GIGA Giga Tronics Inc (QB)

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1)          Organization and Significant Accounting Policies

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

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

Derivatives The Company accounts for certain of its warrants as derivatives. Changes in fair values are reported in earnings as gain or loss on adjustment of warrant liability to fair value. 

Software Development Costs Development costs included in the research and development of new software products and enhancements to existing software products are expensed as incurred, until technological feasibility in the form of a working model has been established. Capitalized development costs are amortized over the expected life of the product and evaluated each reporting period for impairment.

Discontinued Operations The Company reviews its reporting and presentation requirements for discontinued operations in accordance with the guidance provided by ASC 205-20 as it moves to newer technology within the test and measurement market from legacy products to the newly developed Advanced Signal Generator. The disposal of these product line sales represent an evolution of the Company’s Giga-tronics Division to a more sophisticated product offered to the same customer base. The Company has evaluated the sales of product lines (see Note 9, Sale of Product Lines) concluding that each product line does not meet the definition of a “component of an entity” as defined by ASC 205-20.The Company is able to distinguish revenue and gross margin information as disclosed in Note 9, Sale of Product Lines to the accompanying financial statements; however, operations and cash flow information is not clearly distinguishable and the company is unable to present meaningful information about results of operations and cash flows from those product lines.

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

  2)          Going Concern and Management’s Plan

The Company incurred net losses of $396,000 for the second quarter of fiscal 2017 and $498,000 for the first half of fiscal 2017, respectively. These losses have contributed to an accumulated deficit of $24.5 million as of September 24, 2016.

The Company has experienced delays in the development of features, orders, and shipments for the new Advanced Signal Generator (“ASG”). These delays have contributed, in part, to a decrease in working capital from $1.8 million at March 26, 2016, to $1.2 million at September 24, 2016. The new ASG product has shipped to several customers, but potential delays in the development of features, longer than anticipated sales cycles, or the ability to efficiently manufacture the ASG, could significantly contribute to additional future losses and decreases in working capital.

To help fund operations, the Company relies on advances under the line of credit with Bridge Bank. The line of credit expires on May 7, 2017. The agreement includes a subjective acceleration clause, which allows for amounts due under the facility to become immediately due in the event of a material adverse change in the Company’s business condition (financial or otherwise), operations, properties or prospects, or ability to repay the credit based on the lender’s judgment. As of September 24, 2016, the line of credit had an outstanding balance of $800,000, and additional borrowing capacity of $848,000.

These matters raise substantial doubt as to the Company’s ability to continue as a going concern.

To address these matters, the Company’s management has taken several actions to provide additional liquidity and reduce costs and expenses going forward. These actions are described in the following paragraphs. 

Management will continue to review all aspects of the business in an effort to improve cash flow and reduce costs and expenses while continuing to invest, to the extent possible, in new product development for future revenue streams.

Management will also continue to seek additional working capital through debt or equity financing, however, there are no assurances that such financings will be available at all, or on terms acceptable to the Company.

Cumulative losses have had a significant negative impact on the financial condition of the Company and raise substantial doubt about the Company’s ability to continue as a going concern. The Consolidated Financial Statements have been prepared assuming the Company will continue as a going concern and do not include any adjustments that might result if the Company were unable to do so. 

  (3)         Revenue Recognition

The Company records revenue when there is persuasive evidence of an arrangement, delivery has occurred, the price is fixed and determinable, and collectability is reasonably assured. This occurs when products are shipped or the customer accepts title transfer. If the arrangement involves acceptance terms, the Company defers revenue until product acceptance is received. The Company limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations, or subject to customer-specified return or refund privileges. The Company evaluates each deliverable in an arrangement to determine whether they represent separate units of accounting. On certain large development contracts, revenue is recognized upon achievement of substantive milestones. Determining whether a milestone is substantive is a matter of judgment and that assessment is performed only at the inception of the arrangement. The consideration earned from the achievement of a milestone must meet all of the following for the milestone to be considered substantive:

a. It is commensurate with either of the following:

1. The Company’s performance to achieve the milestone.

2. The enhancement of the value of the delivered item or items as a result of a specific outcome resulting from the Company's performance to achieve the milestone.

b. It relates solely to past performance.

c. It is reasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement.

Milestones for revenue recognition are agreed upon with the customer prior to the start of the contract and some milestones will be tied to product shipping while others will be tied to design review. In fiscal 2015 the Company’s Microsource business unit received a $6.5 million order from a major aerospace company for non-recurring engineering services to develop a variant of its high performance fast tuning YIG filters for an aircraft platform and to deliver a limited number of flight-qualified prototype hardware units (the “NRE Order”) which is being accounted for on a milestone basis. The Company considered factors such as estimated completion dates and product acceptance of the order prior to accounting for the NRE Order as milestone revenue. During the three and six month periods ended September 24, 2016, revenue recognized on a milestone basis were $333,000 and $478,000, respectively. During the three and six month periods ended September 26, 2015, revenue recognized on a milestone basis were $18,000 and $710,000, respectively.

On certain contracts with several of the Company’s significant customers the Company receives payments in advance of manufacturing. Advanced payments are recorded as deferred revenue until the revenue recognition criteria described above have been met.

Accounts receivable are stated at their net realizable value. The Company has estimated an allowance for uncollectable accounts based on analysis of specifically identified accounts, outstanding receivables, consideration of the age of those receivables, the Company’s historical collection experience, and adjustments for other factors management believes are necessary based on perceived credit risk.

The Company provides for estimated costs that may be incurred for product warranties at the time of shipment. The Company’s warranty policy generally provides twelve to eighteen months depending on the customer. The estimated cost of warranty coverage is based on the Company’s actual historical experience with its current products or similar products. For new products, the required reserve is based on historical experience of similar products until such time as sufficient historical data has been collected on the new product. Adjustments are made as new information becomes available.

(4)            Inventories

Inventories consisted of the following:

( 5)          Software Development Costs

On September 3, 2015, the Company entered into a software development agreement with a major aerospace and defense company whereby the aerospace company would develop and license its simulation software to the Company. The simulation software (also called Open Loop Simulator or OLS technology) is currently the aerospace company’s intellectual property. The OLS technology generates threat simulations and enables various hardware to generate signals for performing threat analysis on systems under test. The Company intends to license the OLS software as a bundled or integrated solution with its Advanced Signal Generator system. The Company is obligated to pay the aerospace company software development costs and fees for OLS of $919,000 in the aggregate, which is payable in monthly installments as the work is performed by the aerospace company. The OLS technology is a perpetual license agreement that may be terminated by the Company at any time as long as the Company provides a notice to the aerospace company and pays for the development costs incurred through the notice termination date. The Company signed an amendment to the software development agreement in July of 2016 for additional features and functionality at an estimated cost of $265,000 that would be payable in monthly installments as the work is performed by the aerospace company through early 2017. The Company is also obligated to pay royalties to the aerospace company on net sales of its Advanced Signal Generator product sold with the OLS software equal to a percentage of net sales price of each ASG system sold and subject to certain minimums. The Company expenses research and development costs as they are incurred. Development costs of computer software to be sold, leased, or otherwise marketed are subject to capitalization beginning when a product’s technological feasibility has been established and ending when a product is available for general release to customers. As of September 24, 2016, capitalized software costs were $1.2 million. There was no additional cost capitalized in the three months ended September 24, 2016 as the development was substantially complete. The Company intends to begin amortizing the costs of capitalized software to cost of sales in the second half of fiscal 2017, upon the release of the product to its customers.

 ( 6)      Accounts Receivable Line of Credit

On June 1, 2015 the Company entered into a $2.5 million Revolving Accounts Receivable Line of Credit agreement with Bridge Bank. The agreement provides for a maximum borrowing capacity of $2.5 million of which $2.0 million is subject to a borrowing base calculation and $500,000 is non-formula based.

The loan is secured by all assets of the Company including intellectual property and general intangibles and provides for a borrowing capacity equal to 80% of eligible accounts receivable. The loan matures on May 7, 2017 and bears an interest rate equal to 1.5% over the bank’s prime rate of interest (which was 3.5% at September 24, 2016 resulting in an interest rate of 5.0%). Interest is payable monthly with principal due upon maturity. In connection with the agreement, the Company paid a commitment fee of $12,500, and an additional $12,500 was due in May 2016. The loan agreement also contains financial and non-financial covenants that are customary for this type of lending and includes a covenant to maintain an asset coverage ratio of at least 135% (defined as unrestricted cash and cash equivalents maintained with Bridge Bank, plus eligible accounts receivable aged less than 90 days from the invoice date, divided by the total amount of outstanding principal of all obligations under the loan agreement). As of September 24, 2016, the Company was in compliance with all the financial covenants under the agreement. The line of credit requires a lockbox arrangement, which provides for receipts to be swept daily to reduce borrowings outstanding at the discretion of Bridge Bank. This arrangement, combined with the existence of the subjective acceleration clause in the line of credit agreement, necessitates the line of credit be classified as a current liability on the balance sheet. The acceleration clause allows for amounts due under the facility to become immediately due in the event of a material adverse change in the Company’s business condition (financial or otherwise), operations, properties or prospects, or ability to repay the credit based on the lender's judgment. As of September 24, 2016, the Company’s total outstanding borrowings and remaining borrowing capacity under the Bridge Bank line of credit were $800,000 and $848,000, respectively.

( 7 )        Term Loan, Revolving Line of Credit and Warrants  

On March 13, 2014 the Company entered into a three year, $2.0 million term loan agreement with PFG (Partners For Growth IV, L.P.) under which the Company received $1.0 million on March 14, 2014 (“Initial Borrowing”). Interest on the $1.0 million term loan borrowing was fixed at 9.75% and required monthly interest only payments during the first six months of the agreement followed by monthly principal and interest payments over the remaining thirty months. The Company could prepay the loan at any time prior to maturity by paying all future scheduled principal and interest payments. As of September 24, 2016, the Company’s total outstanding debt associated with the initial PFG loan was $140,000.

On June 16, 2014, the Company amended its loan agreement with PFG (the “Amendment”). Under the terms of the Amendment, PFG made a revolving credit line available to Giga-tronics in the amount of $500,000, for which the Company borrowed the entire amount on June 17, 2014. The revolving credit line had a thirty-three month term. The interest on the PFG revolving credit line was fixed, calculated on a daily basis at a rate of 12.50% per annum. The Company was allowed to prepay the credit line borrowings at any time prior to its March 13, 2017 maturity date without a penalty.

On June 3, 2015, the Company further amended its loan agreement with PFG (the “Second Amendment”). The Second Amendment cancelled the Company’s $500,000 of remaining term loan borrowing availability under the June 2014 Amendment and required the Company to pay PFG $150,000 towards its existing $500,000 outstanding balance under the revolving line of credit, which the Company paid in July 2015. The Company also agreed to pay PFG an additional $10,000 per month towards its remaining credit line balance until repaid, followed by like payments towards its term loan balance until repaid. The revolving credit line balance was fully repaid in March 2016.

The PFG loan is secured by all of the Company’s assets under a lien that is junior to the Bridge Bank debt described in Note 6, and limits borrowing under the Bridge Bank credit line to $2.5 million. 

The PFG loan agreement contains financial covenants associated with the Company achieving minimum quarterly net sales and maintaining a minimum monthly shareholders’ equity. In the event of default by the Company, all or any part of the Company’s obligation to PFG could become immediately due. As of September 24, 2016, the Company was in compliance with all the financial covenants under the agreement.

The PFG loan agreement also initially provided for the issuance of warrants convertible into 300,000 shares of the Company’s common stock, of which 180,000 were exercisable upon receipt of the $1.0 million term loan borrowing from the Initial Borrowing, 80,000 became exercisable with the first Amendment and 40,000 were cancelled with the Second Amendment. Each warrant issued under the loan agreement has a term of five years and an exercise price of $1.42 which was equal to the average NASDAQ closing price of the Company’s common stock for the ten trading days prior to the Initial Borrowing.

If the warrants are not exercised before expiration on March 13, 2019, the Company would be required to pay PFG $150,000 and $67,000 as settlement for warrants associated with the Initial Borrowing and the Amendment, respectively. The warrants could be settled for cash at an earlier date in the event of any acquisition or other change in control of the Company, future public issuance of Company securities, or liquidation (or substantially similar event) of the Company. The Company currently has no definitive plans for any of the aforementioned events, and as a result, the cash payment date is estimated to be the expiration date unless warrants are exercised before then. The warrants have the characteristics of both debt and equity and are accounted for as a derivative liability measured at fair value each reporting period with the change in fair value recorded in earnings. The initial fair value of the warrants associated with the Initial Borrowing and Amendment were $173,000 and $168,000, respectively.

As of September 24, 2016, the estimated fair values of the derivative liabilities associated with the warrants issued in connection with the Initial Borrowing and Amendment were $167,000 and $112,000, respectively, for a combined value of $279,000. As of March 26, 2016, the estimated fair value of the derivative liability associated with the warrant issued in connection with the Initial Borrowing and Amendment was $212,000 and $141,000, respectively for a combined value of $353,000.

During the three and six month periods ended September 24, 2016, the change in the fair value of the warrant liability totaled $28,000 and $74,000 respectively. During the three and six month periods ended September 26, 2015, the change in the fair value of the warrant liability totaled $110,000 and $47,000, respectively. These changes are reported in the accompanying statement of operations as a gain on adjustment of derivative liability to fair value.

The initial $1.0 million in proceeds under the term loan agreement were allocated between the PFG loan and the warrants based on their relative fair values on the date of issuance which resulted in initial carrying values of $822,000 and $178,000, respectively. The resulting discount of $178,000 on the PFG loan is being accreted to interest expense under the effective interest method over the term of the PFG loan. During the three and six month periods ended September 24, 2016, the Company recorded accretion of discount expense associated with the warrants issued with the PFG loan of $7,000 and $18,000 respectively. During the three and six month periods ended September 26, 2015, the Company recorded accretion of discount expense associated with the warrants issued with the PFG loan of and $63,000 and $105,000, respectively.

(8)       F air Value

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

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

The carrying amounts of the Company’s cash and cash-equivalents and line of credit approximate their fair values at each balance sheet date due to the short-term maturity of these financial instruments, and generally result in inputs categorized as Level 1 within the fair value hierarchy. The fair values of term debt are based on the present value of expected future cash flows and assumptions about current interest rates and the creditworthiness of the Company and generally result in inputs categorized as Level 3 within the fair value hierarchy. At September 24, 2016 and March 26, 2016, the carrying amounts of the Company’s term debt totaled $137,000 and $370,000, respectively and the estimated fair value totaled $137,000 and $384,000, respectively. The fair value was calculated using a discounted cash flow model and utilized a 20% discount rate. The rates are commensurate with market rates given the remaining term, principal repayment schedule, the Company’s creditworthiness and outstanding loan balance.

The Company’s derivative warrant liability is measured at fair value on a recurring basis and is categorized as Level 3 in the fair value hierarchy. The derivative warrant liability is valued using a Monte Carlo simulation model, which used the following assumptions as of September 24, 2016: (i) the remaining expected life of 2.5 years, (ii) the Company’s historical volatility rate of 116.4%, (iii) risk-free interest rate of 0.84%, and (iv) a discount rate of 20%.

The aforementioned derivative warrant liability is the Company’s only asset and liability recognized and measured at fair value on a recurring or non-recurring basis. The following table presents the fair value measurements for warrant liability:

There were no transfers between Level 1, Level 2, or Level 3 for the three and six month periods ended September 24, 2016 and March 26, 2016.  

The table below summarizes changes in gains and losses recorded in earnings for Level 3 assets and liabilities that are still held at September 24, 2016:

There were no assets measured at fair value on a recurring basis and there were no assets or liabilities measured on a non-recurring basis at September 24, 2016 or March 26, 2016.

The following table presents quantitative information about recurring Level 3 fair value measurements at September 24, 2016 and March 26, 2016:

The discount rate of twenty percent is management’s estimate of the current cost of capital given the Company’s credit worthiness. A significant increase in the discount rate would significantly decrease the fair value, but the magnitude of this decrease would be less significant in a scenario where the Company’s stock price is significantly higher than the exercise price since the holder’s option to take a cash payment at maturity represents a smaller component of the total fair value when the Company’s stock price is higher. The Monte Carlo simulation model simulated the Company’s stock price through the maturity date of March 31, 2019. At the end of the simulated period, the value of the warrant was determined based on the greater of (1) the net share settlement value, (2) the net exercise value, or (3) the fixed cash put value.

( 9 )         Sale of Product Lines  

On June 20, 2016, the Company entered into an Asset Purchase Agreement for the sale of its Switch product line to Astronics Test Systems Inc. (Astronics). Upon signing the agreement, Astronics paid $850,000 for the intellectual property of the product line. The Company recognized a net gain of $802,000 in the first quarter ending June 25, 2016 after related expenses were subtracted from the sales price. The following table presents the breakdown of the gain recognized related to the asset sale:

In calculating the gain included in the accompanying consolidated financial statements, the Company released $278,000 of deferred warranty obligations related to the Switch asset. Pursuant to the terms of the agreement, Astronics assumed all the warranty obligations for the Switch product line, including the products sold prior to the asset being transferred to Astronics. The deferred warranty obligation was previously included in other current liabilities in the consolidated financial statements. The Company also had an existing agreement with a consultant supporting the Switch product line which included a three percent commission on the sales of the Switch product line for a period of 4 years ending in January 2020. The agreement allowed for a buyout of future commissions associated with the Switch product which the Company exercised in connection with the Astronics transaction in June 2016 resulting in a payment by the Company during June of $170,000.

During the three and six months period ended September 24, 2016, the Switch product line accounted for approximately $960,000 and $2.1 million in product revenue, respectively. There was no margin associated with the sales during the three month periods ended September 24, 2016, as the revenues were primarily attributable to inventory transferred at book value to Astronics, in accordance with the Asset Purchase Agreement. Gross margins of the Switch product line for the six month period ended September 24, 2016 was $437,000. During the three and six months period ended September 26, 2015, the Switch product line accounted for approximately $631,000 and $1.2 million in product revenue, respectively, and related margins were $171,000 and $388,000 respectively. While the Company is able to distinguish revenue and gross margin information related to the sale of the Switch product line to Astronics, the Company is unable to present meaningful information about results of operation and cash flows from the Switch product line.

On December 15, 2015, the Company entered into an Asset Purchase Agreement with Spanawave Corporation, whereby Spanawave agreed to purchase the Giga-tronics’ Division product lines for its Power Meters, Amplifiers, and Legacy Signal Generators for $1.5 million. The agreement provided for the transfer of these product lines to Spanawave sequentially in six phases beginning with certain sensor and amplifier products. During the second quarter ended September 24, 2016, the Company and Spanawave became engaged in a dispute, including litigation initiated by Spanawave and an arbitration proceeding initiated by Spanawave’s affiliate Liberty Test Equipment, Inc., as to whether the Company has fulfilled all the requirements to close phases one through five and become entitled to the $375,000 received during the first quarter of fiscal 2017.

The complaint seeks specific performance of the agreement and damages. Spanawave’s affiliate Liberty Test Equipment also filed an arbitration claim for $440,000 under a distribution agreement between the Company and Liberty. The Company has filed cross-complaints in both the litigation and arbitration asserting breach of the respective agreements by Spanawave and Liberty. The Company had previously asserted that the distribution agreement does not extend to the products with respect to which the claim has been made. Certain customers of the lines of business sold to Spanawave are also customers of the Company’s ongoing Advance Signal Generator business. Continued disruption of the phase 6 signal generator business could have an adverse effect on the ASG business. The parties have negotiated in an effort to settle the dispute notwithstanding the filings. The expenses and potential liability of negotiation, any settlement or continued litigation or arbitration could have a material adverse effect on the Company.

During the six months ended September 24, 2016, the Company had received $750,000 from Spanawave under the agreement. Of this amount, the Company returned the $375,000 to Spanawave on July 28, 2016 resulting from the dispute regarding the status of phases one through five. The remaining $375,000 is included in deferred liability related to asset sales in the consolidated balance sheet. In addition, the Company received approximately $275,000 in exchange for raw materials as of September 24, 2016. The purchase price of the raw materials approximated its carrying value, therefore no gain or loss was recognized. The parties are currently attempting to resolve this dispute. No gain has been recognized in connection with this product line sale because of the aforementioned dispute. These product lines accounted for approximately $75,000 and $350,000 in revenue during the three and six month periods ended September 24, 2016. These product lines also accounted for $528,000 and $1.5 million respectively during the three and six month periods ended September 26, 2015. There was no margin associated with the revenue for the first half of fiscal 2017 as the revenues were primarily related to inventory transfer at book value. For the three and six month periods ended September 26, 2015, gross margins on these revenues were $116,000 and $356,000 respectively. While the Company is able to distinguish revenue and gross margin information related to the sale of these product lines, the Company is unable to present meaningful information about results of operation and cash flows from these product lines.

( 10 )   Loss Per Share

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

The exclusion of stock options, restricted stock, convertible preferred stocks and warrants from the computation of diluted earnings per share (EPS) for the three and six month periods ended September 24, 2016 and September 26, 2015 is a result of the Company’s net loss and, therefore, the effect of these instruments would be anti-dilutive.    

(11)     Share Based Compensation

The Company has established the 2005 Equity Incentive Plan, which provides for the granting of options and restricted stock for up to 2,850,000 shares of common stock at 100% of fair market value at the date of grant, with each grant requiring approval by the Board of Directors of the Company. The 2005 Plan has been extended to be effective until 2025. Option grants under the 2000 Stock Option Plan are no longer available. Options granted generally vest in one or more installments in a four or five year period and must be exercised while the grantee is employed by the Company or within a certain period after termination of employment. Options granted to employees shall not have terms in excess of 10 years from the grant date. Holders of options may be granted stock appreciation rights (SARs), which entitle them to surrender outstanding awards for a cash distribution under certain changes in ownership of the Company, as defined in the stock option plan. As of September 24, 2016, no SAR’s have been granted under the option plan. As of September 24, 2016, the total number of shares of common stock available for issuance was 1,172,627. All outstanding options have a ten year life from the date of grant. The Company records compensation cost associated with share-based compensation equivalent to the estimated fair value of the awards over the requisite service period.

Stock Options

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

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

A summary of the changes in stock options outstanding for the six month period ended September 24, 2016 and the fiscal year ended March 26, 2016 is as follows:

As of September 24, 2016, there was $233,000 of total unrecognized compensation cost related to non-vested options. That cost is expected to be recognized over a weighted average period of 2.5 years. There were 102,650 options and 252,650 options that vested during the quarter ended September 24, 2016 and September 26, 2015, respectively. The total grant date fair value of options vested during the quarters ended September 24, 2016 and September 26, 2015 was $126,000 and $243,000, respectively. There were 237,700 and 291,150 options that vested during the six month period ended September 24, 2016 and September 26, 2015, respectively. The total grant date fair value of options vested during the six month periods ended September 24, 2016 and September 26, 2015 was $1,000 and $285,000, respectively. No shares were exercised in the three month and six month period ended September 24, 2016. No shares were exercised in the three month period ended September 26, 2015 and options of 12,000 shares were exercised in the six month period ended September 26, 2015. Share based compensation cost recognized in operating results for the three month periods ended September 24, 2016 and September 26, 2015 totaled $79,000 and $109,000, respectively. Share based compensation cost recognized in operating results for the six month periods ended September 24, 2016 and September 26, 2015 totaled $151,000 and $223,000, respectively.

Restricted Stock

No restricted awards were granted during the second quarter or first half of fiscal 2017 and fiscal 2016. No restricted awards vested during the second quarter or first half of fiscal 2017. The Company granted 50,000 shares of restricted stock outside the 2005 Plan in fiscal 2013 that vested in the first quarter of fiscal 2016. The restricted stock awards are considered fixed awards as the number of shares and fair value at the grant date is amortized over the requisite service period net of estimated forfeitures. There was no compensation cost recognized for restricted and unrestricted stock awards during the second quarter or first half of fiscal 2017. Compensation cost recognized for the restricted and unrestricted stock awards for the three and six month periods ended September 26, 2015 was $89,000 and $309,000, respectively.  

(12)      Significant Customer and Industry Segment Information

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

The tables below present information for the three and six month periods ended September 24, 2016 and September 26, 2015.

During the second quarter of fiscal 2017, two customers accounted for 60% of the Company’s consolidated revenues. One of the customers accounted for 35% of the Company’s consolidated revenue and was included in the Microsource segment. A second customer accounted for 25% of the Company’s consolidated revenue and was also included in the Microsource segment. A third customer accounted for 22% of the Company’s consolidated revenue and was primarily included in the Giga-tronics Division. During the second quarter of fiscal 2016, two customers accounted for 62% of the Company’s consolidated revenues. One of the customers accounted for 31% of the Company’s consolidated revenue and was included in the Giga-tronics Division. A second customer accounted for another 31% of the Company’s consolidated revenue for the three months ended September 26, 2015 and was primarily included in the Microsource segment. A third customer accounted for 12% of the Company’s consolidated revenue for the three months ended September 26, 2015 and was primarily included in the Giga-tronics Division. 

During the first half of fiscal 2017, one customer accounted for 33% of the Company’s consolidated revenues and was primarily included in the Microsource segment. A second customer accounted for 16% of the Company’s consolidated revenue and was also included in the Microsource segment. A third customer accounted for 12% of the Company’s consolidated revenue and was primarily included in the Gigatronics Division. During the first half of fiscal 2016, one customer accounted for 31% of the Company’s consolidated revenues and was primarily included in the Microsource segment. A second customer accounted for 20% of the Company’s consolidated revenue and was included in the Giga-tronics Division. A third customer accounted for 10% of the Company’s consolidated revenue and was primarily included in the Microsource segment.

(13)     Income Taxes

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

The Company recorded $2,000 tax expense for the three and six month periods ended September 24, 2016 and September 26, 2015. The effective tax rate for the three and six month periods ended September 24, 2016 and September 26, 2015 was 0%, primarily due to a valuation allowance recorded against the net deferred tax asset balance.

As of September 24, 2016, the Company had recorded $106,000 for unrecognized tax benefits related to uncertain tax positions. The unrecognized tax benefit is netted against the non-current deferred tax asset on the Consolidated Balance Sheet. The Company does not expect the liability for unrecognized tax benefits to change materially within the next 12 months. The Company does have a California Franchise Tax Board audit that is currently in process. The Company is working with the California Franchise Tax Board to resolve all audit issues and does not believe any material taxes, penalties or fees are due. However, as a result of the on-going examination, the Company recorded an estimated associated tax liability of $45,000 in the first quarter of fiscal 2015.

(14)        Warranty Obligations

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

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

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

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

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

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

The table below presents information as of September 24, 2016 and March 26, 2016. 

(16)        Private Placement Offering

On January 19, 2016, the Company entered into a Securities Purchase Agreement for the sale of 2,787,872 Units, each consisting of one share of common stock and a warrant to purchase 0.75 shares of common stock, to approximately 20 private investors. The purchase price for each Unit was $1.24375. Gross proceeds were approximately $3.5 million. Net proceeds to the Company after fees was approximately $3.1 million. The portion of the purchase price attributable to the common shares included in each Unit was $1.15, which was the consolidated closing bid price for the Company’s common stock on January 15, 2016. The warrant price was $.09375 per Unit (equivalent to $0.125 per whole warrant share), with an exercise price of $1.15 per share. The warrants expire on January 29, 2021. Emerging Growth Equities, Ltd also received warrants to purchase 292,727 shares of common stock at an exercise price of $1.15 per share as part of its consideration for serving as placement agent in connection with the private placement.

(17 ) Exercise of Series C and Series D Warrants

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

( 18) Commitments and Contingencies

The Company’s current lease agreement for its 47,300 square foot facility located in San Ramon, California expires on December 31, 2016. The Company is currently seeking to lease a smaller facility in or around the San Ramon area to better fit its current and future operating needs. The Company currently expects to enter into a definitive agreement for a smaller facility before December 31, 2016, however, no assurances can be made that such lease agreement will be finalized by such date or on terms satisfactory to the Company. Additionally, the Company does not expect to occupy a new facility until at least March 31, 2017 since certain leasehold modifications will more than likely be required prior to occupancy of such premises. The total amount of such leasehold expenditures is expected to be significant and the sharing of such expenditures between a prospective landlord and the Company are unknown at this time. The Company plans to continue occupying its current facility until a new facility becomes available. The Company expects any lease payments to its current landlord beyond December 31, 2016 will be at the rate of approximately $87,000 per month which is equal to 150% of its current base rent.

The Company also entered into an agreement with Spanawave Corporation for the sale of certain legacy lines of business. However, the transaction and related matters been the subject of an ongoing dispute and litigation. See “Legal Proceedings” below