, 2019

  OR  

[     ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from		to

 

Commission File No. 001-14605

 

GIGA-TRONICS INCORPORATED

(Exact name of registrant as specified in its charter)

 

California		94-2656341
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
5990 Gleason Drive, Dublin CA 94568		(925) 328-4650
(Address of principal executive offices)		Registrant’s telephone number, including area code

 

 Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of each class		Trading Symbol(s)			Name of each exchange on which registered
Common Stock, No par value		GIGA			OTCQB Market

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:

Yes [ X ]     No [    ]

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes [ X ]     No [    ]

 

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

 

Large accelerated filer	[     ]		Accelerated filer	[     ]
Non-accelerated filer	[     ]		Smaller reporting company	[ X ]
			Emerging growth company	[     ]

 

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

 

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

Yes [    ]     No [ X ]

 

There were a total of 38,624,750 shares of the Registrant’s Common Stock outstanding as of November 8, 2019.  

 

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INDEX

   

				Page No.
PART I - FINANCIAL INFORMATION
	Item 1.	Financial Statements
			Unaudited Condensed Consolidated Balance Sheets as of September 28, 2019 and March 30, 2019	4
			Unaudited Condensed Consolidated Statements of Operations, Three and Six Months Ended September 28, 2019 and September 29, 2018	5
			Unaudited Consolidated Statements of Shareholders’ Equity, Six Months Ended September 28, 2019 and September 29, 2018	6
			Unaudited Condensed Consolidated Statements of Cash Flows, Six Months Ended September 28, 2019 and September 29, 2018	7
			Notes to Unaudited Condensed Consolidated Financial Statements	8
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		26
	Item 4.	Controls and Procedures		26
PART II - OTHER INFORMATION
	Item 1.	Legal Proceedings		26
	Item 1A.	Risk Factors		26
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		26
	Item 3.	Defaults Upon Senior Securities		26
	Item 4.	Mine Safety Disclosures		26
	Item 5.	Other information		26
	Item 6.	Exhibits		26
SIGNATURES				27
		Exhibit Index
			31.1 Certification of CEO pursuant to Section 302 of Sarbanes-Oxley Act.
			31.2 Certification of CFO pursuant to Section 302 of Sarbanes-Oxley Act.
			32.1 Certification of CEO pursuant to Section 906 of Sarbanes-Oxley Act.
			32.1 Certification of CFO pursuant to Section 302 of Sarbanes-Oxley Act.

 

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(In thousands except share data)		September 28, 2019				March 30, 2019
Assets
Current assets:
Cash and cash-equivalents		$	704			$	878
Trade accounts receivable, net of allowance of $8 and $8, respectively			994				568
Inventories, net			3,217				2,734
Prepaid expenses and other current assets			1,864				1,354
Total current assets			6,779				5,534
Property and equipment, net			567				569
Right of use asset			1,231				—
Other long term assets			176				176
Total assets		$	8,753			$	6,279
Liabilities and shareholders' equity
Current liabilities:
Accounts payable		$	1,512			$	747
Loans payable, net of discounts and issuance costs			2,073				1,781
Accrued payroll and benefits			280				476
Deferred rent			2				74
Lease obligations			396				41
Deferred liability related to asset sale			29				40
Other current liabilities			591				754
Total current liabilities			4,883				3,913
Other non-current liabilities			192				172
Long term deferred rent			2				358
Long term obligations - leases			1,268				21
Total liabilities			6,345				4,464
Commitments and contingencies
Shareholders' equity:
Preferred stock; no par value; Authorized - 1,000,000 shares Series A convertible- designated 250,000 shares; no shares at September 28, 2019 and March 30, 2019 issued and outstanding			—				—
Series B, C, D convertible - designated 19,500 shares; 17,781.64 shares at September 28, 2019 and 18,533.51 at March 30, 2019 outstanding; (liquidation preference of $3,367 at September 28, 2019 and $3,540 at March 30, 2019)			2,745				2,911
Series E convertible- designated 100,000 shares; 97,800 shares at September 28, 2019 and 98,400 shares at March 30, 2019 outstanding; (liquidation preference of $3,668 at September 28, 2019 and $3,690 at March 30, 2019)			1,878				1,895
Common stock; no par value; Authorized - 40,000,000 shares; 13,215,188 shares at September 28, 2019 and 11,360,511 shares at March 30, 2019 issued and outstanding			26,279				25,557
Accumulated deficit			(28,494	)			(28,548	)
Total shareholders' equity			2,408				1,815
Total liabilities and shareholders' equity		$	8,753			$	6,279

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		Three Months Ended								Six Months Ended
(In thousands except per share data)		September 28, 2019				September 29, 2018				September 28, 2019				September 29, 2018
Net revenue
Goods		$	373			$	109			$	2,311			$	316
Services			2,662				2,571				4,222				5,414
Total revenue			3,035				2,680				6,533				5,730
Cost of goods and services			1,787				1,554				3,754				3,298
Gross profit			1,248				1,126				2,779				2,432
Operating expenses:
Engineering			349				343				704				718
Selling, general and administrative			751				900				1,798				1,901
Total operating expenses			1,100				1,243				2,502				2,619
Operating income (loss)			148				(117	)			277				(187	)
Interest expense:
Interest expense, net			(66	)			(87	)			(124	)			(173	)
Interest expense from accretion of loan discount			—				(54	)			(19	)			(105	)
Total interest expense, net			(66	)			(141	)			(143	)			(278	)
Income (loss) before income taxes			82				(258	)			134				(465	)
Provision for income taxes			2				2				2				42
Net income (loss)		$	80			$	(260	)		$	132			$	(507	)
Deemed dividend on Series E shares		$	(36	)		$	(22	)		$	(73	)		$	(62	)
Net income (loss) attributable to common shareholders		$	44			$	(282	)		$	59			$	(569	)
Income (loss) per common share - basic		$	0.00			$	(0.03	)		$	0.01			$	(0.06	)
Income (loss) per common share - diluted		$	0.00			$	(0.03	)		$	0.00			$	(0.06	)
Weighted average shares used in per share calculation:
Basic			11,693				10,546				11,693				10,254
Diluted			23,699				10,546				23,699				10,254

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		Preferred Stock								Common Stock								Accumulated
(In thousands except share data)		Shares				Amount				Shares				Amount				Deficit				Total
Balance at March 31, 2018			62,334			$	3,613				10,312,653			$	25,200			$	(28,682	)		$	131
Cumulative effect of ASC 606 adoption			—				—				—				—				1,176				1,176
Net loss			—				—				—				—				(287	)			(287	)
Share based compensation			—				—				—				57				—				57
Warrant exercises, net of issuance costs			—				—				60,300				15				—				15
Equity issuance for PFG Loan			—				—				7,500				—				—				—
Restricted stock granted			—				—				38,500				—				—				—
Series E preferred stock issuance, net of offering costs of $15			8,800				205				—				—				—				205
Balance at June 30, 2018			71,134			$	3,818				10,418,953			$	25,272			$	(27,793	)		$	1,297
Net loss			—				—				—				—				(282	)			(282	)
Share based compensation			—				—				—				46				—				46
Warrant exercises, net of issuance costs			—				—				512,558				97				—				97
Equity issuance for PFG Loan			—				—				7,500				—				—				—
Series E preferred stock issuance, net of offering costs of $15			17,400				371				—				—				—				371
Balance at September 29, 2018			88,534			$	4,189				10,939,011			$	25,415			$	(28,075	)		$	1,529

		Preferred Stock								Common Stock								Accumulated
(In thousands except share data)		Shares				Amount				Shares				Amount				Deficit				Total
Balance at March 30, 2019			116,934			$	4,806				11,360,511			$	25,557			$	(28,548	)		$	1,815
Net income			—				—				—				—				15				15
Share based compensation			—				—				—				95				—				95
Equity issuance for PFG Loan			—				—				2,500				—				—				—
Restricted stock forfeited			—				—				(20,000	)			—				—				—
Series E preferred stock issuance, reclass of offering costs of $2			—				(2	)			—				2				—				—
Balance at June 29, 2019			116,934			$	4,804				11,343,011			$	25,654			$	(28,533	)		$	1,925
Net income			—				—				—				—				44				44
Share based compensation			—				—				—				67				—				67
Warrant exercises			—				—				1,227,120				230				—				230
Series E dividends			—				—				509,870				142				—				142
Series E converted to common stock			(600	)			(15	)			60,000				20				(5	)			—
Series B converted to common stock			(752	)			(166	)			75,187				166				—				—
Balance at September 28, 2019			115,582			$	4,623				13,215,188			$	26,279			$	(28,494	)		$	2,408

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		Six Months Ended
(In thousands)		September 28, 2019				September 29, 2018
Cash flows from operating activities:
Net income (loss)		$	59			$	(569	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization			95				142
Share based compensation			162				103
Accretion of discounts and issuance costs on debt			20				105
Accrued interest and fees on loan payable			(192	)			56
Change in deferred rent			1				(29	)
Changes in operating assets and liabilities
Trade accounts receivable			(426	)			(383	)
Inventories			(483	)			695
Prepaid expenses and other assets			(510	)			(792	)
Right of use asset			130				—
Accounts payable			765				(155	)
Accrued payroll and benefits			(196	)			24
Deferred revenue			—				(807	)
Other current and non-current liabilities			(12	)			(24	)
Net cash used in operating activities			(587	)			(1,634	)
Cash flows from investing activities:
Purchases of property and equipment			(94	)			—
Net cash used in investing activities			(94	)			—
Cash flows from financing activities:
Principal payments on leases			(188	)			(27	)
Proceeds from issuance of preferred stock, net of issuance costs			—				576
Proceeds from exercise of warrants			230				112
Proceeds from borrowings, net of issuance costs			889				—
Repayments of borrowings			(424	)			—
Net cash provided by financing activities			507				661
Decrease in cash and cash-equivalents			(174	)			(973	)
Beginning cash and cash-equivalents			878				1,485
Ending cash and cash-equivalents		$	704			$	512
Supplementary disclosure of cash flow information:
Cash paid for income taxes		$	2			$	2
Cash paid for interest		$	66			$	114
Supplementary disclosure of noncash financing activities:
Cumulative effect of adoption of ASC 606 on inventory		$	—			$	(1,581	)
Cumulative effect of adoption of ASC 606 on prepaid expenses and other current assets		$	—			$	189
Cumulative effect of adoption of ASC 606 on deferred revenue		$	—			$	2,567
Cumulative effect of adoption of ASC 842 on right of use assets		$	1,361			$	—
Cumulative effect of adoption of ASC 842 on deferred rent		$	429			$	—
Cumulative effect of adoption of ASC 842 on lease liability		$	1,790			$	—
Issuance of dividends in kind		$	142			$	—

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 (1)          Organization and Significant Accounting Policies

 

The condensed consolidated financial statements included herein have been prepared by Giga-tronics Incorporated (“Giga-tronics,” “Company” or “we”), pursuant to the rules and regulations of the Securities and Exchange Commission. The consolidated results of operations for the interim periods shown in this report are not necessarily indicative of results to be expected for the fiscal year. In the opinion of management, the information contained herein reflects all adjustments (consisting of normal recurring entries) necessary to make the consolidated results of operations for the interim periods a fair statement of such operations. For further information, refer to the consolidated financial statements and footnotes thereto, included in the Annual Report on Form 10-K, filed with the Securities and Exchange Commission for the year ended March 30, 2019.

   

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

  

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

 

Leases

 

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-02 - Leases (ASC 842), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification determines whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less are accounted for similar to guidance for operating leases existing prior to ASC 842. ASC 842 supersedes the previous leases standard, ASC 840 Leases. The Company adopted ASC 842 as of March 31, 2019. The new standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which amends ASC Topic 842 to provide another transition method, allowing a cumulative effect adjustment to the opening balance of retained earnings during the period of adoption. The Company has one long term office lease. The adoption of ASU 2016-02 on March 31, 2019 resulted in the recognition of right-of-use assets of approximately $1.4 million, lease liabilities for operating leases of approximately $1.8 million and no material impact to the Consolidated Statements of Operations or Cash Flows. See below for further information regarding the impact of the adoption of ASU 2016-02 on the Company's financial statements.

 

Revenue Recognition and Deferred Revenue Beginning April 1, 2018, the Company follows the provisions of ASU 2014-09 as subsequently amended by the 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 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 it fulfills its obligations under its agreements, the Company performs the following steps: (i) identifies the promised goods or services in the contract; (ii) determines whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measures the transaction price, including the constraint on variable consideration; (iv) allocates the transaction price to the performance obligations based on estimated selling prices; and (v) recognizes revenue when (or as) the Company satisfies each performance obligation.

 

The Company generates 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 the Company’s contracts with its customers. For highly engineered products, the customer typically controls the work in process as evidenced either by contractual termination clauses or by the Company’s 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 the Company’s 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 (“EW”) equipment.

 

Performance Obligations

 

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC Topic 606. The Company’s performance obligations include:

 

●

Design and manufacturing services

 

●

Product supply – Distinct goods or services that are substantially the same

 

●

Engineering services

 

The majority of the Company’s contracts have a single performance obligation as the promise to transfer the individual goods or services is not separately identifiable from other promises in the contracts and, therefore, not distinct.

 

Transaction Price

 

The Company has both fixed and variable consideration. Under the Company’s highly engineered design and manufacturing arrangements, advance payments and unit prices are considered fixed, as product is not returnable and the Company has an enforceable right to reimbursement in the event of a cancellation. For standard and minimally customized products, payments can include variable consideration, such as product returns and sales allowances. The transaction price in engineering services arrangements may include estimated amounts of variable consideration, including award fees, incentive fees, or other provisions that can either increase or decrease the transaction price. Milestone payments are identified as variable consideration when determining the transaction price. At the inception of each arrangement that includes milestone payments, the Company evaluates whether the milestones are considered probable of being achieved and estimates the amount to be included in the transaction price using the most likely amount method. The Company estimates variable consideration at the amount to which they expect to be entitled, and determines whether to include estimated amounts as a reduction in the transaction price based largely on an assessment of the conditions that might trigger an adjustment to the transaction price and all information (historical, current and forecasted) that is reasonably available to the Company. The Company includes estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the estimation uncertainty is resolved.

 

Allocation of Consideration

 

As part of the accounting for arrangements that contain multiple performance obligations, the Company must develop assumptions that require judgment to determine the stand-alone selling price of each performance obligation identified in the contract. When a contract contains more than one performance obligation, the Company uses key assumptions to determine the stand-alone selling price of each performance obligation. Because of the customized nature of products and services, estimated stand-alone selling prices for most performance obligations are estimated using a cost-plus margin approach. For non-customized products, list prices generally represent the standalone selling price. The Company allocates the total transaction price to each performance obligation based on the estimated relative stand-alone selling prices of the promised goods or service underlying each performance obligation.

 

Timing of Recognition

 

Significant management judgment is required to determine the level of effort required under an arrangement and the period over which the Company expects to complete its performance obligations under the arrangement. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. The Company generally uses the cost-to-cost measure of progress as this measure best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. Under the cost-to-cost method, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenue is recognized for design and manufacturing services and for engineering services over time proportionate to the costs that the Company has incurred to perform the services using the cost-to-cost input method and for products at a point in time.

 

Changes in Estimates

 

The effect of a contract modification on the transaction price and the measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.

 

 

For contracts using the cost-to-cost method, management reviews the progress and execution of the performance obligations. This process requires management judgment relative to estimating contract revenue and cost, and making assumptions for delivery schedule. This process requires management’s judgment to make reasonably dependable cost estimates. Since certain contracts extend over a longer period of time, the impact of revisions in cost and revenue estimates during the progress of work may adjust the current period earnings through a cumulative catch-up basis. This method recognizes, in the current period, the cumulative effect of the changes on current and prior quarters. Contract cost and revenue estimates for significant contracts are generally reviewed and reassessed quarterly.

 

Balance Sheet Presentation

 

The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets), and deferred revenue (contract liabilities) on the Condensed Consolidated Balance Sheet. Under the typical payment terms of over time contracts, the customer pays either performance-based payments or progress payments. Amounts billed and due from customers are classified as receivables on the Condensed Consolidated Balance Sheet. Interim payments may be made as work progresses, and for some contracts, an advance payment may be made. A liability is recognized for these interim and advance payments in excess of revenue recognized and is presented as a contract liability which is included within accrued liabilities and other long-term liabilities on the Condensed Consolidated Balance Sheet. Contract liabilities typically are not considered a significant financing component because these cash advances are used to meet working capital demands that can be higher in the early stages of a contract. When revenue recognized exceeds the amount billed to the customer, an unbilled receivable (contract asset) is recorded for the amount the Company is entitled to receive based on its enforceable right to payment and is included in Prepaid Expenses and Other Current Assets on the Condensed Consolidated Balance Sheet.

 

Remaining performance obligations represent the transaction price of firm orders for which work has not been performed as of the period end date and excludes unexercised contract options and potential orders under ordering-type contracts (e.g., indefinite-delivery, indefinite-quantity).

 

Recognition Prior to April 1, 2018

 

Prior to April 1, 2018 under the legacy GAAP, the Company recorded revenue when there was persuasive evidence of an arrangement, delivery had occurred, the price was fixed and determinable, and collectability was reasonably assured. This occurred when products were shipped or the customer accepted title transfer. If the arrangement involved acceptance terms, the Company deferred revenue until product acceptance was received. On certain large development contracts, revenue was recognized upon achievement of substantive milestones.  Advanced payments were recorded as deferred revenue until the revenue recognition criteria described above had been met. Amounts for periods ending prior to April 1, 2018 have not been adjusted for ASC 606 and continue to be reported in accordance with the Company’s previous accounting practices.

 

New Accounting Standards

 

In June 2018, the FASB issued ASU 2018-07, “Improvements to Nonemployee Share-Based Payment Accounting,” to simplify the accounting for share based transactions with nonemployees in which the grantor acquires goods or services to be used or consumed. Under the new standard, most of the guidance on recording share-based compensation granted to nonemployees will be aligned with the requirements for share-based compensation granted to employees. This standard will be effective in the first quarter of fiscal 2020, and early adoption is permitted. We do not expect the adoption of this standard to have a material impact on our consolidated financial statements.

 

In February 2016, the FASB issued authoritative guidance under ASU 2016-02, Leases (Topic 842). ASU 2016-02 requires lessees to recognize right-of-use assets and lease liabilities for most leases on the balance sheet and to provide expanded disclosures about leasing arrangements. The Company adopted the standard effective March 31, 2019 using the optional transition method and did not restate comparative periods. There was no effect on accumulated deficit at adoption.

 

Practical expedients elected

The Company has elected to apply the package of practical expedients under ASU 2016-02 to (a) not reassess whether expired or existing contracts are or contain leases, (b) not reassess the lease classification for any expired or existing leases and (c) not reassess the accounting for initial direct costs. As a result, leases classified as operating leases prior to adoption of the new lease standard remain as operating leases and leases classified as capital leases prior to adoption of the new lease standard are now finance leases.

 

 

The adoption of the new leases standard resulted in the following adjustments to the consolidated balance sheet as of March 30, 2019 (in thousands):

 

 

(a) Represents net book value of capital lease assets reclassified to Finance right of use assets.

(b) Represents current portion of deferred rent reclassified to Operating lease obligation, current portion.

(c) Represents current portion of capital lease liability reclassified to Finance lease obligation - current portion.

(d) Represents noncurrent portion of deferred rent reclassified to Operating lease liability - non-current portion.

(e) Represents noncurrent portion of capital lease obligation reclassified to Finance lease obligation - non-current portion.

 

Adoption of the standards related to leases had no impact to cash from or used in operating, financing, or investing activities on our consolidated cash flows statements.

 

(2)            Inventories

 

Inventories consisted of the following:

 

 

 

(3)      Financed Receivables

 

On March 11, 2019, the Company entered into an Amended and Restated Business Financing Agreement (the “Restated Financing Agreement”) with Western Alliance Bank, as successor to Bridge Bank. The Restated Financing Agreement amends, restates and replaces a credit agreement with 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 $2.5 million 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 included in the Previous Financing Agreement.

 

 

Under the Restated Financing Agreement, interest accrues on outstanding amounts at an annual rate equal to the greater of prime or 4.5% plus, in either case, one percent. The Company is required to pay certain fees, including an annual facility fee of $14,700, to be paid in two equal semiannual installments. The Company’s obligations under the Restated Financing Agreement are secured by a security interest in substantially all of the assets of the Company and any domestic subsidiaries, subject to certain customary exceptions. The Restated Financing Agreement has no specified term and may be terminated by either the Company or Western Alliance Bank at any time.

 

The Restated Financing Agreement contains customary events of default, including, among others: non-payment of principal, interest or other amounts when due; providing false or misleading representations and information; Western Alliance Bank failing to have an enforceable first lien on the collateral; cross-defaults with certain other indebtedness; certain undischarged judgments; bankruptcy, insolvency or inability to pay debts; and a change of control of the Company. Upon the occurrence and during the continuance of an event of default, the interest rate on the outstanding borrowings increases by 500 basis points and Western Alliance Bank may declare the loans and all other obligations under the Restated Financing Agreement immediately due and payable.

 

As of September 28, 2019 and March 30, 2019, the Company’s total outstanding borrowings under the Restated Financing Agreement were $839,290 and zero, respectively, and are included in Loans payable, net of discounts and issuance costs on the Condensed Consolidated Balance Sheet.

 

(4)        Term Loan and Warrants  

 

On April 27, 2017, the Company entered into a $1,500,000 loan agreement with Partners For Growth V, L.P. (“PFG”), which was funded by PFG on April 28, 2017 (the “2017 Loan”). The 2017 Loan, which was scheduled to mature on April 27, 2019, provides for interest only payments during the term of the loan with principal and any accrued interest and fees due upon maturity. The 2017 Loan bears interest at a fixed aggregate per annum rate equal to 16% per annum, of which 9.5% per annum rate is payable monthly in cash and 6.5% per annum rate is accrued monthly and due upon maturity. In addition, the Company agreed to pay PFG a cash fee of up to $100,000 payable upon maturity (the “back-end fee”), $76,000 of which was earned on April 27, 2017, and $24,000 of which is earned at the rate of $1,000 per month on the first day of each month if the loan principal (or any amount thereof) is outstanding during any day of the prior month.

 

Additionally, the 2017 Loan provides for the Company’s issuance of up to 250,000 common shares to PFG, of which 190,000 was earned by PFG upon signing (April 27, 2017) and 60,000 of which is earned at the rate of 2,500 per month on the first day of each month if the loan principal (or any amount thereof) is outstanding during any day of the prior month. The 2017 Loan provided for certain financial covenants related to the revenue achievement and maintenance of tangible net worth. PFG can accelerate the maturity of the loan in case of a default and the Company can prepay the loan before maturity without interest prepayments or penalty. The Company has pledged all of its assets as collateral for the 2017 Loan, including all its accounts, inventory, equipment, deposit accounts, intellectual property and all other personal property; however, the 2017 Loan is subordinate to the Bridge Bank line of credit (see Note 3, Accounts Receivable Line of Credit).

 

The requirement to issue 60,000 shares of the Company’s common stock over the term of the loan is an embedded derivative (an embedded equity forward). The Company evaluated the embedded derivative in accordance with ASC 815-15-25. The embedded derivative is not clearly and closely related to the debt host instrument and therefore is being separately measured at fair value, with subsequent changes in fair value being recognized in the consolidated statements of operations.

 

The proceeds received upon issuing the loan were allocated to: i) common stock, for the fair value of the 190,000 shares of common stock initially issued to the lender; ii) the fair value of the embedded derivative; and iii) the loan host instrument. Upon issuance of the loan, the Company recognized $1,576,000 of principal payable to PFG, representing the stated principal balance of $1,500,000 plus the initial back-end fee of $76,000. The initial carrying value of the loan was recognized net of debt discount aggregating approximately $326,000, which is comprised of the following:

  

  

The bifurcated embedded derivative and the debt discount are presented net with the related loan balance in the consolidated balance sheets. The debt discount is being amortized to interest expense over the loan’s term using the effective interest method. During the six months ended September 28, 2019, the Company amortized discounts of approximately $20,000 to interest expense.

 

PFG’s ability to call the debt on default (contingent put) and its ability to assess interest rate at a default rate (contingent interest) are embedded derivatives, which the Company evaluated. The fair value of these embedded features was determined to be immaterial and was not bifurcated from the debt host for accounting purposes.

 

 

Between June 24, 2017 and March 25, 2018, the Company was not in compliance with the 2017 Loan’s revenue and tangible net worth financial covenants and was subject to a default interest rate of 22% per annum which it accrued and paid when due during this period.

 

On March 26, 2018, concurrent with the execution of the Securities Purchase Agreement for the Series E Shares (see Note 12 – Preferred Stock and Warrants - Series E Senior Convertible Voting Perpetual Preferred Stock), the Company and PFG entered into a modification agreement providing for the restructuring of certain terms associated with approximately $1.7 million in indebtedness under the 2017 Loan. Subject to the sale of at least $1.0 million in Series E Shares, PFG agreed to waive all current defaults and cease applying the applicable default interest rate, returning to the stated non-default rate of 16%, and to lower the revenue and tangible net worth covenants for the remaining term of the loan. As consideration for the modifications, the Company reduced the exercise price of outstanding warrants previously granted to PFG (pursuant to its 2014 Loan Agreement and Credit Line with PFG) to purchase 260,000 shares of the Company’s common stock from $1.42 to $0.25 per share and extended the exercisability of the warrants by one year to March 13, 2020. The Company and PFG also agreed to eliminate PFG’s cash put provision associated with these warrants in exchange for the issuance of 150,000 shares of the Company’s common stock. As of September 28, 2019, the Company had issued to PFG 400,000 common shares under the loans.

 

The amendments to the 2017 Loan Agreement were recognized as a loan modification. The change in fair value of the warrants of $43,700, resulting from the reduced strike price and extension of term, was recognized as a discount to the 2017 Loan and is being amortized to interest expense over the remaining term of the 2017 Loan Agreement.

 

In December 2018, the Company and PFG agreed to modify the 2017 Loan Agreement to extend the maturity date from April 27, 2019 to November 1, 2019, to require the Company to pay all accrued interest on May 1, 2019 and to require the Company to make monthly prepayments of principal of $75,000 and accrued interest from May 1, 2019 until maturity. The effectiveness of the modification was conditioned on the Company raising $500,000 in additional equity 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 to add financial covenants requiring the Company to maintain a minimum tangible net worth and minimum revenues.

 

On June 28, 2019, the Company and PFG agreed to further modify the 2017 Loan Agreement to adjust the financial covenants requiring the Company to maintain a minimum tangible net worth and minimum revenues. At September 28, 2019, the Company was in compliance with these financial covenants under ASC 606.

 

As of September 28, 2019 and March 30, 2019, the Company’s total outstanding loan balances were $1.2 million and $1.8 million, respectively, and are included in Loans payable, net of discounts and issuance costs on the Condensed Consolidated Balance Sheet.

 

The Company anticipates it will need to achieve significant product shipments and resulting cash inflows and or seek additional funds through the issuance of new debt or equity securities to repay the 2017 Loan (including accrued interest and back end fees) in full upon maturity or otherwise enter into a refinancing agreement with PFG.

 

(5)         Leases

 

Operating leases

Building - The Company has a non-cancelable operating lease for office, research and development, engineering, laboratory, storage and/or warehouse uses in Dublin, California for 77 months from April 1, 2017 through August 31, 2023. The Company agreed to pay an aggregate base rent of $2,384,913 for the period of 77 months, with an annual increase of $0.05 per rentable square foot for each subsequent year. The agreement provided for rent abatement of $173,079 during the initial five months of the lease, subject to the Company performing the terms and conditions required under the lease, and certain tenant improvements completed at the landlord’s expense of $358,095.

 

Per the terms of the Company’s lease agreements, the Company does not have any residual value guarantees. In calculating the present value of the lease payments, the Company has elected to utilize its incremental borrowing rate. The Company has elected for facility operating leases to not separate each lease component from its associated non-lease components. The building lease includes variable payments (i.e. common area maintenance) which are charged and paid separately from rent based on actual costs incurred and therefore are not included in the right-of-use asset and liability but reflected in operating expense in the period incurred.

 

 

Lease costs

 

For the three months ended (in thousands):

 

 

For the six months ended (in thousands):

 

 

Other information (in thousands except weighted average amounts):

 

 

 

Future lease payments as of September 28, 2019 were as follows (in thousands):

 

 

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(6)       Fair Value

 

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

  

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

  

•

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

  

•

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

  

•

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

 

The carrying amounts of the Company’s cash and cash-equivalents and line of credit approximate their fair values at each balance sheet date due to the short-term maturity of these financial instruments, and generally result in inputs categorized as Level 1 within the fair value hierarchy. The carrying value of the outstanding PFG loan approximates the estimated aggregate fair value and classified with the loan host. The fair value estimate of the embedded equity forward is based on the closing price of the Company’s common stock on the measurement date, the risk-free rate, the date of expiration, and any expected cash distributions of the underlying asset before expiration. The estimated fair value of the embedded equity forward represents a Level 2 measurement.

 

On March 26, 2018, the Company and PFG agreed to eliminate the cash put provision contained in warrants in exchange for the Company issuing 150,000 shares of the Company’s common stock. Upon removal of the put, the warrants were re-valued using the Black-Scholes option-pricing model with the following assumptions: (i) remaining term of 0.96 years, (ii) expected volatility of 85%, (iii) risk-free interest rate of 2.12%, and (iv) no expected dividends. The resulting change in fair value of the warrants, along with the fair value of the common stock issued to PFG, was recognized as an adjustment of warrant liability in the consolidated statements of operations.

 

There were no assets measured at fair value on a recurring basis and there were no assets or liabilities measured on a non-recurring basis at September 28, 2019 and March 30, 2019.

 

(7)   Income (loss) Per Share

 

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

 

Shares included in the diluted EPS calculation for the six month period ended September 28, 2019 are as follows:

 

 

 

Shares excluded from the diluted EPS calculation for the six month period ended September 29, 2018 because they would be anti-dilutive are as follows:

 

 

The stock options, restricted stock, convertible preferred stocks and warrants not included in the computation of diluted earnings per share (EPS) for the six month period ended September 29, 2018 is a result of the Company’s net loss and, therefore, the effect of these instruments would be anti-dilutive.

 

(8)     Share-based Compensation and Employee Benefits Plans

 

On September 20, 2018, shareholders approved the Company’s 2018 Equity Incentive Plan under which the Company may issue up to 2,500,000 shares of common stock upon the exercise of options, stock awards and grants. With the adoption of the 2018 Equity Incentive Plan, no further awards will be issued under the 2005 Equity Incentive Plan, though all awards under the 2005 Equity Incentive Plan that are outstanding will continue to be governed by the terms, conditions and procedures set forth in the plan and any applicable award agreement. Option grants under the Company’s previous 2000 Stock Option Plan are no longer available.

 

Options granted generally vest in one or more installments in a four or five-year period and must be exercised while the grantee is employed by the Company (or while providing services under a service arrangement in the case of non-employees) or within a certain period after termination of employment or service arrangement in the case of non-employees. Options granted to employees shall not have terms in excess of 10 years from the grant date. Holders of options may be granted SARs, which entitle them to surrender outstanding awards for a cash distribution under certain changes in ownership of the Company, as defined in the stock option plan. As of September 28, 2019, no SARs have been granted under any option plan. As of September 28, 2019, the total number of shares of common stock available for issuance was 638,500. All outstanding options have a ten-year life from the date of grant. The Company records compensation cost associated with share-based compensation equivalent to the estimated fair value of the awards over the requisite service period. 

 

Stock Options

 

In calculating compensation related to stock option grants, the fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option-pricing model and the following weighted average assumptions:

 

 

The computation of expected volatility used in the Black-Scholes-Merton option-pricing model is based on the historical volatility of the Company’s share price. The expected term is estimated based on a review of historical employee exercise behavior with respect to option grants. The risk-free interest rate is based on the U.S. Treasury rates with maturity similar to the expected term of the option on the date of grant.

 

 

A summary of the changes in stock options outstanding for the six-month period ended September 28, 2019 and the fiscal year ended March 30, 2019 is as follows:

 

   

As of September 28, 2019, there was $491,000 of total unrecognized compensation cost related to non-vested options. That cost is expected to be recognized over a weighted average period of 3.14 years. There were 144,672 options and 15,550 options that vested during the quarter ended September 28, 2019 and September 29, 2018, respectively. The total grant date fair value of options vested during the quarters ended September 28, 2019 and September 29, 2018 was $47,000 and $20,000, respectively. There were 351,964 and 22,750 options that vested during the six-month period ended September 28, 2019 and September 29, 2018, respectively. The total grant date fair value of options vested during the six-month period ended September 28, 2019 and September 29, 2018 was $100,000 and $29,000, respectively. No shares were exercised during the three and six-month period ended September 28, 2019 and September 29, 2018. Share based compensation cost recognized in operating results for the three-month periods ended September 28, 2019 and September 29, 2018 totaled $52,000 and $24,000, respectively. Share based compensation cost recognized in operating results for the six-month periods ended September 28, 2019 and September 29, 2018 totaled $103,000 and $44,000, respectively.

 

Restricted Stock

 

The Company granted no awards during the second quarter and first half of fiscal 2020 and 2019. The restricted stock awards are considered fixed awards as the number of shares and fair value at the grant date is amortized over the requisite service period net of estimated forfeitures. As of September 28, 2019, there was $19,000 of total unrecognized compensation cost related to non-vested awards. That cost is expected to be recognized over a weighted average period of 0.50 years and will be adjusted for subsequent changes in estimated forfeitures. Compensation cost recognized for the restricted and unrestricted stock awards during the second quarter and first half of fiscal 2020 was $15,000 and $60,000, respectively. Compensation cost recognized for the restricted and unrestricted stock awards during the second quarter and first half of fiscal 2019 was $23,000 and $59,000, respectively.

   

A summary of the changes in non-vested restricted stock awards outstanding for the six-month period ended September 28, 2019 and the fiscal year ended March 30, 2019 is as follows:

 

 

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(9)      Significant Customer and Industry Segment Information 

 

The Company has two reportable segments: Microsource and the Giga-tronics Division. Microsource’s primary business is the design of custom Microwave Integrated Components (“MIC”) as well as the production of MIC components using chip and wire assembly methods. The Company’s Microsource Division 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. These high-speed, tunable notch filters are designed to block interference from both continuous wave and wide bandwidth emissions using proprietary driver and phase lock technology. The Company designs these filters specifically for each application. Microsource’s two largest customers are prime contractors for which it develops and manufactures RADAR filters used in fighter jet aircraft.

 

The Giga-tronics Division designs, manufactures and markets a family of functional test products for the RADAR and Electronic Warfare (RADAR/EW) segment of the defense electronics market. The Company’s RADAR/EW test products are used to evaluate and improve the performance of RADAR/EW systems.

 

The tables below presents information for the two reportable segments:

 

  

 

During the second quarter of fiscal 2020, one customer accounted for approximately 57% of the Company’s consolidated revenues and was included in the Microsource segment. A second customer accounted for 31% of the Company’s consolidated revenue and was also included in the Microsource segment. During the second quarter of fiscal 2019, one customer accounted for approximately 60% of the Company’s consolidated revenues and was included in the Microsource segment. A second customer accounted for 25% of the Company’s consolidated revenue and was also included in the Microsource segment.

 

During the first half of fiscal 2020, one customer accounted for 47% of the Company’s consolidated revenues and was primarily included in the Microsource segment. A second customer accounted for 30% of the Company’s consolidated revenue and was included in the Giga-tronics division. During the first half of fiscal 2019, one customer accounted for 62% of the Company’s consolidated revenues and was primarily included in the Microsource segment. A second customer accounted for 28% of the Company’s consolidated revenue and was also included in the Microsource segment.

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(10)     Income Taxes

 
The Company accounts for income taxes using the asset and liability method as codified in Topic 740. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards.

 

The Company recorded $2,000 and $42,000 income tax expense for the six months ended September 28, 2019 and September 29, 2018, respectively. The effective tax rate for the six months ended September 30, 2019 and September 30, 2018 was 0% each year, primarily due to a valuation allowance recorded against the net deferred tax asset balance.

 

As of September 30, 2019, the Company had recorded $123,000 for unrecognized tax benefits related to uncertain tax positions. The unrecognized tax benefit is netted against the non-current deferred tax asset on the Consolidated Balance Sheet. The Company does not expect the liability for unrecognized tax benefits to change materially within the next 12 months.

 

(11)        Warranty Obligations

 

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

 

  

 

(12)      Preferred Stock and Warrants

 

Series E Senior Convertible Voting Perpetual Preferred Stock

 

On March 26, 2018, the Company entered into a Securities Purchase Agreement for the sale of 42,800 shares of a newly designated series of 6.0% Series E Senior Convertible Voting Perpetual Preferred Stock (“Series E Shares”) to approximately 15 private investors. The sale was completed and the Series E Shares were issued on March 28, 2018.

 

Holders of Series E Shares are entitled to receive, when, as and if declared by the Company’s Board of Directors, cumulative preferential dividends, payable semiannual in cash at a rate per annum equal to 6.0% of the initial purchase price of $25.00 per share or in-kind (at the Company’s election) through the issuance of shares of the Company’s common stock, based on the 10 day volume weighted average price of the common stock. The deemed dividend is reflected on the face of the income statement as an increase in net loss or a decrease in net income to arrive a net income (loss) attributable to common shareholders.

 

The purchase price for each Series E Share was $25.00. Gross proceeds received by the Company were approximately $1.095 million (the “Placement”). Net proceeds to the Company after fees and expenses of the Placement were approximately $1.0 million. Placement agent fees incurred in connection with the transaction were 5% of gross proceeds or approximately $57,000 in cash, plus warrants to purchase 5% of the number of common shares into which the Series E shares can be converted (223,000 shares) at an exercise price of $0.25 per share.

 

During the 2019 fiscal year, the Company issued and sold an additional 57,200 Series E Shares for the price of $25.00 per share, resulting in gross proceeds of $1,405,000. Net proceeds from sales of Series E Shares during the 2019 fiscal year were approximately $1.2 million after fees and expenses of approximately $212,000. Placement agent fees incurred in connection with the transaction were 5% of gross proceeds or approximately $56,875 in cash, plus warrants to purchase 5% of the number of common shares into which the Series E shares can be converted (100 shares) at an exercise price of $0.25 per share.

 

For the six months ended September 28, 2019, no additional Series E shares were issued.

 

 

The table below presents information as of September 28, 2019:

 

 

 

(13)        Subsequent Events

  

Sale of Common Stock

 

On November 8, 2019, the Company completed an underwritten public offering of 11,960,000 shares of its common stock at $0.25 per share. The net proceeds from the offering after deducting underwriting discounts and commissions and estimated offering expenses were approximately $2.1 million. The Company intends to use the net proceeds of this offering for general corporate purposes, which may include the repayment of debt. In connection with the offering, the Company granted the underwriter a warrant to purchase 358,800 shares of common stock at the price of $0.30 per share.  The warrant is immediately exercisable and has a five year term.

 

Series E Exchange

 

Beginning on September 30, 2019, the Company offered holders of its 6.0% Series E Shares the opportunity to exchange all or some of their shares of Series E Shares for shares of the Company’s common stock in a private exchange offer at the rate of 150 shares of common stock for each Series E Share, plus an additional number of shares of common stock having a market value equal to the accrued but unpaid dividends thereon.  The private exchange offer was conditioned and became effective upon the Company selling at least $2.0 million of common stock in a public offering.  The Company completed the private exchange offer on November 8, 2019, issuing an aggregate of 13,449,562 shares of common stock in exchange for 88,600 shares of Series E Preferred Stock and dividends accrued thereon. The shares of common stock to be issued in the exchange were issued in reliance on the exemptions from registration set forth in Sections 3(a)(9) and 4(a)(2) of the Securities Act of 1933 (the “Securities Act”), though other exemptions may be available.

 

Reverse Stock Split Announced

 

At the Annual Meeting of Shareholders on September 19, 2019, the Company’s shareholders approved a reverse stock split of the Company’s common stock and authorized the Board of Directors to determine the exact ratio of the reverse split within the range of 1-for-10 to 1-for-20.  On November 6, 2019, the Company announced that the Board of Directors approved a reverse split of the common stock at a ratio of 1-for-15. 

 

The shares amounts and related financial information in this Form 10-Q do not reflect the reverse split, which is expected to be effective on November 29, 2019.  At the effective time of the reverse stock split, every 15 shares of issued and outstanding common stock will be converted into one share of issued and outstanding common stock, and the authorized shares of common stock will be reduced from 200,000,000 to 13,333,333 shares, without par value.  The reverse stock split will not modify the rights of the common stock.  Proportional adjustments will be made to the conversion and exercise prices of the Company’s convertible preferred stock, common stock warrants and stock options.

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