Guerrilla RF, Inc. - Quarter Report: 2022 September (Form 10-Q)

GLOSSARY OF TERMS AND ABBREVIATIONS

The following is a glossary of technical terms used in this Report:

64T64R, 32T32R, 16T16R, 8T8R systems — Describes the number of transmit and receive paths in a 5G system architecture.

5G — A technology standard to increase the speed or amount of data communicated in a cellular network relative to 3G or LTE networks.

AEC-Q100 — Automotive Electronic Council’s electronic stress qualification standard for integrated circuits.

Cellular booster/DAS — System which extends and distributes a cellular signal within buildings such as below ground, large-area, or high-rise structures.

Cellular Compensator — Improves a cellular link inside a motorized vehicle by using an antenna outside the vehicle in combination with amplifiers to boost the signal in both the transmit and receive paths.

Cellular Repeater — Improves poor cellular service by boosting signal strength inside a building or structure.

C-V2X — Cellular-technology-based vehicle-to-everything communication standard.

CMOS — Complementary MOS (metal oxide semiconductor), widely used semiconductor transistor architecture.

Copper lead frame — Copper-based substrate used as a foundation for semiconductor packages.

DAB — Digital audio broadcasting. A terrestrial-based digital radio standard (HD Radio).

Design win — Acknowledgment by an end-user customer that a product has been chosen or finalized for use in the customer’s system or application.

Die/Chip — An individual semiconductor device on the wafer.

Distribution-customer — A customer that purchases Guerrilla RF products for the purpose of selling to a third-party rather than for its own use.

DSA — Digital step attenuator.

DSRC — Dedicated short-range communications. (Typically used in electronic toll collection).

End-user customer — The ultimate customer that utilizes or incorporates our products into its own products or solutions whether it purchased our products directly from Guerrilla RF or a third party.

EAR — Export Administration Regulation

Fab — Fabrication, generally refers to a semiconductor wafer fabrication facility.

Fabless — Semiconductor company that utilizes pure-play or outsourced wafer fabrication partners rather than owning and operating their own wafer foundry.

FM/DAB — Terrestrial-based radio broadcast standards.

GaN — Gallium nitride semiconductor process used in high-power amplifier applications.

GaAs HBT — Gallium arsenide heterojunction bipolar transistor. A semiconductor process allowing higher efficiency and improved linearity compared to GaAs MESFET processes.

GaAs pHEMT — Gallium Arsenide pseudomorphic high electron mobility transistor. A semiconductor process that allows larger bandgap differences, thus providing higher performance than a GaAs MESFET technology.

Gain blocks, switches, power detectors, drivers, mixers, digital step attenuators, high power amplifiers — Functional building blocks of RF components in a typical radio frequency system or architecture.

GHz — Frequency of operation (in Gigahertz) in an RF system.

GPS/GNSS — Global satellite positioning technologies.

IP — Intellectual property.

LNA — Low noise amplifier.

Linear driver amplifier — An amplifier used before the final amplification stage that produces increased power levels while adding minimal distortion to the output signal.

mMIMO active antenna array — Massive multiple-input and multiple-output antenna systems that include beamforming ability.

MMIC — Monolithic microwave integrated circuit. An integrated circuit designed to utilize the microwave frequency bands. (300MHz to 300GHz).

MESFET — Metal-semiconductor field-effect transistor, a type of transistor.

OEM — Original equipment manufacturers.

PA — Power Amplifier.

Package lead frame — Substrate (typically copper) used as a foundation to mount and package semiconductor devices.

pHEMT — Pseudomorphic high electron mobility transistor, a type of transistor.

Point-to-point radio — Radio link used between two communication endpoints or devices.

RF — Radio frequency.

RFIC — Radio frequency integrated circuit.

RFID — Radio frequency identification.

SDARS — Satellite Digital Audio Radio Service (e.g., Sirius XM Satellite Radio).

Si — Silicon — Standard fabrication process used for semiconductor processing.

SOI — Silicon on insulator. Fabrication process used for semiconductor manufacturing. Beneficial to reduce parasitic capacitance for a device.

Tape and reel — A method of packing surface mount devices by placing each device in an individual pocket on a carrier tape. Clear tape is applied to contain the device within the pocket. The carrier tape is wound on a reel, easing device handling and transportation.

Telematics — The convergence of telecommunications and information processing. The term is generally used for describing systems used in motor vehicles.

UWB — Ultra-wideband Radio technology using very low energy levels for short-range, high-bandwidth communications.

V2X — Vehicle-to-everything. Communication technology to allow vehicles to communicate with other vehicles, infrastructure, pedestrian devices, etc.

Wafer — Thin slice of semiconductor material used as the substrate for building electronic circuits. Wafers are the output from the semiconductor foundry process before the assembly/packaging processes.

WiFi — Wireless network protocol, based on the IEEE 802.11 family of standards.

Wireless backhaul point-to-point — A method used by communication providers to use wireless data links to connect radio towers or the core network.

Wireless infrastructure — Systems designed or used by network operators or other professionals to ensure strong communication links to consumers or customers.

PART I. FINANCIAL INFORMATION.

ITEM 1.

The following unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC").  Certain information and note disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to those rules and regulations, although Guerrilla RF, Inc. (the "Company") believes that the disclosures made are adequate to make the information not misleading.

These unaudited interim condensed consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s latest Annual Report on Form 10-K filed with the SEC on April 1, 2022.

GUERRILLA RF, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

GUERRILLA RF, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

GUERRILLA RF, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

GUERRILLA RF, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. ORGANIZATION AND NATURE OF BUSINESS

All references in this Quarterly Report to “Guerrilla RF” refer to Guerrilla RF Operating Corporation, our direct, wholly-owned subsidiary.  Unless otherwise stated or the context otherwise indicates, references to the “Company”, “we”, “our”, “us” or similar terms refer to Guerrilla RF, Inc. (formerly known as Laffin Acquisition Corp.) together with its wholly-owned subsidiary, Guerrilla RF.  Guerrilla RF holds all material assets and conducts all business activities and operations of the Company.  Accordingly, there are frequent references to Guerrilla RF throughout this Quarterly Report.

Guerrilla RF, Inc. was incorporated in the State of Delaware on November 9, 2020.  On October 22, 2021, the Company's wholly-owned subsidiary, Guerrilla RF Acquisition Corp., a corporation formed in the State of Delaware on October 20, 2021 (“Acquisition Sub”) and privately held Guerrilla RF Operating Corporation (formerly known as Guerrilla RF, Inc.) entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”).  Pursuant to the terms of the Merger Agreement, on October 22, 2021 (the “Closing Date”), Acquisition Sub merged with and into Guerrilla RF Operating Corporation with Guerrilla RF Operating Corporation continuing as the surviving corporation and a wholly-owned subsidiary of the Company (the “Merger”). 

Prior to the Merger, Laffin Acquisition Corp. was a “shell” company registered under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), with no specific business plan or purpose until it began operating the business of Guerrilla RF Operating Corporation following the closing of the Merger.

Guerrilla RF designs high‐performance Monolithic Microwave Integrated Circuits (MMICs) for the wireless infrastructure market.  Guerrilla RF primarily focuses on researching and developing its existing and future products and building an infrastructure to handle a global distribution network; therefore, it has incurred significant start‐up losses. 

The Merger was accounted for as a “reverse acquisition” since, immediately following the consummation of the Merger, Guerrilla RF effectively controlled the Company.  For accounting purposes, Guerrilla RF was deemed the accounting acquirer in the Merger.  Consequently, the Merger is treated as a recapitalization of Guerrilla RF (i.e., a capital transaction involving the issuance of shares by the Company for the shares of Guerrilla RF).  Accordingly, the assets, liabilities, and results of operations of Guerrilla RF became the historical consolidated financial statements of the Company, and the Company’s assets, liabilities, and results of operations were consolidated with Guerrilla RF beginning at the Closing Date.  No step-up in basis or intangible assets or goodwill were recorded in the Merger.

Liquidity and Going Concern

In accordance with Financial Accounting Standards (“FASB”) Accounting Standards Update (“ASU”) No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (Subtopic 205-40), the Company has evaluated whether there are conditions and events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the unaudited interim condensed consolidated financial statements are issued.  The accompanying unaudited interim condensed consolidated financial statements have been presented on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the ordinary course of business.  The Company has historically financed its activities principally from common and preferred equity securities and debt issuances.

The Company has incurred recurring losses, and negative cash flows from operations in nearly every fiscal period since its inception, including a net loss of $3.7 million for the three months ended September 30, 2022.  In addition, as of September 30, 2022, the Company had an accumulated deficit of $23.3 million.  The Company expects losses and negative cash flows to continue, primarily as a result of continued investment in research and development, capital additions supporting our planned business expansion and growth, and sales and marketing efforts.  The Company had a cash balance of $2.1 million at September 30, 2022.  In June 2022, the Company established a new loan facility with Spectrum Commercial Services Company, L.L.C. ("Spectrum") providing for advances of up to $3.0 million (the "Spectrum Loan Facility" further described in Note 5).  As of September 30, 2022, the outstanding balance under the Spectrum Loan Facility was $0.2 million.  In August 2022, the Company established a new loan facility with Salem Investment Partners V, Limited Partnership ("Salem") providing for advances of up to $8.0 million (the "Salem Loan Facility" further described in Note 5).  As of September 30, 2022, the undiscounted outstanding balance under the Salem Loan Facility was $5.0 million.

The Company is actively pursuing additional financing to support its current and future liquidity needs, including an equity capital raise of up to $10 million.  The Company believes that its cash and funding availability under its two loan facilities will provide sufficient resources to support operations through the middle of December 2022.  In the event the Company does not successfully close the equity capital raise on a timely basis the Company will request that Salem release some or all of the remaining $3.0 million provided for under the Salem Loan Facility.  There is no assurance that the pending equity capital raise will successfully close on a timely basis, or at all.  Nor is there any assurance that Salem will consent to the Company drawing down some or all of the $3.0 million additional loan facility.  If the Company is unsuccessful in securing sufficient additional funding before the middle of December 2022, it will be unable to fund ongoing operations and pay its obligations as they become due.  This requirement for additional funding raises substantial doubt about our ability to continue as a going concern.  The unaudited interim condensed consolidated financial statements do not include any adjustments relating to the recoverability of the recorded assets or the classification of liabilities that may be necessary should the Company be unable to continue as a going concern.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Risks and Uncertainties

The Company is subject to several risks associated with companies at a similar stage, including dependence on key individuals, competition from similar products and larger companies, volatility of the industry, ability to obtain adequate financing to support growth, the ability to attract and retain additional qualified personnel to manage the anticipated growth of the Company, and general economic conditions.

In December 2019, a novel strain of coronavirus disease (“COVID-19”) was reported, and in March 2020, the World Health Organization characterized COVID-19 as a global pandemic.  The COVID-19 pandemic has forced international, federal, state, and local governments to enforce prohibitions of non-essential activities.  The Company first saw the impact of COVID-19 in the first quarter of 2020.  The extent and duration of the adverse impact of COVID-19 on the Company over the longer term remains uncertain and dependent on future developments that cannot be accurately predicted at this time, such as the severity and transmission rate of COVID-19 and its related variants, the extent and effectiveness of containment actions taken, including mobility restrictions, the timing, availability, and effectiveness of vaccines, and the impact of these and other factors on travel behavior in general and on the Company’s business.

As the impact of COVID-19 continues to evolve, estimates and assumptions about future events and their effects cannot be determined with certainty and therefore require increased judgment.  These estimates and assumptions may change in future periods and will be recognized in the condensed consolidated financial statements as new events occur, and additional information becomes known.  To the extent the Company’s actual results differ materially from those estimates and assumptions, the Company’s future condensed consolidated financial statements could be affected.

2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the rules and regulations for reporting the Quarterly Report on Form 10-Q ("Form 10-Q"), and are presented in U.S. dollars.  Accordingly, they do not include all of the information and notes required by GAAP for annual consolidated financial statements.  Any reference in these Notes to applicable guidance is meant to refer to the authoritative GAAP as found in the Accounting Standards Codification (“ASC”) and as amended by Accounting Standards Updates (“ASU”) of the Financial Accounting Standards Board (“FASB”).  The accompanying unaudited interim condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Guerrilla RF.  All intercompany accounts and transactions have been eliminated in consolidation.

The condensed consolidated balance sheet at December 31, 2021 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements.  These financial statements have been prepared on a basis that is substantially consistent with the accounting principles applied in our Annual Report on Form 10-K for the fiscal year ended  December 31, 2021 ("2021 Form 10-K").  This report should be read in conjunction with our 2021 Form 10-K filed with the SEC on April 1, 2022.  In our opinion, the accompanying unaudited interim condensed consolidated financial statements include all normal and recurring adjustments (which consist primarily of accruals, estimates, and assumptions that impact the financial statements) considered necessary to present fairly the Company’s financial position as of September 30, 2022 and its results of operations, cash flows, and changes in stockholders' equity (deficit) for the nine months ended September 30, 2022 and 2021.  The results for the three and nine months ended September 30, 2022 are not necessarily indicative of the results expected for any future period or the full year.

Emerging Growth Company

The Company is an “emerging growth company,” as defined in Section 2(a) of the Securities Act of 1933, as amended (the "Securities Act"), as modified by the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and it may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in its periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved.

Further, Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act registration statement declared effective or do not have a class of securities registered under the Exchange Act) are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such election to opt out is irrevocable.  The Company has elected not to opt out of the extended transition period, which means that when a standard is issued or revised and it has different application dates for public and private companies, the Company, as an emerging growth company, can adopt the new or revised standard at the time private companies adopt the new or revised standard.  This may make comparison of the Company’s financial statements with another public company which is neither an emerging growth company nor an emerging growth company which has opted out of using the extended transition period difficult or impossible because of the potential differences in accounting standards used.

Use of Estimates

The preparation of our condensed consolidated financial statements requires management to make estimates and assumptions that affect the amounts reported in our condensed consolidated financial statements and related disclosures.  Additionally, the business and economic uncertainty resulting from the COVID-19 pandemic and the Russia-Ukraine conflict has made such estimates and assumptions more difficult to calculate.  The preparation of the unaudited interim condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the unaudited interim condensed consolidated financial statements, and reported amounts of revenue and expenses during the reporting period.  The Company’s significant estimates and judgments involve the identification of performance obligations in revenue recognition, the valuation of share-based compensation, and the valuation of share-based financing, including the underlying fair value of the common stock.  Accordingly, actual results could differ from those estimates.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Segment Information

Operating segments are defined as components of an enterprise about which separate discrete information is available for evaluation by the chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance.  The Company views its operations and manages its business in one segment.

Concentrations of Credit Risk and Major Customers

Financial instruments at September 30, 2022 and 2021 that potentially subject the Company to concentration of credit risk consist primarily of cash and accounts receivable.

The Company’s cash is deposited with major financial institutions in the U.S.  At times, deposits in financial institutions located in the U.S. may be in excess of the amount of insurance provided on such deposits by the Federal Deposit Insurance Corporation.  To date, the Company has not experienced any losses on its cash deposits.

The Company’s accounts receivable are derived from revenue earned from customers located in and outside of the U.S.  Major customers are defined as those generating revenue in excess of 10% of the Company’s aggregate annual revenue.  The Company had one major distributor customer, Richardson RFPD, Inc. ("RFPD") accounting for 81% of product shipment revenue for the nine months ended September 30, 2022 and 2021.  Accounts receivable from RFPD represented 84% and 94% of accounts receivable at September 30, 2022 and 2021, respectively.  

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Accounts Receivable

Accounts receivable primarily relate to amounts due from customers, which are typically due within 30 to 45 days. Accounts receivable also include royalty revenue from our one royalty agreement. The Company provides credit to its customers in the ordinary course of business and evaluates the need for allowances for potential credit losses. The Company does not require collateral or other security for accounts receivable. To reduce credit risk with accounts receivable, the Company performs ongoing evaluations of its customers’ financial condition. Historically, such losses have been immaterial and within management's expectations.

The Company had a factoring agreement that provided advance payments on up to 85% of invoices issued to RFPD, its largest distributor, with receivables less than 90 days outstanding secured by the remaining 15%.  As of September 30, 2022 and December 31, 2021, the Company had $0 of factored invoices.  The Company terminated this factoring agreement in conjunction with entering into the Spectrum Loan Facility discussed in Note 5.

On June 1, 2022,  the Company established a new loan facility with Spectrum.  The Spectrum Loan Facility provides for advance payments up to $3 million, calculated, in part, based on the value of eligible accounts receivable assigned to Spectrum as security for advances under the Spectrum Loan Facility.  As of September 30, 2022, $0.3 million of invoices were assigned as security to Spectrum.  At September 30, 2022, $0.3 million was due from Spectrum, which is included in accounts receivable on the unaudited interim condensed consolidated balance sheets.  See Note 5 for additional discussion on the Spectrum Loan Facility.

Property and Equipment

Property and equipment are stated at cost, less accumulated depreciation and amortization.  The Company depreciates computer hardware, software, production and computer equipment, and lab equipment using the straight-line method over their estimated useful lives, ranging from three to five years.  The Company depreciates furniture and fixtures using the straight-line method over their estimated useful lives of seven years.  Leasehold improvements are amortized over the shorter of the asset’s useful life or the remaining lease term.  Repairs and maintenance are expensed as incurred by the Company.

Impairment of Long-Lived Assets

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable.  The recoverability of assets held and used is measured by comparing the carrying amount of an asset to future net cash flows expected to be generated by the asset.  If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets, less costs to sell.  The Company evaluated its long-lived assets for impairment in the three months ended September 30, 2022 and determined a small subset of its production mask sets were impaired and recorded an asset impairment expense.  See Note 4 for further information.

Deferred Offering Costs

The Company has not capitalized legal, professional, accounting, and other third-party fees directly associated with common equity financings as deferred offering costs as these acquisition costs are immaterial in relation to the financing and as a portion of our condensed consolidated balance sheet.  Transaction costs consisting of legal, accounting, financial advisory, and other professional fees incurred as part of the Merger mentioned in Note 1 were offset against the total proceeds from the Merger in the condensed consolidated financial statements for the year ended December 31, 2021.  At September 30, 2022, there were no deferred offering costs.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Revenue Recognition

The Company recognizes product revenue when it satisfies a performance obligation by transferring a product or service to its customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those products and services. Sales and other taxes the Company collects concurrent with revenue-producing activities are excluded from revenue.  Shipping and handling fees charged to customers are reported within revenue.  The Company does not have any significant financing components as payment is due at or shortly after the point of sale.  The Company provides an assurance-type warranty to its customers as part of its contracts' standard terms and conditions, which does not include a right of return for properly functioning products not deemed obsolete.  These warranties do not provide an additional distinct service to the customer and are not deemed a separate performance obligation.  Royalty revenue is recognized at the later of when the subsequent sale or usage occurs, or the performance obligation to which some or all the sales-based royalties have been allocated is satisfied.  The costs incurred by the Company for shipping and handling are classified as cost of revenue in the unaudited interim condensed consolidated statements of operations.  Any incidental items that are immaterial in the context of a sale to a customer are recognized as expense.

Direct Product Costs

The Company’s direct product costs consist primarily of salaries and related expenses, overhead, third party services vendors, shipping and handling, and depreciation expense related to the equipment and information technology costs incurred directly in the Company’s revenue-generating activities.

Share-Based Compensation

The Company measures and recognizes compensation expense for all stock options, shares of stock, and restricted stock units ("RSU") awarded to employees and nonemployees based on the estimated fair market value of the award on the grant date.  The Company uses the Black-Scholes option-pricing model to estimate the fair value of its stock option awards.  The Company estimates the fair value of RSUs awarded based upon the known fair market value of the underlying shares on the grant date.  The Company recognizes compensation expense on a straight-line basis over the applicable vesting period.  In addition, the Company accounts for forfeitures of awards as they occur.

The Company applies ASU 2018-7, Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, which simplifies the accounting for share-based payments granted to nonemployees for goods and services.  Share-based awards issued to nonemployees are no longer required to be revalued at each reporting period.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Estimating the fair market value of options requires the input of subjective assumptions, including the estimated fair value of the Company’s common stock, the expected life of the options, stock price volatility, the risk-free interest rate, and expected dividends.  Therefore, the assumptions used in the Company’s Black-Scholes option-pricing model represent management’s best estimates and involve many variables, uncertainties, assumptions, and the application of management’s judgment, as they are inherently subjective.

Research and Development Costs

Research and development costs are expensed as incurred and consist primarily of personnel-related engineering and technical staff wages and benefits, prototype costs, and other direct expenses.

Advertising Costs

All advertising costs are expensed as incurred and included in sales and marketing expenses.  Advertising expenses for the nine months ended September 30, 2022, and 2021 were$36,302 and $15,107, respectively.

Inventories

Inventories are valued at the lower of cost and net realizable value.  Cost is determined by the first‐in, first‐out (FIFO) method.

Income Taxes

Income taxes are accounted for under the asset and liability method as required by FASB ASC Topic 740, Income Taxes (“ASC 740”).  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated 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 corresponding to the enactment date.  Under ASC 740, a valuation allowance is required when it is more likely than not that all or some portion of the deferred tax assets will not be realized through generating sufficient future taxable income.

FASB ASC Subtopic 740 10, Accounting for Uncertainty of Income Taxes, (“ASC 740 10”) defines the criterion upon which an individual tax position must meet for any part of the benefit of the tax position to be recognized in consolidated financial statements prepared in conformity with GAAP.  The Company may only recognize the tax benefit from an uncertain tax position if it is more likely than not that such tax position will be sustained on examination by the taxing authorities, based solely on the technical merits of the respective tax position.  The tax benefits recognized in the consolidated financial statements from such a tax position should be measured based on the largest benefit having a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority.  In accordance with the disclosure requirements of ASC 740 10, the Company’s policy on income statement classification of interest and penalties related to income tax obligations is to include such items as part of total income tax expense.  See further information about the Company's income taxes in Note 9.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Net Income (Loss) Per Share

Basic net loss per share of common stock is computed by dividing net loss by the basic shares, i.e., the weighted average number of shares of common stock outstanding during each period.  Diluted net income per share of common stock includes the effect of the potential exercise or conversion of securities, such as options and warrants, which results in the issuance of incremental common stock.  For periods prior to the Merger mentioned in Note 1, each of Guerrilla RF’s shares of capital stock issued and outstanding immediately prior to the closing of the Merger was retrospectively converted into approximately 2.95 shares of the Company's common stock.  In computing basic and diluted net loss and income per share, the weighted average number of shares is the same for both calculations because a net loss existed for the nine months ended September 30, 2022 and 2021.  There were 33,260,160 and 6,761,771 basic shares for the nine months ended September 30, 2022 and 2021, respectively, and 33,316,416 and 6,794,216 basic shares for the three months ended September 30, 2022, and 2021, respectively.  As such, all preferred stock, warrants, and options were excluded from the calculation of basic shares and net loss per share for the nine months ended September 30, 2022 and 2021.

The following potentially dilutive securities have been excluded from the computation of basic shares for the three and nine months ended September 30, 2022 and 2021, as they would be anti-dilutive:

Recent Accounting Pronouncements

In February 2016, the FASB issued ASC Topic 842, Leases. This standard requires all entities that lease assets with terms of more than 12 months to capitalize the assets and related liabilities on the balance sheet.  In June 2020, the FASB issued ASU 2020-05, which delayed the effective date of Topic 842 until January 1, 2022.  The Company adopted Topic 842 in the fiscal quarter ending March 31, 2022.  See Note 8 for further information related to lease obligations on the unaudited interim condensed consolidated balance sheet upon adopting ASC Topic 842.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, which requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected.  This standard is effective for fiscal years beginning after December 15, 2022, and early adoption is permitted.  The Company does not intend to adopt this standard early and is currently evaluating the impact of this standard.  The Company does not expect this standard to have a material impact on its condensed consolidated financial statements upon adoption.

In August 2020, the FASB issued ASC Update No. 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The goal of the ASC is to simplify the complexity associated with applying GAAP for certain financial instruments with characteristics of liabilities and equity. More specifically, the amendments focus on the guidance for convertible instruments and derivative scope exception for contracts in an entity’s own equity. The new standard is effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The Company adopted this accounting guidance in the fiscal quarter ending March 31, 2022, and it did not have a material impact on its unaudited interim condensed consolidated financial statements.

Effective January 1, 2022, we adopted ASU No. 2019-12, Income Taxes (Topic 740) Simplifying the Accounting for Income Taxes.  The amendments in ASU 2019-12 eliminate certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences.  ASU 2019-12 also clarifies and simplifies other aspects of the accounting for income taxes.  The amendments in ASU 2019-12 became effective for us as of the beginning of our 2022 fiscal year.  We adopted ASU 2019-12 on a prospective basis and the adoption did not have a material impact upon our financial condition or results of operations.

In September 2022, the FASB issued ASU No. 2022-04, Liabilities - Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations.  This guidance requires annual and interim disclosures for entities that use supplier finance programs in connection with the purchase of goods and services.  These amendments are effective for fiscal years beginning after December 15, 2022, except for the amendment on rollforward information, which is effective for fiscal years beginning after December 15, 2023.  The Company is currently assessing the impact of this guidance on our condensed consolidated financial statements.

The Company has reviewed all other recently issued accounting pronouncements and concluded they were either not applicable or not expected to have a material impact on its unaudited interim condensed consolidated financial statements.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. INVENTORIES

Inventories are summarized as follows:

4. PROPERTY AND EQUIPMENT

Property and equipment is summarized as follows:

The Company recorded depreciation and amortization expense of $0.9 million and $0.3 millionfor the nine months ended September 30, 2022, and 2021, respectively.

Impairment of Long-Lived Assets

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the asset’s carrying amount may not be recoverable.  The Company conducts its long-lived asset impairment analyses in accordance with ASC 360-10, Property, Plant, and Equipment.  ASC 360-10 requires the Company to group assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities and evaluate the asset group against the sum of the undiscounted future cash flows.  If the undiscounted cash flows do not indicate the carrying amount of the asset is recoverable, an impairment charge is measured as the amount by which the carrying amount of the asset group exceeds its fair value based on discounted cash flow analysis or appraisals.

In the third quarter of fiscal 2022, the Company concluded the undiscounted future cash flows associated with certain of its long-lived assets, specifically mask sets used in the production of a small subset of Company products, indicated the carrying amount of those mask sets is not recoverable.  As a result, the Company reviewed the long-lived assets for impairment and recorded an $18 thousand impairment charge on the unaudited interim condensed consolidated statement of operations.  The impairment was measured under an income approach utilizing forecasted discounted cash flows to determine fair values of the impairment assets.  The inputs utilized in the analyses are classified as Level 3 inputs within the fair value hierarchy as defined in ASC 820, Fair Value Measurement.

At  September 30, 2022, the Company concluded it did not have any other triggering events requiring assessment of impairment of its long-lived assets.  Refer to Note 1, “Summary of Significant Accounting Policies,” of the notes to our unaudited interim condensed consolidated financial statements for further information.

5. DEBT

Factoring Arrangement

The Company previously had an accounts receivable factoring arrangement with a financial institution (the “Factor”).  Under the terms of the agreement, the Company, from time to time, sold to the Factor certain of its accounts receivable balances on a recourse basis for credit approved accounts.  The Factor remitted 85% of the domestic accounts receivable balance to the Company (the “Advance Amount”), with the remaining balance, less fees to be paid to the Company once the Factor collected the entire accounts receivable balance from the customer.  The factoring fee was 0.98 % of the invoice’s face value factored for the first 30 days required to collect the invoice and prorated on a per diem basis at 0.0327 % each day thereafter.  The minimum invoice fee for any factored invoices was $1.50.  The Company included the cost of factoring in interest expense.

As stated previously, the Company factored the accounts receivable on a recourse basis.  Therefore, if the Factor could not collect the factored accounts receivable, the Company had to refund the Advance Amount remitted to it for any uncollected accounts receivable.  Accordingly, the Company recorded the liability of having to refund the Advance Amount as short-term debt when the factoring arrangement was utilized.  The Company terminated the factoring arrangement as of June 1, 2022.  As of September 30, 2022, there were no advances or other liabilities outstanding under the factoring arrangement. 

The cost of factoring was as follows for the periods indicated:

As mentioned in Note 2, on June 1, 2022 (the “Spectrum Effective Date”), the Company entered into the Spectrum Loan Facility with Spectrum. 

Pursuant to the terms of the General Credit and Security Agreement (the "Credit Agreement"), the Company may borrow monies to purchase eligible equipment in an amount equal to the lesser of (i) 75% of the cost of such eligible equipment and (ii) $500,000; provided that this maximum eligibility will automatically be reduced by 1/48^th each month during the term of the facility. The Credit Agreement also allows for additional borrowing in an amount equal to the lesser of (i) 50% of the net amount of eligible inventory (as defined in the Credit Agreement), (ii) $350,000, and (iii) 50% of the purchased accounts receivable outstanding under the related Assignment of Accounts and Security Agreement (the “AR Agreement”).

Under the terms of the AR Agreement, Spectrum has agreed to advance funds equal to approximately 85% of eligible accounts receivable that are collected by Spectrum under a “lock box” arrangement.  The maximum amount that may be advanced under the AR Agreement is $3,000,000 less any amounts loaned under the Credit Agreement.

The scheduled term of the Spectrum Loan Facility is 24 months from the Spectrum Effective Date, unless earlier terminated as per the terms of the Spectrum Loan Facility.  The term of the facility will automatically renew unless either party provides at least 60 days’ notice prior to the scheduled expiration date.  In the event of an early termination of the AR Agreement by the Company or resulting from the Company’s default or other circumstances impacting the Company (including bankruptcy, reorganization, sale of assets, and cessation of business), the Company will be required to pay a prepayment fee.

The Company’s obligations under the Spectrum Loan Facility are secured by first-priority liens on essentially all of the Company’s assets; provided, however, that the Company is permitted to grant purchase money security interests on certain equipment, furniture and similar tangible assets financed by a third party.

In addition to annual facility fees of $30,000 and other quarterly and transaction fees payable to Spectrum, interest accrues on amounts owed under the Spectrum Loan Facility at the prime rate as quoted by the Wall Street Journal plus 3.5%, but in no event lower than 7.0%.

The Spectrum Loan Facility contains various covenants and restrictions on the Company's financial and business operations including restrictions on the purchase or redemption of any Company shares and the declaration or payment of any dividends on the Company's stock.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The foregoing summary of the terms of the Spectrum Loan Facility does not purport to be complete and is subject to, and qualified in its entirety by, reference to the full text of the Credit Agreement and the AR Agreement, which were attached as Exhibits to the Company's Current Report on Form 8-K, filed with the SEC on June 6, 2022.

The Company has borrowed $0.2 million under the Spectrum Loan Facility as of September 30, 2022.  The Company includes the interest expense of the Spectrum Loan Facility ($20 thousand)as part of its interest expense on its unaudited interim condensed consolidated statements of operations, and the total amount of $0.2 million borrowed under the Spectrum Loan Facility is included as short-term debt on the unaudited interim condensed consolidated balance sheet as of September 30, 2022.

In response to COVID-19, the Small Business Administration ("SBA") created the EIDL program in March 2020.  The program's purpose was to help small businesses meet financial obligations that could have been met had the COVID-19 pandemic not occurred.  Unlike the Paycheck Protection Program ("PPP"), an EIDL loan is not forgivable in the future but provides favorable interest and payment terms.  The maximum EIDL available was equivalent to six months of a business’s working capital, up to $150,000.  Businesses could use EIDL proceeds for working capital and normal operating expenses.  On June 24, 2020, the Company received loan proceeds of $150,000 under the EIDL program.  As part of the EIDL program, the Company agreed to the SBA collateral conditions and agreed to pay annual interest of 3.75% per annum on the outstanding principal balance.  Monthly installment payments were to commence at the end of the anticipated deferral allowance period in December 2022 for up to a maximum of 30 years from the loan date (thus, 2050).  As mentioned above, in conjunction with closing the Salem Loan Facility on August 11, 2022, the Company repaid the entire outstanding principal ($149,900) and accrued interest ($12 thousand) of the EIDL loan.

Loans Payable - PPP

On April 30, 2020, Guerrilla RF received loan proceeds of $535,800 under the PPP.  PPP loans and accrued interest are forgivable after a “covered period” (24 weeks) as long as the borrower maintains its payroll levels and uses the loan proceeds for eligible purposes, including payroll, benefits, rent, and utilities.  As of December 31, 2020, Guerrilla RF had $535,800 of principal outstanding on the PPP loan together with accrued interest of $3,611 as accounts payable and accrued expenses on the consolidated balance sheet.  On February 17, 2021, Guerrilla RF received notice from the SBA that the $535,800 PPP loan was forgiven, including all accrued interest.

On February 19, 2021, Guerrilla RF received a second PPP loan of $833,300 (the “2021 PPP Loan”).  Guerrilla RF used the 2021 PPP Loan to retain current employees, maintain payroll, and make lease and utility payments.  On August 18, 2021, Guerrilla RF received confirmation from the SBA that the 2021 PPP Loan, including accrued interest, had been forgiven.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Debt Maturity

Outstanding debt (as discounted) as of September 30, 2022 is expected to mature as follows:

6. COMMON STOCK AND PREFERRED STOCK

Common Stock

Each share of common stock entitles the holder to one vote on each matter submitted to a vote of the Company’s stockholders.  Subject to preferences that may apply to any outstanding preferred stock, holders of common stock are entitled to receive ratably any dividends that the Company’s board of directors may declare out of funds legally available for that purpose on a non-cumulative basis.  No dividends have been declared through September 30, 2022.

Common Stock Warrants

In October and November 2021, the Company issued warrants to nonemployees to purchase 183,100 and 148,480 shares of common stock, respectively, as payment for services related to the private placement and the Merger.  The warrants have an exercise price of $2.00 per share and are immediately exercisable and expire in October and November 2026, respectively.  The Company determined the warrants to be equity classified awards and recorded them as issuance costs related to the sale of common stock associated with the private placement and Merger (see Note 1).

Preferred Stock

The Company’s board of directors is authorized, subject to limitations prescribed by Delaware law, to issue preferred stock in one or more series, to establish from time to time the number of shares to be included in each series, and to fix the designation, powers, preferences, and rights of the shares of each series.

7. SHARE-BASED COMPENSATION

In 2014, the Company adopted the Long‐Term Stock Incentive Plan (the “2014 Plan”), with 568,000 shares of common stock authorized for issuance under the 2014 Plan.  Subsequently, stockholders approved an increase in the number of shares available under the 2014 Plan to 1,260,000 shares.  Exercise prices range from $0.70 to $1.57 per share, depending on the date of the award.  No further awards may be made under the 2014 Plan.

In 2021, the Board adopted the Equity Incentive Plan (the “2021 Plan”), which authorizes the award of stock options, restricted stock awards, stock appreciation rights, restricted stock units ("RSU"), performance awards, cash awards, and stock bonus awards.  The Company initially reserved 222,991 shares of common stock, plus any reserved shares not issued or subject to outstanding grants under the 2014 Plan on the effective date of the 2021 Plan, for issuance pursuant to awards granted under the 2021 Plan.  The number of shares reserved for issuance under the 2021 Plan will increase automatically on January 1 each year until 2031 by the number of shares equal to the lesser of 5% of the total number of outstanding shares of our common stock as of the immediately preceding December 31, or a number as may be determined by our board of directors.

The general purpose of the 2014 Plan and the 2021 Plan is to allow the Company to attract and motivate key employees and directors to align their interests with those of the Company’s shareholders.

Stock Performance Awards

On  January 1, 2022, the compensation committee of the board of directors awarded 75,000 shares of the Company's common stock (valued at $2.00 per share) to the non-employee directors for services provided in 2021.  These common stock awards vested immediately.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Stock Option Awards

The Company measures the fair value of each option award on the date of grant using the Black‐Scholes option-pricing model, which takes into account inputs such as the exercise price, the value of the underlying ordinary shares at the grant date, expected term, expected volatility, risk-free interest rate, and dividend yield. The fair value of each grant of options during the three months ended September 30, 2022 was determined using the methods and assumptions discussed below:

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

For the three and nine months ended September 30, 2022 and 2021, the grant date fair value of all option grants was estimated at the time of grant using the Black-Scholes option-pricing model using the following weighted-average assumptions:

The weighted average grant date fair value of stock option awards granted was$1.40 and $3.23 during the three months ended September 30, 2022, and 2021, respectively.

The value of stock options is recognized as compensation expense by the straight-line method over the vesting period.  Unrecognized compensation costs related to non‐vested options at September 30, 2022, and 2021 amounted to$538,812 and $74,731, respectively, which are expected to be recognized over an average of three years.

Stock option activity by share is summarized as follows for the three and nine months ended September 30, 2022:

Each outstanding unexercised stock option at the closing date of the Merger ( October 22, 2021) was converted into the right to purchase approximately 2.95 shares of the Company's common stock.  Pursuant to the Merger Agreement, options to purchase 1,065,067 shares of Guerrilla RF’s common stock issued and outstanding immediately prior to the closing of the Merger under the 2014 Plan were assumed and converted into options to purchase 3,146,366 shares of the Company's common stock.  In conjunction with the modification of the number of shares issuable under the options, the exercise price of the options was also reduced by a corresponding 2.95 factor.

In April 2022, the compensation committee of the board of directors granted stock options to new employees of the Company to purchase an aggregate of 248,500 shares of the Company's common stock at an exercise price of $2.00 per share.  These option awards vest equally over four years (25% per year) on the anniversary of the date the recipient started working for the Company.

In September 2022, the compensation committee of the board of directors granted stock options to new employees of the Company to purchase an aggregate of 93,500 shares of the Company's common stock at multiple exercise prices between $2.00 and $4.15 per share.  These option awards vest equally over four years (25% per year) on the anniversary of the date the recipient started working for the Company.

No options were exercised during the three months ended September 30, 2022.  The aggregate intrinsic value of outstanding options exercisable as of September 30, 2022, was $3.7 million.  As of September 30, 2022, stock-based compensation for unvested options granted of $0.5 million will be recognized over a remaining weighted-average requisite service period of 2.3 years.

Restricted Stock Unit ("RSU") Awards

In the nine months ended September 30, 2022, the compensation committee of the board of directors granted 493,800 RSUs (net of cancellations/forfeitures) to various employees and non-employees.  The RSU awards made to non-employees (150,000, net of cancellations/forfeitures) vest 100% on the earliest of (i) June 2, 2023, subject to the recipient's continued service to the Company, (ii) the recipient's death, or (iii) the recipient's disability. The RSUs awarded to employees (343,800, net of cancellations/forfeitures) vest over three equal annual installments from the date of the grant.  The RSUs awarded are subject to the recipient’s continued service through the applicable vesting date and the shares not vested are forfeited upon separation from or discontinuation of services to the Company.  The share-based compensation expense to be recognized for these RSUs over the remaining vesting period subsequent to September 30, 2022 is approximately $0.7 million.

The employee stock option and RSU grants during the nine months ended September 30, 2022 were issued from the 2021 Plan.  The fair value of each RSU was estimated on the date of grant based on the weighted average price of the Company's stock reduced by the present value of the expected dividend stream during the vesting period using the risk-free interest rate.  The Company will issue new shares of common stock to satisfy RSUs upon vesting.  The Company did not make any RSU grants in 2021.  The following table summarizes the RSU activity and weighted averages.

The following table summarizes share-based awards granted under the terms of the 2021 Plan:

Pursuant to awards made under the 2014 Plan and the 2021 Plan, the Company recorded stock-based compensation expense in the following expense categories in the unaudited interim condensed consolidated statements of operations for the nine months ended September 30, 2022 and 2021:

No income tax benefits have been recognized in the unaudited interim condensed consolidated statements of operations for stock-based compensation arrangements, and no stock-based compensation costs have been capitalized as property and equipment through September 30, 2022.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

8. COMMITMENTS AND CONTINGENCIES

Lease Commitments

As of January 1, 2022 the Company adopted ASC Topic 842 and selected the transition alternative method with no comparative period adjustment.  The practical expedients elected were no reassessment of lease classification, no re-evaluation of embedded leases, no reassessment of initial direct costs, and short-term lease exemption.  On January 1, 2022 the Company recorded a finance lease asset and liability of $2.6 million and an operating right-of-use asset and liability of $0.3 million. 

The Company determines whether an arrangement is an operating lease or financing lease at inception.  Lease assets and obligations are recognized at the lease commencement date based on the present value of lease payments over the term of the lease.  The Company generally uses its incremental borrowing rate, which is based on information available at the lease commencement date, to determine the present value of lease payments.

The Company has entered into leases primarily for real estate and equipment used in research and development.  Operating lease expense is recognized in continuing operations by amortizing the amount recorded as an asset on a straight-line basis over the lease term.  Financing lease expense is comprised of both interest expense, which will be recognized using the effective interest method, and amortization of the right-of-use assets.  These expenses are presented consistently with other interest expense and amortization or depreciation of similar assets.  In determining lease asset values, the Company considers fixed and variable payment terms, prepayments, incentives, and options to extend, terminate or purchase.  Renewal, termination, or purchase options affect the lease term used for determining lease asset value only if the option is reasonably certain to be exercised.

Balance sheet information related to right-of-use assets and liabilities is as follows:

Lease cost recognized in the unaudited interim condensed consolidated financial statements is summarized as follows:

(1) Represent amounts under ASC 840.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Other supplemental information related to leases is summarized as follows:

The Company leases its office facilities in Greensboro, North Carolina under a lease agreement, which expires in June 2024.  The lease agreement allows for early cancellation, subject to payment of an early cancellation penalty.  Under the lease agreement, the Company is responsible for certain insurance and maintenance expenses.  In addition, the lease agreement contains scheduled rent increases.  The related rent expense for the lease is calculated on a straight-line basis according to the rental terms of the lease.

In July 2021, the Company entered into a lease agreement for additional office facilities in Greensboro, North Carolina, with an expiration date ten (10) years from the date the Company commences occupancy, which it estimates will be in the first quarter of 2023.  Under the lease agreement, the Company is responsible for certain insurance and maintenance expenses, which are not part of the minimum lease payments.  In addition, the lease agreement contains scheduled rent increases.  Upon taking control of the building, the related rent expense for the lease will be calculated on a straight-line basis according to the lease's rental terms.  The Company will not remit any scheduled lease payments until it occupies the building.  The Company anticipates approximately $4.0 million of excess construction costs for which it will be responsible (as discussed in Note 5), and an annual lease expense of approximately $1.1 million upon occupancy.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Legal

In the ordinary course of business, the Company may become involved in legal disputes.  In the opinion of management, any potential liabilities resulting from any disputes would not have a material adverse effect on the Company’s unaudited interim condensed consolidated financial statements.  As a result, no liability related to any such disputes has been recorded at September 30, 2022, or December 31, 2021.

Indemnification Agreements

From time to time, in the ordinary course of business, the Company may indemnify other parties when it enters into contractual relationships, including members of the Board of Directors, employees, customers, lessors, lenders, and parties to other transactions with the Company.  In addition, the Company may agree to hold other parties harmless against specific losses, such as those that could arise from a breach of representation, covenant, or third-party infringement claims. It may not be possible to determine the maximum potential amount of liability under such indemnification agreements due to the unique facts and circumstances likely to be involved in each particular claim and indemnification provision.  Management believes any liability arising from these agreements will not be material to the unaudited interim condensed consolidated financial statements.  As a result, no liability for these agreements has been recorded at September 30, 2022, or December 31, 2021.

Employment Agreement

The Company has entered into an employment agreement with one executive.  This employment agreement was entered into effective as of January 1, 2020.  The Company desired the assurance of the executive's continued association and services to retain the executive's experience, skills, abilities, background, and knowledge. The employment is at-will, and the Company may terminate the employment relationship at any time, with or without cause, and with or without notice.  The terms of the agreement stipulate compensation, benefits, specific restrictive covenants, and Company obligations upon termination of the employment agreement, including severance pay calculated as twelve monthly payments of 100% of the executive's monthly base salary.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

9. INCOME TAXES

The Company did not have any income tax expense for the three months ended September 30, 2022 or 2021.

Income tax expense during interim periods is based on applying an estimated annual effective income tax rate to year-to-date income, plus any significant unusual or infrequently occurring items recorded in the interim period.  The provision for income taxes for the three and nine months ended September 30, 2022 and 2021 differs from the amount that would be provided by applying the statutory U.S. federal income tax rate of 21% to pre-tax income primarily due to a valuation allowance.

The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income for the year and permanent differences.  The accounting estimates used to compute the provision for income taxes may change as new events occur, more experience is obtained, additional information becomes known, or the tax environment changes.

In assessing the need for a valuation allowance, management must determine that there will be sufficient taxable income to realize deferred tax assets.  Based upon the historical and anticipated future losses, management has determined that the deferred tax assets do not meet the more likely than not threshold for realizability.  Accordingly, a valuation allowance has been recorded against the Company’s net deferred tax assets as of September 30, 2022, and December 31, 2021.

On August 9, 2022, the U.S. government enacted the U.S. CHIPS and Science Act (“CHIPS Act”).  The CHIPS Act creates a 25% investment tax credit for certain investments in domestic semiconductor manufacturing.  The credit is provided for qualifying property, which is placed in service after December 31, 2022, and any impact to the Company would start in fiscal 2023.  On August 16, 2022, the U.S. government enacted the Inflation Reduction Act.  The Inflation Reduction Act introduces a new 15% corporate minimum tax, based on adjusted financial statement income of certain large corporations.  Applicable corporations would be allowed to claim a credit for the minimum tax paid against regular tax in future years.  The Inflation Reduction Act also includes an excise tax that would impose a 1% surcharge on stock repurchases.  This excise tax is effective January 1, 2023.  The Company is currently evaluating the effect the CHIPS Act and the Inflation Reduction Act will have on its condensed consolidated financial statements.  At present, the Company does not expect that any of the provisions included in the two aforementioned pieces of legislation will result in a material impact to the Company’s deferred tax assets, liabilities, or income taxes payable.

Potential 382 Limitation

As disclosed in our Annual Report on Form 10-K for the year ended  December 31, 2021, the Company’s ability to utilize its net operating loss ("NOL") and research and development ("R&D") credit carryforwards may be substantially limited due to ownership changes that may have occurred or that could occur in the future, as required by Section 382 of the Internal Revenue Code (the "Code"), as well as similar State provisions.  These ownership changes may limit the amount of NOL and R&D credit carryforwards that can be utilized annually to offset future taxable income and tax, respectively.  In general, an “ownership change,” as defined by Section 382 of the Code, results from a transaction or series of transactions over a three-year period resulting in an ownership change of more than 50 percent of a company's outstanding stock by certain stockholders or public groups.

If the Company has experienced an ownership change, utilization of the NOL or R&D credit carryforwards would be subject to an annual limitation, which is determined by first multiplying the value of the Company’s stock at the time of the ownership change by the applicable long-term, tax-exempt rate, and then could be subject to additional adjustments, as required.  The Section 382 limitation is a limitation on the amount of a new loss corporation’s post-change year taxable income that can be offset by the old loss corporation’s pre-change NOLs.  Any such limitation may result in the expiration of a portion of the Company's NOL or R&D credit carryforwards before utilization.  Any carryforwards that expire prior to utilization as a result of such limitations will be removed from deferred tax assets with a corresponding reduction of the Company's deferred tax valuation allowance.

In the third quarter of 2022, the Company's tax advisors completed a study to assess whether one or more ownership changes have occurred since the Company became a loss corporation under the definition of Section 382.  It was determined that the Company has not experienced any "ownership changes" since 2014.  If an "ownership change" occurs in the future, such change  may result in the expiration of a portion of the Company's NOL or R&D credit carryforwards before utilization.  As a result of the Section 382 study completed in the third quarter of 2022, no amounts are being considered as an uncertain tax position or disclosed as an unrecognized tax benefit under ASC-740.  The Company has a full deferred tax valuation allowance as of September 30, 2022.

At December 31, 2021, the Company had federal NOL and R&D credit carryforwards of approximately $16,439,757 and $365,668, respectively, which are available to offset future taxable income subject to any future "ownership change."

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

10. Related Party Transactions

We have not had any related party transactions, other than compensation arrangements in the quarter ended September 30, 2022.  Any related party transactions between January 1, 2019 and December 31, 2021 are further described below and in our Annual Report on Form 10-K for the year ended December 31, 2021.

We describe below transactions since January 1, 2019, in which the amounts involved exceeded $120 thousand, and any of our directors, executive officers, or holders of more than 5% of Guerrilla RF’s pre-Merger capital stock, or an affiliate or immediate family member thereof, had or could have had a direct or indirect material interest.  The following descriptions are historical and have not been adjusted to give effect to the Merger.

2019 Notes

In March 2019, Guerrilla RF sold in a private placement an aggregate of $1.75 million of term notes at an interest rate of 12% per annum (each, a “2019 Note” and collectively, the “2019 Notes”).  Prior to the Merger, and in anticipation of the Merger and the related private placement offering, all of the 2019 Notes were amended to cause the principal amount to convert to shares of our common stock at $1.70 per share, and at the time of the private placement offering, the principal amounts owed under the 2019 Notes were converted under those terms, and accrued interest owed under such 2019 Notes was paid.  The following table sets forth the principal amount of the 2019 Notes, and the number of shares of our common stock into which they were converted upon the closing of the Merger, sold to our directors, executive officers or holders of more than 5% of Guerrilla RF’s pre-Merger capital stock, or an affiliate or immediate family member thereof.

AMB Notes

Guerrilla RF previously issued several promissory notes (the “AMB Notes”) to AMB Investments LLC (“AMB Investments”), which holds more than 5% of our outstanding capital stock.  Certain of the AMB Notes were originally issued to Al Bodford, and each AMB Note originally issued to Al Bodford was assigned by him to AMB Investments in September 2021.  The AMB Notes and their original terms are as follows:  (i) Non-Negotiable Note dated March 27, 2017 issued to Al Bodford in the principal amount of $333,333 accruing interest at the rate of 8% per annum; (ii) Non-Negotiable Note dated March 12, 2018 issued to Al Bodford in the principal amount of $1,000,000 accruing interest at the rate of 8% per annum; (iii) Term Note dated March 31, 2019 issued to Al Bodford in the principal amount of $175,000 accruing interest at the rate of 12% per annum (a 2019 Note, discussed above); and (iv) Term Note dated April 15, 2020 issued to AMB Investments in the principal amount of $500,000 accruing interest at the rate of 12% per annum; and, (v) Term Note dated April 2, 2019 issued to CML Microcircuits (USA), Inc. (f/k/a CML Microsystems, Inc.) in the principal amount of $400,000 and assigned to AMB Investments on October 15, 2021 (a 2019 Note discussed above).  Prior to the Merger, and in anticipation of the Merger and the private placement offering, all of the AMB Notes were amended to cause the principal amount to convert to shares of our common stock at $1.70 per share, and upon the closing of the related private placement offering, the principal amount owed under the AMB Notes was converted under those terms, and accrued interest owed under such AMB Notes was paid.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Thompson Note

In July 2020, Guerrilla RF issued an unsecured Term Note (the “Thompson Note”) to Greg Thompson, a member of our Board of Directors, in the principal amount of $250,000 accruing interest at the rate of 12% per annum.  Prior to the Merger, and in anticipation of the Merger and the related private placement offering, the Thompson Note was amended to cause the principal amount to convert to shares of our common stock at $1.70 per share, and upon the closing of the private placement offering, the principal amount owed under the Thompson Note was converted under those terms, and accrued interest owed thereunder was paid.

2021 Convertible Debt Financing

Between July 15, 2021 and October 1, 2021, Guerrilla RF sold an aggregate of $1,488,600 of convertible promissory notes to ten accredited investors at an interest rate of 6% per annum (each, a “Convertible Note” and collectively, the “Convertible Notes”).  The corresponding note purchase agreements provided for the mandatory conversion of the Convertible Notes into shares of the Company’s common stock upon the closing of the Merger and the related private placement offering at the offering price ($2.00 per share).

The following table sets forth the principal amount of the Convertible Notes, and the number of shares of our common stock into which they were converted upon the closing of the Merger, sold to our directors, executive officers or holders of more than 5% of Guerrilla RF’s pre-Merger capital stock, or an affiliate or immediate family member thereof.

2021 Promissory Notes to Warrant Holders

In August 2021, Guerrilla RF issued promissory notes for an aggregate principal amount of approximately $300,000 to the holders of its outstanding warrants (the “2021 Notes”).  The 2021 Notes accrued interest at the rate of 6% per annum until November 30, 2021 and at the rate of 12% per annum thereafter.  Immediately prior to the closing of the Merger, the warrants were exercised and the warrant exercise price paid in exchange for the cancelation of the 2021 Notes.  The following table sets forth the principal amount of the 2021 Notes.

GUERRILLA RF, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Certain privately held Guerrilla RF, Inc.'s existing investors, including investors affiliated with certain of our directors and officers, purchased an aggregate of 1,294,000 shares of our common stock in the private placement offering associated with the Merger, for an aggregate gross purchase price of $2,588,000.  Such purchases were made on the same terms as the shares that were sold to other investors in the private placement offering and not pursuant to any pre-existing contractual rights or obligations.

Policies and Procedures for Related Party Transactions

The Audit Committee of our Board of Directors adopted a charter in the fourth quarter of 2021, which requires that any transaction with a related person and any other potential conflict of interest situation must be reviewed, approved, and monitored by our Audit Committee.

11. Employee Benefit Plan

The Company has a 401(k) plan to provide defined contribution retirement benefits for all eligible employees. Participants may contribute a portion of their compensation to the plan, subject to the limitations under the Internal Revenue Code.  The Company’s contributions to the plan are at the discretion of executive management with board of directors advisement.  Under the 401(k) plan, the Company may contribute up to four percent (4%) of eligible employee salaries.  The Company made $93,728 and $58,780 of contributions to the plan in the three months ended September 30, 2022 and 2021, respectively.

12. Subsequent Events

Management has evaluated subsequent events occurring after September 30, 2022, through  November 10,2022, the date the unaudited interim condensed consolidated financial statements were issued, and concluded no subsequent events have occurred during that period.

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

The following discussion and analysis of our financial condition and results of operations, as well as other sections in this Quarterly Report on Form 10-Q, should be read together with the unaudited interim condensed consolidated financial statements and related notes included elsewhere in Item 1 of Part I of this Quarterly Report on Form 10-Q and with the audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 as filed with the SEC on April 1, 2022.

This Quarterly Report on Form 10-Q includes "forward-looking statements" within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. 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 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 U.S. federal securities laws.

Our business is subject to numerous risks and uncertainties including:

● those relating to fluctuations in our operating results;

● we may not be able to generate sufficient cash to service all of our debt or meet our operating needs;

● we may not be able to raise sufficient equity capital to support our operating needs and fund our strategic plans;

● our dependence on developing new products, achieving design wins, and several large customers for a substantial portion of our revenue;

● the COVID-19 pandemic materially and adversely affecting our financial condition and results of operations;

● a loss of revenue if purchase contracts are canceled or delayed;

● our dependence on third parties such as suppliers, product manufacturers, and product assemblers and testers;

● risks related to sales through independent sales representatives and distributors;

● risks associated with the operation of our third-party manufacturing providers;

● business disruptions;

● poor manufacturing yields;

● increased inventory risks and costs due to timing of customer forecasts;

● our ability to continue to innovate in a very competitive industry;

● unfavorable changes in interest rates, pricing of certain precious metals, utility rates, and shipping and freight costs;

● our strategic investments failing to achieve financial or strategic objectives;

● our ability to attract, retain, and motivate key employees;

● warranty claims, product recalls, and product liability;

● changes in our effective tax rate and the enactment of international or domestic tax legislation, or changes in regulatory guidance;

● risks associated with environmental, health and safety regulations, and climate change;

● risks from international sales and third-party vendor operations;

● the impact of, and our expectations regarding, changes in current and future laws and regulations;

● changes in government trade policies, including the imposition of tariffs and export restrictions;

● claims of infringement of third-party intellectual property rights;

● security breaches and other similar disruptions compromising our information;

● theft, loss, or misuse of personal data by or about our employees, customers, or third parties;

● our inability to remediate the material weaknesses identified in internal controls over financial reporting relating to certain control processes;

● provisions in our governing documents and Delaware law may discourage takeovers and business combinations that our stockholders might consider to be in their best interests; and,

● volatility in the price of our common stock. 

These and other risks and uncertainties, which are described in more detail in our most recent Annual Report on Form 10-K that we filed with the SEC and those listed under the caption "Risk Factors" within this Quarterly Report on Form 10-Q, could cause actual results and developments to be materially different from those expressed or implied by any of these forward-looking statements.  Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make.

You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, performance, or achievements. We undertake no obligation to update any of these forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q or to conform these statements to actual results or revised expectations, except as required by law.

You should read this Quarterly Report on Form 10-Q and the documents that we reference in this Quarterly Report on Form 10-Q as exhibits with the understanding that our actual future results, performance, and events and circumstances may be materially different from what we expect.

Overview

Guerrilla RF is a fabless semiconductor company based in Greensboro, N.C. Guerrilla RF was founded in 2013 with a mission to employ RF semiconductor technology to deliver RF solutions to customers in underserved markets. Over the past several years, Guerrilla RF has become a leader in developing high-performance MMIC products for wireless connectivity. It continues to target underserved markets and customers, delivering a range of high-performance MMIC products and associated technical support to a diverse set of customers that enable a more connected world.  Guerrilla RF is a wholly-owned subsidiary of the Company.  Guerrilla RF holds all material assets and conducts all business activities and operations of the Company.  Accordingly, there are frequent references to Guerrilla RF throughout this discussion and analysis.

Guerrilla RF possesses in-house design, applications, sales, and customer support functions as a fabless semiconductor company. We outsource the manufacture and production of our MMIC products to subcontractors located overseas, providing access to multiple semiconductor process technologies. Guerrilla RF’s primary external wafer foundries are in Taiwan and Singapore, and our primary assembly and test suppliers are located in Malaysia and the Philippines.

Merger Agreement

On October 22, 2021, the Company (formerly known as Laffin Acquisition Corp.), Guerrilla RF Acquisition Corp., and Guerrilla RF entered into a merger agreement (the 'Merger Agreement') pursuant to which Guerrilla RF Acquisition Corp. merged with and into Guerrilla RF, with Guerrilla RF continuing as the surviving corporation and a wholly-owned subsidiary of the Company (the 'Merger').

COVID-19 Pandemic and Supply Chain Update

In light of the uncertain and continuously evolving situation relating to the spread of the COVID-19 pandemic and in compliance with government orders, we have taken measures intended to help minimize the risk of transmitting the virus to our employees, our customers, and the communities in which we participate, which could negatively impact our business. While we have a distributed workforce and our employees are accustomed to working remotely or with other remote employees, our workforce is not fully remote.  Under normal conditions, our employees frequently travel to establish and maintain relationships with one another and with our customers, partners, and investors.

The COVID-19 pandemic negatively impacted revenue for the year ended December 31, 2021, as we experienced lower revenues due to a significant number of customers experiencing supply chain challenges.  Consequently, we implemented cost reduction actions across our functional disciplines to assist us in navigating through what continues to be an uncertain environment.  We experienced increased sales during the first half of 2022, driven by rebounding volumes in markets recovering from supply chain difficulties that impacted the timing of our customers' orders of our products; however, we anticipate that further supply chain disruptions through the end of 2022 will negatively impact customer order patterns, resulting in reduced sales growth.

Our management team has, and will likely continue, to spend time, attention, and resources monitoring the COVID-19 pandemic and seeking to manage its effects on the supply chain, our business, and workforce.  The extent to which the COVID-19 pandemic and our precautionary measures may impact our business will depend on future developments, which remain uncertain and cannot be predicted at this time.

THIRD QUARTER FISCAL 2022 FINANCIAL HIGHLIGHTS

●  Revenue for the third quarter of fiscal 2022 increased 2.4% as compared to the third quarter of fiscal 2021, which was driven primarily by higher royalties for our 5G wireless infrastructure products, and higher demand for our 5G infrastructure and catalog products for a wide variety of customer applications.  Offsetting the increase in these product categories was a decline in our automotive product revenues driven by constrained automotive industry conditions.  As a result, product revenues were essentially flat for the comparable periods.

●   Gross profit for the third quarter of fiscal 2022 was 57.2% of revenues as compared to 56.3% for the third quarter of fiscal 2021.  Although the Company has continued to experience supply chain price increases, we have been able to mitigate the effect of these increases by increasing the prices we charge our customers related to the raw materials and assembly/test cost increases we experienced.  Product contribution margins increased from 71.4% to 77.7%, from Q3 2021 to Q3 2022, mostly due to these aforementioned price increases which outpaced corresponding cost increases. The higher product contribution margins were marginally offset by higher overhead costs, on a comparative period basis, which increased due to headcount additions in our Quality group, as well as increased costs of production mask amortization.

●   Operating loss was $3.3 million for Q3 2022 as compared to $1.2 million for Q3 2021.  This operating loss increase was primarily due to higher operating expenses relative to sales (208.0% in Q3 2022 vs. 110.6% in Q3 2021).  Increased operating expenses were primarily attributable to increased investment in research and development (which grew 98%), sales and marketing headcount additions, and additional costs associated with being a public company.  Selling, general, and administrative costs increased year over year by 80.5% from 2021 to 2022 on a year-to-date basis.

●   Net loss per share was $0.11 and $0.07 for the third quarter of fiscal 2022 and 2021, respectively; and $0.25 and $0.14 per share for the nine months ended September 30, 2022, and 2021, respectively.  

●   Capital expenditures were $3.6 million for the third quarter of fiscal 2022 as compared to $0.2 million for the third quarter of fiscal 2021.  The majority of capital expenditures for the third quarter of 2022 are related to capital additions for the Company's new headquarters building, which is expected to be ready for occupancy in the first quarter of 2023.  

Key metrics

These non-GAAP measures have limitations as analytical tools and should not be considered in isolation or as a substitute for analysis of Company results as reported under GAAP.  The Company compensates for such limitations by relying primarily on our GAAP results and using non-GAAP measures only as supplemental data.  In addition, because these non-GAAP measures are not measures of financial performance under GAAP and are susceptible to varying calculations, these measures, as defined by us, may differ from and may not be comparable to similarly titled measures used by other companies.

We regularly review the following key metrics to measure our performance, identify trends affecting our business, formulate financial projections, make strategic business decisions, and assess working capital needs.

Number of products released:  The total quantity of distinct new products released into production (products that have completed design, quality, and supply chain readiness) during the period.

Number of total products:  The cumulative number of production-released products since Guerrilla RF's inception through the end of the period.

Number of products with lifetime revenue exceeding $100 thousand:  The number of products that have achieved the threshold of cumulative sales of $100,000 since Guerrilla RF's inception through the end of the period.

Components of Results of Operations

Revenues

We derive our revenue from sales of high-performance RF semiconductor products. We design, integrate, and package differentiated, semiconductor-based products that we sell to customers through our direct sales organization, our network of independent sales representatives, and our distributors. We generate revenue from customers located within and outside the U.S.  In addition to sales to customers, we generate royalty revenue under a royalty agreement with one semiconductor manufacturer.

Direct Product Costs and Gross Profit

Direct Product Costs.  Our direct product costs primarily consist of salaries and related expenses, overhead, third-party services vendors, and depreciation expense related to the equipment and information technology costs incurred directly in the Company’s revenue-generating activities.

Gross Profit.  Our gross profit is calculated by subtracting our direct product costs from revenues. Gross margin is expressed as a percentage of total revenues. Our gross profit may fluctuate from period to period as revenues fluctuate due to the mix of products we sell to customers, royalty revenue volume, operational variations, and changes to our technology expenses and customer support.

We plan to focus on and grow the sales volume of new and existing products with the highest gross margin. We intend to continue investing additional resources in our engineering and design capabilities, which drives our research and development efforts and, in turn, drives additional revenue streams and enables us to improve our gross margin over time. The level and timing of investment in these areas could affect our cost of revenues in the future.

Operating Expenses

Operating expenses consist primarily of research and development expenses, sales and marketing expenses, and employee compensation costs for operations, management, finance, accounting, information technology, compliance, and human resources personnel.  In addition, general and administrative expenses include non-personnel costs, such as facilities, non-income taxes, legal, accounting, and other professional fees, and other supporting corporate expenses not allocated to other departments.  We expect our general and administrative expenses will increase in absolute dollars as our business grows, but we expect general and administrative expenses to decrease as a percent of revenues in the coming years.

Research and development ("R&D") expenses consist of costs for the design, development, testing, and enhancement of our products and are generally expensed as incurred.  These costs consist primarily of personnel costs, including salaries, benefits, bonuses, and share-based compensation for our product development personnel   Research and development expenses also include training costs, product management, third-party partner fees, and third-party consulting fees. We expect our research and development expenses to increase in absolute dollars as our business grows, but as a percent of revenues, R&D expenses are expected to decrease.

Sales and marketing expenses consist primarily of employee compensation costs related to sales and marketing, including salaries, benefits, bonuses, and share-based compensation, costs of general marketing activities and promotional activities, travel-related expenses, and allocated overhead.  Sales and marketing expenses also include costs for advertising and other marketing activities.  Advertising is expensed as incurred.  We expect our sales and marketing expenses will increase in absolute dollars as we expand our sales and marketing efforts.

Non-income taxes include excise taxes, sales and use taxes, capital stock and franchise taxes, and property taxes.  Capital stock and franchise taxes are taxes that States charge the Company for the privilege of incorporating or doing business in a State.

Interest Expense

Interest expense consists primarily of the interest incurred on our debt obligations, our prior factoring arrangement expense, the non-cash interest expense associated with the amortization of common stock warrants, the non-cash interest expense associated with the amortization of common stock issued in conjunction with debt financing, and lease expense related to our capital leases.

Other Income (Expenses)

On April 30, 2020, Guerrilla RF received loan proceeds of $535,800 under the PPP established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) administered by the SBA.  PPP loans and accrued interest are forgivable after a “covered period” (24 weeks) as long as the borrower maintained its payroll levels and used the loan proceeds for eligible purposes, including payroll, benefits, rent, and utilities.  As of December 31, 2020, Guerrilla RF had $535,800 of principal outstanding on its PPP loan together with accrued interest of $3,611, recorded as accounts payable and accrued expenses on our consolidated balance sheet.  On February 17, 2021, Guerrilla RF received notice from the SBA that the $535,800 PPP loan was forgiven, including all accrued interest.

On February 19, 2021, Guerrilla RF received a second PPP loan of $833,300 (the 2021 PPP Loan). Guerrilla RF used the 2021 PPP Loan to retain current employees, maintain payroll, and make lease and utility payments.  On August 18, 2021, Guerrilla RF received notice from the SBA that the 2021 PPP Loan, including accrued interest, had been forgiven.

Results of Operations

The following table summarizes the results of our operations for the periods presented:

Comparison of the three months ended September 30, 2022 and 2021 (unaudited):

Revenues increased $0.05 million to $2.22 million for the three months ended September 30, 2022, as compared to $2.17 million for the three months ended September 30, 2021.  The increase in revenues was attributable to $0.05 million increase in royalty income while product revenue remained flat. Within product revenues, sales to our large automotive supplier customers are being impacted by macroeconomic conditions beyond our control and as a result we noted a decline of $0.3 million in this market.  As we indicated in our Quarterly Report on Form 10-Q for Q1 2022, we anticipate further supply chain disruptions through the end of 2022.  Offsetting the decline in our automotive market revenues were small increases in our catalog business market ($0.2 million) and our wireless infrastructure market ($0.1 million).  We anticipate we will likely continue to see increased volatility in customer order patterns for the remainder of 2022 and into 2023, resulting in reduced sales growth in some quarters and increased sales growth in others.

We generate revenue from customers located within and outside the U.S.  While we have several large customers, we define major customers as those responsible for more than 10% of Guerrilla RF’s annual product shipment revenue. Using this definition, Guerrilla RF had one major customer, RFPD, during the three months ended September 30, 2022, and September 30, 2021.  RFPD, a large product distributor serving numerous end-user customers, generated 75% and 83% of product shipment revenue for the three months ended September 30, 2022 and 2021, respectively.

Royalty revenuesincreased 39% for the three months ended September 30, 2022, compared to the three months ended September 30, 2021, as our customer with whom we have a royalty agreement experienced an increase in sales of wireless infrastructure products licensed under our proprietary designs.

International shipments amounted to $0.5 million (approximately 25% of product revenue) and $0.3 million (approximately 14% of product revenue) for the three months ended September 30, 2022, and September 30, 2021, respectively.

Direct Product Costs and Gross Profit

Direct product costs remained relatively flat for the three months ended September 30, 2022, compared to the three months ended September 30, 2021.  The lack of change in direct product cost compares to a change of less than 1% in product sales on a comparative period basis.  This sustained direct product cost mix resulted in improved contribution margins of 3.7% supplemented by a higher revenue mix of royalty revenues versus direct product sales revenue.  Overhead costs relative to sales increased from 15.0% to 20.6% from Q3 2021 to Q3 2022 due to increases in Operations and Quality staffing.  From 2021 to 2022 on a comparative period basis, royalties and non-recurring engineering revenue grew from $0.14 million to $0.20 million having an impact on our overall gross profit.

Research and Development Expenses

Research and development expenses increased $1.0  million to $2.1 million for the three months ended September 30, 2022, compared to $1.1 million for the three months ended September 30, 2021.  The increase was attributable to $0.4 million of staffing additions in our engineering department, $0.6 million of research lab and equipment depreciation, and engineering support and prototype expenses.

Sales and Marketing Expenses

Sales and marketing expenses increased $0.5 million to $1.2 million for the three months ended September 30, 2022, compared to $0.7 million for the three months ended September 30, 2021.  The increase year over year was driven by increases of $0.4 million in staffing costs and $0.1 million in various sales and marketing expenses including sales commissions, information technology support, and customer support.

General and Administrative Expenses

General and administrative expenses increased $0.6 million to $1.3 million for the three months ended September 30, 2022, compared to $0.7 million for the three months ended September 30, 2021.  The increase was primarily related to an increase of $0.4 million in wages and benefits, $0.2 million of directors’ and officers’ insurance, and professional fees.  The increase in wages, benefits, and professional fees was driven by headcount additions within our information technology and accounting departments, and expenses incurred to support our public company structure.

Other Income (Expenses)

Interest expense increased approximately $0.1 million to $0.3 million for the three months ended September 30, 2022, compared to $0.2 million for the three months ended September 30, 2021.  The increase was attributable to financing costs.

Other income (expense) was $0.8 million in Q3 2021 compared to $(0.02) million for the three months ended September 30, 2022.  Other expense in Q3 2022 was attributable to an impairment loss on mask sets. Other income in Q3 2021 was a result of our PPP loan forgiveness.

Comparison of the nine months ended September 30, 2022 and 2021(unaudited):

Revenues increased $1.4 million to $9.2 million for the nine months ended September 30, 2022, as compared to $7.7 million for the nine months ended September 30, 2021.  The increase in revenues was driven by increased product sales to our repeat customers and our catalog products over a wide breadth of applications and customers.  Sales to repeat customers grew approximately 24% from the prior year comparative period and catalog products grew 29%.  Increases in our overall number of product offerings and the number of customers we ship to contributed to increased sales.  Increased sales during this nine month period were driven by increased sales in the first half of 2022.  We noted a decrease in customer demand as we entered the third quarter of 2022.  We attribute much of this third quarter 2022 customer demand decline to market conditions within industries we supply as they evaluated and pulled back on their inventory positions.

We generate revenue from customers located within and outside the U.S.  While we have several large customers, we define major customers as those responsible for more than 10% of Guerrilla RF’s annual product shipment revenue. Using this definition, Guerrilla RF had one major customer, RFPD, during the nine months ended September 30, 2022, and September 30, 2021.  RFPD, a large product distributor serving numerous end-user customers, generated 81% product revenue for the nine months ended September 30, 2022 and 2021 .

Royalty revenuesincreased 49% for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, as our customer with whom we have a royalty agreement experienced an increase in sales of wireless infrastructure products licensed under our proprietary designs.

International shipments amounted to $1.6 million (approximately 19% of product revenue) and $1.2 million (approximately 17% of product revenue) for the nine months ended September 30, 2022, and September 30, 2021, respectively.

Direct Product Costs and Gross Profit

Direct product costs increased $0.6 million to $3.8 million for the nine months ended September 30, 2022, compared to $3.1 million for the nine months ended September 30, 2021.  The 20% increase in direct product costs was primarily driven by a product sales volume increase of 16% (excluding royalty revenue).  Direct product costs relative to sales increased due to increases in Operations and Quality staffing.  Year over year, royalties grew 49%, thus having a positive impact on our gross margin percentage due to the shift in our overall revenue mix.  Royalty revenues were $0.7 million for the nine months ended September 30, 2022, and $0.5 million for the nine months ended September 30, 2021.

Research and Development Expenses