GIGA TRONICS INC MANAGEMENT REPORT AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS (Form 10-K)

Insight

Giga-tronics manufactures specialized electronic equipment for use in both
military test and airborne operational applications. Our operations consist of
two business segments, those of our wholly owned subsidiary, Microsource Inc.,
and those of our Giga-tronics Division. Our Microsource segment designs and
manufactures custom microwave products for military airborne applications while
the Giga-tronics Division designs and manufactures real time solutions for
RADAR/EW test applications.



Our Microsource subsidiary generates revenue through sole-source production
contracts for custom engineered components funded by the U.S. Federal
Government. Microsource revenue for fiscal year 2022 was $8.3 million from the
delivery of RADAR filters for the F-15D, F-16 and F/A-18E aircrafts. These
filters solve an interference problem that occurs between the aircraft's radar
system and the onboard electronic warfare suite when these older aircrafts
receive upgraded radar systems. The engineering of each filter variant was
funded by the U.S. Government indirectly through prime contractors, including
filters for foreign military sales.



Orders for Microsource components are typically between $1.0 million to $5.0
million each and involve production contracts where the period of performance
spans multiple years. We believe opportunities exist for expanding the use of
our Microsource RADAR filters by offering to design variants, such as for use in
other aircraft or in situations where the electronic warfare suite is externally
mounted on a pylon rather than onboard the aircraft. Microsource will also
pursue development contracts for adapting the Company's ASGA technology for the
benefit of customers who will appreciate faster operation of our RADAR filters,
representing a potential source of new revenue as customers upgrade their
installed base. In addition, from time-to-time, the Company may pursue adding
third party sole-source component revenue though acquisition.



Our Giga-tronics Division participates in the EW test segment with modular
microwave up and down converters, our real-time TEmS solution and integrated
playback and record solutions. The Giga-tronics solutions are architected like a
RADAR system but built like a test system. This approach differentiates
TEmS from the other suppliers' products and provides a better correlation
between laboratory tests and actual field results. The platform was specifically
designed to address the need for multiple test channels and delivers a product
that is smaller, more flexible, easier to use and lower in cost than those
previously available.



Orders for Giga-tronics EW test solutions are relatively large, tend to be
sporadic and typically involve a long and consultive sales process. Competing
against market incumbents has exposed greater than expected challenges in
displacing them in laboratory settings. We have achieved limited success to date
because existing solutions offer extensive test capability with a record of
success built over years of use. These larger and higher cost multi-purpose
solutions have become the accepted standard and customers face substantial risk
switching to a new solution on a large-scale basis. Consequently, our EW test
sales have fallen short of our expectations due to the longer than expected time
required to establish credibility and grow market share in the laboratory
segment.



During fiscal 2021, we moved beyond the laboratory environment and pursued
opportunities for open-air range applications for our TEmS solution. Market
incumbents on these ranges offer single-purpose solutions because the
applications being addressed are less data-intensive and narrower in their
requirements compared to those in the laboratory environment. During fiscal
2022, Giga-tronics successfully won sales into applications for air-crew
training and air-to-ground missile testing. We believe our initial success in
the market for open-air range application results in part because customers only
need to compare our accuracy and fidelity against a competing single purpose
solution rather than the extensive capability offered by competing laboratory
solutions. We believe, the Giga-tronics solution is also competitive with
incumbent open-air solutions due to its lower price point, smaller size, and
relative ease of use. Our early success in applications for air-crew training
and air-to-ground missile testing leads us to believe that we can grow our
market share faster in this segment compared to laboratory settings. Management
expects that additional sales for air-crew training and field testing on ranges
throughout the country represent an opportunity for the growth of the Company's
EW test business revenue in fiscal 2023.



COVID-19 Impact



Following the initial impact of the COVID-19 pandemic in early 2020,
Giga-tronics was identified early on as an essential business by the U.S.
Department of Homeland Security due to the importance of our Microsource RADAR
filters to the U.S. Department of Defense. The Company restored operations as
quickly as feasible while taking the necessary steps to protect our employees
from potential harm. Although Giga-tronics experienced a relatively brief
shutdown period in late fiscal 2020, the impact was nevertheless significant
financially as we had to absorb all of our overhead expenses without any
offsetting shipments during that period. During fiscal 2021, Giga-tronics
applied for and received a loan of $786,200 from the Small Business
Administration ("SBA") associated with the U.S. Government's Payroll Protection
Program. The loan, including all accrued interest, was subsequently forgiven in
November 2020 and was recorded as a gain on extinguishment of debt during our
third quarter of fiscal 2021.



The COVID-19 pandemic had a significant impact on our ability to directly
interact in person with customers at the end of fiscal 2020 and throughout most
of fiscal 2021. Consequently, the progress in demonstrating solutions to
customers and increasing awareness of Giga-tronics within the user community was
delayed. Furthermore, we were unable to discuss customer needs and how our
solutions could solve their problems as the military bases blocked outside
personnel from visiting and mandated many of their personnel to work from home.
In addition, travel restrictions made it difficult for our sales team to visit
locations throughout the country due to mandatory quarantine periods.



The pandemic also impacted our supply chain during most of fiscal 2021 and
fiscal 2022. Many of our suppliers have indicated similar challenges in keeping
their own operations running and management believes there may still be some
residual delays in fulfilling orders due limited availability of parts and
services. We expect this situation to improve throughout fiscal 2023.



While we expect the impact of COVID-19 to be temporary, the disruptions caused
by the pandemic negatively impacted our revenue and results from operations
beginning in March of 2020 and throughout most of fiscal year 2021 and 2022.
Looking ahead, we see that our sales team is better able to interact with and
demonstrate our solutions to customers, and as a result we anticipate a positive
impact on orders for our Giga-tronics EW test solutions in fiscal year 2023.



                                       17

————————————————– ——————————

  Table of Contents



Results of Operations

For the year ended March 26, 2022 compared to the year ended March 27, 2021

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

New orders
(Dollars in thousands)

Category                  2022         2021       $ Change      % Change

RADAR/EW test products $596 $2,677 ($2,081) (78)% Legacy Products

              415          164           251           153 %
Giga-tronics Division      1,011        2,841        (1,830 )         (64 )%
Microsource                4,259        8,572        (4,313 )         (50 )%
Total                    $ 5,270     $ 11,413     $  (6,143 )         (54 )%




The RADAR/EW test products orders decreased by 78% over the prior year. While we
believe that we have a superior product for range applications as described
above, we encountered delays in the procurement process for our systems. Legacy
product orders increased by $251,000 due to an end-of-life purchase for our
signal generators. Microsource orders decreased by 50% primarily due to timing
differences of the placement of large orders which typically have scheduled
deliveries (and revenue recognition) covering multiple fiscal year periods.

Order backlog by reporting segment is as follows for the fiscal years ended:

Backlog
(Dollars in thousands)

Category                      2022        2021       $ Change      % Change
RADAR/EW Test Products       $     8     $    21     $     (13 )         (62 )%
Legacy Products                  303          49           254           518 %
Giga-tronics Division            311          70           241           344 %
Microsource                    1,048       5,045        (3,997 )         (79 )%
Backlog of unfilled orders   $ 1,359     $ 5,115     $  (3,756 )         (73 )%




The allocation of Net revenue by reporting segment was as follows for the fiscal
years shown:



Allocation of Net revenue
(Dollars in thousands)

Category                     2022         2021       $ Change      % Change
RADAR/EW Test               $   609     $  3,554     $  (2,945 )         (83 )%
Legacy Products                 161          116            45            39 %
Giga-tronics Division           770        3,670        (2,900 )         (79 )%
Microsource                   8,257        9,382        (1,125 )         (12 )%
Total                       $ 9,027     $ 13,052     $  (4,025 )         (31 )%




Net revenue for fiscal 2022 was $9.0 million, a decrease of 31%, compared to
$13.1 million for fiscal 2021. The majority of the net revenue decrease in
fiscal 2022 was attributable to the Giga-tronics Division which decreased by
$2.9 million due to the lack of orders described above. The decrease in
Microsource revenue in fiscal 2022 was primarily due to the lack of new orders.

Cost of sales and gross margin by reporting segment were as follows for the years indicated:

Cost of revenue and Gross profit
(Dollars in thousands)

Category                                     2022        % of Total Revenue        2021        % of Total Revenue
Giga-tronics Division                      $     627                       7 %   $   2,058                      16 %
Microsource                                    5,144                      57 %       6,053                      46 %
Total Cost of revenue                      $   5,771                      64 %   $   8,111                      62 %

Gross profit                               $   3,257                      36 %   $   4,941                      38 %




The cost of revenue of the Giga-tronics Division was $627,000 or 7% of total
revenue and 81% of its revenue. Giga-tronics Division revenues were adversely
impacted by the low volume of shipments resulting in high material costs and
large variances. The cost of revenue for Microsource was $5.1 million or 57% of
total revenue and 62% of its revenue. The gross profit for the Company decreased
marginally by 2% over the prior fiscal year due to a higher percentage of
Microsource revenue in fiscal 2022. Total gross profits for fiscal 2022 was $3.3
million with a 36% gross margins.



                                       18

————————————————– ——————————

Contents

Operating expenses are as follows for the years presented:

Operating expenses
(Dollars in thousands)

Category                               2022        2021       $ Change      % Change
Engineering                           $ 1,153     $ 2,153     $  (1,000 )         (46 )%
Selling, general and administrative     4,089       3,873           216             6 %
Transaction expenses                      611           -           611           N/A
Total                                 $ 5,853     $ 6,026     $    (173 )          (3 )%




Total operating expenses in fiscal 2022 decreased 3% to $5.9 million from $6.0
million in fiscal 2021. Engineering expenses decreased by $1.0 million or 46%
during fiscal 2022 compared to fiscal 2021, primarily due to an engineering
services contract which caused engineering expenses to be charged to cost of
revenue, as well as due to the engineering hours charged to capitalization of
software, lower consulting expenses and reduction in personnel expenses on
account of lower headcount. Selling, general and administrative expenses
increased by 6% or $216,000 primarily due to increased personnel related
expenses including the addition of staffing in sales and additional stock-based
compensation. In addition, we incurred $611,000 of transaction expenses related
to the proposed Exchange Transaction with BitNile. (See Note 20 - Share Exchange
Agreement with BitNile and Gresham.)

The exchange transaction fees were as follows for fiscal year 2022

Foreign exchange transaction fees

(Dollars in thousands)



Category                               2022
Legal Fees                             $ 238
Investment banker's fairness opinion     150
Consulting fees                          105
Retention bonuses                        118
Total                                  $ 611

Of the $611,000 costs related to the exchange transaction incurred during the 2022 financial year, $523,000 and $88,000 were accounted for as selling, general and administrative expenses and cost of revenue respectively.

Interest expense, net and other is as follows for the years presented:

Interest expense, net and other
(Dollars in thousands)

Category                                      2022      2021       $ Change       % Change
Gain on extinguishment of PPP Loan            $   -     $ 791     $     (791 )         (100 )%
Interest expense, net                         $ (52 )   $ (97 )   $      (45 )          (46 )%
Other expense, net                            $ (65 )   $   -     $       65            N/A
Provision for income tax                      $  (2 )   $  (2 )   $        -              0 %

Deemed dividend on Series E Preferred Shares $ (53 ) $ (14 ) $39

            279 %




The Company received a Paycheck Protection Program Loan ("PPP Loan") of $786,000
in April 2020 which was forgiven along with corresponding interest of $4,521 in
November 2020.

Interest expense, net for fiscal year 2022, was $52,000a decrease of $45,000 compared to fiscal 2021. Interest expense decreased primarily due to lower outstanding borrowings under a term loan that was fully repaid at the end of fiscal 2021.

The deemed dividend on the Series E Preferred Shares was $53,000 in fiscal year 2022 compared to $14,000 in fiscal 2021 due to the conversion of the Series E Preferred Shares into common shares in fiscal 2022.

                                       19

————————————————– ——————————

Contents

Cash and capital resources

The Company incurred net losses of $2.7 million and $0.4 million in fiscal years
2021 and 2022, respectively. These losses have contributed to an accumulated
deficit of $34.0 million as of March 26, 2022. The Company has also experienced
delays in receipt of orders for the EW test system products. These delays have
contributed, in part, to the losses, decrease in working capital and increase in
inventories.



Our primary sources of liquidity come from customer sales and our Financing
Agreement, both of which are dependent on our receipt and shipment of customer
orders, and capital raised from investors and lenders. Therefore, if we are
unable to maintain sufficient levels of liquidity solely from sales to customers
and borrowings under the Financing Agreement, we may be required to seek funding
from other sources.



The Company's limitation in resources as a small public company has caused it to
reevaluate its future alternatives and as a result, has entered into the
Exchange Agreement (See Note 20 - Share Exchange Agreement with BitNile and
Gresham). To address our liquidity needs in the near term, we entered into a
loan agreement with Digital Power Lending, LLC ("DPL"), an affiliate of BitNile,
the parent company of Gresham and borrowed $500,000 on November 12, 2021. On
January 7, 2022, the parties amended this loan agreement which allowed the
Company to borrow an additional $300,000 (See Note 7 - Term Loans). On April 5,
2022, the parties amended this loan agreement which allowed the Company to
borrow an additional $500,000, for a total of $1,300,000 (See Note 21 -
Subsequent Events).



The Exchange Agreement provides that following our combination with of Gresham,
we will pursue an underwritten public offering of $25 million of our common
stock. BitNile has agreed to purchase up to $5.75 million of common stock in the
public offering and simultaneously therewith, to convert $4.25 million of
indebtedness that BitNile has agreed to lend to us upon the closing of our
acquisition of Gresham. There can be no assurance that we will successfully
complete the acquisition of Gresham or the public offering or that additional
financing will be available to us in the future.



We have also put in place a plan as a standalone company and plan to repay the
loan to BitNile in November 2022 without raising additional funding because of
the large inventory on hand for the TEmS solution, which will result in cash
with sales of TEmS.



Management will continue to review all aspects of its business including, but
not limited to, the contribution of its individual business segments, in an
effort to improve cash flow and reduce costs and expenses, while continuing to
invest, to the extent possible, in new product development for future revenue
streams.



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



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



Cash Flows



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



Cash Flows
(Dollars in thousands)
                                                                     Fiscal Year Ended
Category                                                    March 26, 2022 

March 27, 2021
Net cash provided by (used in) operating activities $ (2,386 ) $

            359
Net cash used in investing activities                                     -                  (94 )
Net cash provided by (used in) financing activities                   1,675                 (186 )
Net increase (decrease) in cash                                        (711 )                 79

Cash at the beginning of the fiscal year                                736                  657
Cash at the end of the period                              $             25     $            736




Our cash balance decreased by $711,000 during fiscal 2022 primarily due to cash
used in operating activities of $2.4 million, which was partially offset by $1.7
million in cash provided by financing activities.

Cash flow from operating activities

In fiscal 2022, we used cash from $2.4 million in operating activities, mainly due to the loss of $2.7 million and the constitution of an inventory of $1.3 million.

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

Cash flow from investing activities

In fiscal year 2022, there was no investment in property, plant and equipment, compared to fiscal year 2021 where $94,000 has been invested.

                                       20

————————————————– ——————————

Contents

Cash flow from financing activities

In fiscal 2022, we provided $1.7 million of cash in financing activities, compared to $186,000 cash used in financing activities in fiscal 2021.

The $1.9 million The increase is mainly due to the issuance of pre-funded warrants, common shares (see note 10 – Sale of common shares) and loans received (see note 7 – Term loans), partially offset by principal payments on leases.

Financed Receivables

On March 11, 2019the Company has entered into an Amended and Restated Corporate Finance Agreement with Western Alliance Bank.

Under the Financing Agreement, we may borrow up to 85% of the amounts of customer invoices issued by us, up to a maximum of $2.5 million in total outstanding advances at any time.

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

From March 26, 2022 and March 27, 2021the Company’s total outstanding borrowings under the financing agreement were $450,000 and $683,000respectively.

Term Loan



On November 12, 2021, the Company entered into a loan agreement with DPL, a
California limited liability company and licensed California Finance Lender, and
an affiliate of BitNile, a Delaware corporation. The loan is evidenced by a
secured promissory note dated as of November 12, 2021, which provides, among
other things that the principal amount of the loan will bear interest at the
rate of 10.0% per annum. Unless prepaid by the Company, all principal and
accrued interest under the loan is payable on November 12, 2022 or, if earlier,
upon the Company's completion of an underwritten public offering or the
termination of the Exchange Agreement with BitNile and Gresham, a Delaware
corporation. The Company's obligations under the loan are secured by a pledge of
all of the Company's assets. The loan and the lender's security interest are
subordinate to the Company's existing bank lending arrangement. The Company's
outstanding balance of this loan as of March 26, 2022 was $800,000 and is
included in Loans payable, net of discounts and issuance costs on the
Consolidated Balance Sheets.



On April 27, 2017, the Company entered into a $1.5 million loan agreement with
Partners For Growth ("PFG"), which was funded by PFG on April 28, 2017 ("PFG
Loan"). As of March 27, 2021, the Company's total outstanding loan balance under
this loan was paid off in full and the agreement was terminated.

Paycheck Protection Program under the CARES Act

On April 23, 2020, the Company borrowed $786,200 from Western Alliance Bank
pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief,
and Economic Security Act. The Company accounted for the PPP Loan as a loan
under Accounting Standards Codification ("ASC") 470, Debt, ("ASC470"). The PPP
Loan had a stated maturity date of April 23, 2022 with interest accruing on the
principal balance at the rate of 1.0% per annum.

On November 19, 2020the outstanding principal and accrued interest of the PPP loan were fully forgiven by the SBA.

Contractual Obligations



We lease our Dublin, California facility under an operating lease agreement
which expires in March 2023. Total future minimum lease payments under these
leases amount to approximately $696,500, of which $487,500 is scheduled to be
paid in fiscal 2023.



We lease our Nashua, New Hampshire facility under an amended operating lease
agreement which expires February 28, 2023. Total future minimum lease payments
under this lease amount to $27,500, all of which is scheduled to be paid in
fiscal 2023.

We are committed to purchasing certain inventory under non-cancellable, non-returnable (“NCNR”) purchase orders. From March 26, 2022total NCNR purchase orders were approximately $400,000 and must be delivered to the Company on various dates until March 2023.

                                       21

————————————————– ——————————

  Table of Contents



Non-GAAP Financial Measures



A non-GAAP financial measure is generally defined by the SEC as a numerical
measure of a company's historical or future performance, financial position or
cash flows that includes or excludes amounts from the most directly comparable
measure under GAAP. Non-GAAP financial measures should be viewed in addition to,
and not as an alternative to, our reported results prepared in accordance with
GAAP. Users of this financial information should consider the types of events
and transactions that are excluded from these measures.



We measure our operating performance in part based on earnings before interest,
taxes, depreciation and amortization ("EBITDA") which is a non-GAAP financial
measure that is commonly used but is not a recognized accounting term under
GAAP. We use EBITDA to monitor and facilitate internal evaluation of the
performance of our business operations, to facilitate external comparison of our
business results to those of others in our industry, and to plan and evaluate
operating budgets. We believe that our measure of EBITDA provides useful
information to the public regarding our operating performance and ability to
service debt and fund capital expenditures and may help our investors understand
and compare our results to other companies that have different financing,
capital and tax structures. EBITDA should not be considered in isolation or as a
substitute for, but instead as a supplemental to, income or loss from
operations, net income or loss, cash flows from operating activities, or other
income or cash flow data prepared in accordance with GAAP.



We define Adjusted EBITDA as EBITDA adjusted for net other income or expense
items, share based compensation and certain one-time income or expense items. In
the following reconciliation, we provide amounts as reflected in our
accompanying consolidated financial statements unless otherwise noted.



The reconciliation of our net loss to Adjusted EBITDA for the fiscal years ended
below is as follows:



                                                                2022        2021
Net (loss)                                                    $ (2,715 )   $ (393 )
Cumulative and deemed dividends on Series E preferred stock        (53 )      (14 )
Net (loss) attributable to common shareholders                  (2,768 )     (407 )
Depreciation and amortization                                      202        253
Interest and taxes                                                  54         99
EBITDA                                                          (2,512 )      (55 )

Adjustments:
Stock-based compensation                                           543        354
Finance costs for issuance of prefunded warrants                   157      

–

Gain on remeasurement of prefunded warrants liability              (92 )    

–

Gain on extinguishment of PPP Loan                                   -       (791 )
Transaction related expenses                                       611          -
Adjusted EBITDA                                               $ (1,293 )   $ (492 )

Critical accounting policies

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



Revenue Recognition



The Company follows the provisions of Accounting Standards Update ("ASU")
2014-09 as subsequently amended by the Financial Accounting Standards Board
("FASB") between 2015 and 2017 and collectively known as ASC Topic 606, Revenue
from Contracts with Customers ("ASC 606"). The guidance provides a unified model
to determine how revenue is recognized. In addition, the standard requires
disclosure of the nature, amount, timing, and uncertainty of revenue and cash
flows arising from contracts with customers.



In determining the appropriate amount of revenue to be recognized as we fulfill
our obligations under our agreements, we perform the following steps:
(i) identify the contract with the customer; (ii) identify the performance
obligations in the contract; (iii) determine the transaction price;
(iv) allocate the transaction price and (v) recognize revenue when (or as) we
satisfy each performance obligation.



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



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



                                       22

————————————————– ——————————

  Table of Contents



Product Warranties



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

Accounts receivable and allowance for doubtful accounts

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



Inventories, net



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



Income Taxes



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



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



Stock-Based Compensation



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



Going Concern



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

Off-balance sheet arrangements

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

© Edgar Online, source Previews