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 31, 2018.
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 and embedded debt features as derivatives. Changes in fair values are reported in earnings as gain or loss on adjustment of these instruments to fair value.
Revenue Recognition and Deferred Revenue
Beginning
April
1,
2018,
the Company follows the provisions of ASU
2014
-
09
as subsequently amended by the Financial Accounting Standards Board (“FASB”) between
2015
and
2017
and collectively known as ASC Topic
606,
Revenue from Contracts with Customers
(“ASC
606”
)
. Amounts for prior periods are
not
adjusted and continue to be reported in accordance with the Company’s prior historic accounting practices. The guidance provides a unified model to determine how revenue is recognized. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.
In determining the appropriate amount of revenue to be recognized as it fulfills its obligations under its agreements, the Company performs the following steps: (i) identifies the promised goods or services in the contract; (ii) determines whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measures the transaction price, including the constraint on variable consideration; (iv) allocates the transaction price to the performance obligations based on estimated selling prices; and (v) recognizes revenue when (or as) the Company satisfies each performance obligation.
The Company generates revenue through the design, manufacture, and sale of products used in the defense industry to major prime defense contractors, the armed services (primarily in the U.S.) and research institutes. There is generally
one
performance obligation in the Company’s contracts with its customers. For highly engineered products, the customer typically controls the work in process as evidenced either by contractual termination clauses or by the Company’s right to payment for costs incurred to date plus a reasonable profit for products or services that do
not
have an alternative use. In these circumstances, the performance obligation is the design and manufacturing service. As control transfers continuously over time on these contracts, revenue is recognized based on the extent of progress towards completion of the performance obligation using a cost-to-cost method. Engineering services are also satisfied over time and recognized on the cost-to-cost method. These types of revenue arrangements are typical for our defense contracts within the Microsource segment for its YIG RADAR filter products used in fighter jet aircrafts.
For the sale of standard or minimally customized products, the performance obligation is the series of finished products which are recognized at the points in time the units are transferred to the control of the customer, typically upon shipment. This type of revenue arrangement is typical for our commercial contracts within the Giga-tronics segment for its Advanced Signal Generation and Analysis system products used for testing RADAR and Electronic Warfare (“EW”) equipment.
Performance Obligations
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC Topic
606.
The Company’s performance obligations include:
|
●
|
Design and manufacturing services
|
|
●
|
Product supply – Distinct goods or services that are substantially the same
|
The majority of the Company’s contracts have a single performance obligation as the promise to transfer the individual goods or services is
not
separately identifiable from other promises in the contracts and, therefore,
not
distinct. The Company’s revenue in fiscal
2019
under ASC
606
primarily relates to design and manufacturing services, there was
no
product supply, and engineering services were nominal.
Transaction Price
The Company has both fixed and variable consideration. Under the Company’s highly engineered design and manufacturing arrangements, advance payments and unit prices are considered fixed, as product is
not
returnable and the Company has an enforceable right to reimbursement in the event of a cancellation. For standard and minimally customized products, payments can include variable consideration, such as product returns and sales allowances. The transaction price in engineering services arrangements
may
include estimated amounts of variable consideration, including award fees, incentive fees, or other provisions that can either increase or decrease the transaction price. Milestone payments are identified as variable consideration when determining the transaction price. At the inception of each arrangement that includes milestone payments, the Company evaluates whether the milestones are considered probable of being achieved and estimates the amount to be included in the transaction price using the most likely amount method. The Company estimates variable consideration at the amount to which they expect to be entitled and determines whether to include estimated amounts as a reduction in the transaction price based largely on an assessment of the conditions that might trigger an adjustment to the transaction price and all information (historical, current and forecasted) that is reasonably available to the Company. The Company includes estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will
not
occur when the estimation uncertainty is resolved.
Allocation of Consideration
As part of the accounting for arrangements that contain multiple performance obligations, the Company must develop assumptions that require judgment to determine the stand-alone selling price of each performance obligation identified in the contract. When a contract contains more than
one
performance obligation, the Company uses key assumptions to determine the stand-alone selling price of each performance obligation. Because of the customized nature of products and services, estimated stand-alone selling prices for most performance obligations are estimated using a cost-plus margin approach. For non-customized products, list prices generally represent the standalone selling price. The Company allocates the total transaction price to each performance obligation based on the estimated relative stand-alone selling prices of the promised goods or service underlying each performance obligation.
Timing of Recognition
Significant management judgment is required to determine the level of effort required under an arrangement and the period over which the Company expects to complete its performance obligations under the arrangement. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. The Company generally uses the cost-to-cost measure of progress as this measure best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. Under the cost-to-cost method, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenue is recognized for design and manufacturing services and for engineering services over time proportionate to the costs that the Company has incurred to perform the services using the cost-to-cost input method and for products at a point in time. Approximately
94%
of the Company’s revenue is recognized over time, with the remaining
6%
recognized at a point in time.
Changes in Estimates
The effect of a contract modification on the transaction price and the measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.
For contracts using the cost-to-cost method, management reviews the progress and execution of the performance obligations. This process requires management judgment relative to estimating contract revenue and cost and making assumptions for delivery schedule. This process requires management’s judgment to make reasonably dependable cost estimates. Since certain contracts extend over a longer period of time, the impact of revisions in cost and revenue estimates during the progress of work
may
adjust the current period earnings through a cumulative catch-up basis. This method recognizes, in the current period, the cumulative effect of the changes on current and prior quarters. Contract cost and revenue estimates for significant contracts are generally reviewed and reassessed quarterly. Revenue recognized over time using the cost-to-cost method represented approximately
99%
of revenue for the
first
three
quarters of fiscal
2019.
The aggregate effects of these changes on contracts in the
first
three
quarters of fiscal
2019
was nominal.
Balance Sheet Presentation
The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets), and deferred revenue (contract liabilities) on the Condensed Consolidated Balance Sheet. Under the typical payment terms of over time contracts, the customer pays either performance-based payments or progress payments. Amounts billed and due from customers are classified as receivables on the Condensed Consolidated Balance Sheet. Interim payments
may
be made as work progresses, and for some contracts, an advance payment
may
be made. A liability is recognized for these interim and advance payments in excess of revenue recognized and is presented as a contract liability which is included within accrued liabilities and other long-term liabilities on the Condensed Consolidated Balance Sheet. Contract liabilities typically are
not
considered a significant financing component because these cash advances are used to meet working capital demands that can be higher in the early stages of a contract. When revenue recognized exceeds the amount billed to the customer, an unbilled receivable (contract asset) is recorded for the amount the Company is entitled to receive based on its enforceable right to payment.
Remaining performance obligations represent the transaction price of firm orders for which work has
not
been performed as of the period end date and excludes unexercised contract options and potential orders under ordering-type contracts (e.g., indefinite-delivery, indefinite-quantity).
Recognition Prior to
April 1, 2018
Prior to
April 1, 2018
under the legacy Generally Accepted Accounting Principles (“GAAP”), the Company recorded revenue when there was persuasive evidence of an arrangement, delivery had occurred, the price was fixed and determinable, and collectability was reasonably assured. This occurred when products were shipped or the customer accepted title transfer. If the arrangement involved acceptance terms, the Company deferred revenue until product acceptance was received. On certain large development contracts, revenue was recognized upon achievement of substantive milestones. Advanced payments were recorded as deferred revenue until the revenue recognition criteria described above had been met. Amounts for periods ending prior to
April 1, 2018
have
not
been adjusted for ASC
606
and continue to be reported in accordance with the Company’s previous accounting practices.
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.
New Accounting Standards
In
February 2016,
the FASB issued ASU
2016
-
02
(“ASU
2016
-
02”
), Leases. ASU
2016
-
02
requires that lessees recognize assets and liabilities for the rights and obligations for leases with a lease term of more than
one
year. The amendments in this ASU are effective for annual periods ending after
December 15, 2018.
Early adoption is permitted. The Company is currently evaluating the impact of the adoption of ASU
2016
-
02
on its consolidated financial statements.
In
May 2014,
the FASB issued Revenue from Contracts with Customers. In
August 2015
and
March,
April,
May
and
December 2016,
the FASB issued additional amendments to the new revenue guidance relating to reporting revenue on a gross versus net basis, identifying performance obligations, licensing arrangements, collectability, noncash consideration, presentation of sales tax, transition, and clarifying examples. Collectively these are referred to as ASC
606,
which replaces all legacy GAAP guidance on revenue recognition and eliminates all industry-specific guidance. ASC
606
establishes a broad principle that would require an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve this principle, an entity identifies the contract with a customer, identifies the separate performance obligations in the contract, determines the transaction price, allocates the transaction price to the separate performance obligations and recognizes revenue when each separate performance obligation is satisfied. ASC
606
was further updated to provide clarification on a number of specific issues as well as requiring additional disclosures. ASC
606
may
be applied either retrospectively or through the use of a modified-retrospective method. The full retrospective method requires companies to recast each prior reporting period presented as if the new guidance had always existed. Under the modified retrospective method, companies would recognize the cumulative effect of initially applying the standard as an adjustment to opening retained earnings at the date of initial application. ASC
606
is effective for annual reporting periods beginning after
December
15,
2017,
and early adoption is permitted beginning in the
first
quarter of
2017.
The Company adopted ASC
606
on
April 1, 2018 (
beginning of the Company’s fiscal year) using the modified retrospective method. Under this approach,
no
restatement of fiscal years
2017
or
2018
was required. Rather, the effect of the adoption was recorded as a cumulative adjustment decreasing the opening balance of accumulated deficit at
April 1, 2018.
The most significant change relates to the timing of revenue and cost recognition on the Company’s customer contracts. Under ASC
606,
revenue is recognized as the customer obtains control of the goods and services promised in the contract. Given the nature of the Company’s products and terms and conditions in the contracts, the customer typically obtains control as the Company performs work under such contract. Therefore, the Company expects to recognize revenue over time for substantially all of its contracts using the percentage-of-completion cost-to-cost method. As a result, the Company now recognizes revenue for these contracts as it incurs costs, as opposed to when units are delivered. This change has generally resulted in earlier revenue recognition in the performance period as compared to the legacy method for those contracts, giving rise to a decrease to the Company’s opening balance of accumulated deficit as of
April 1, 2018.
Adopting ASC
606
involves significant new estimates and judgments such as estimating stand-alone selling prices, variable consideration, and total costs to complete the contract. All of the estimates are subject to change during the performance of the contract which
may
cause more variability due to significant estimates involved in the new accounting.
The cumulative effect of the changes made to the Company’s consolidated
April 1, 2018
balance sheet for the adoption of ASC
606
were as follows (in thousands):
|
|
Balance at
March 31, 2018
|
|
|
ASC 606
Adjustments
|
|
|
Balance at
April 1, 2018
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid and other current assets
|
|
$
|
87
|
|
|
$
|
188
|
|
|
$
|
275
|
|
Inventories, net
|
|
|
5,487
|
|
|
|
(1,581
|
)
|
|
|
3,906
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred revenue
|
|
$
|
3,374
|
|
|
$
|
(2,568
|
)
|
|
$
|
806
|
|
Stockholders' Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated deficit
|
|
$
|
(28,682
|
)
|
|
$
|
1,176
|
|
|
$
|
(27,506
|
)
|
In accordance with the requirements of ASC
606,
the disclosure of the impact of adoption on our condensed consolidated income statement and balance sheet for the
nine
-month period ended
December 29, 2018
was as follows (in thousands except for net loss per share):
For the
nine
months
ended
Dece
mber 29
, 2018
|
|
Without ASC
606 Adoption
|
|
|
ASC 60
6 Adjustments
|
|
|
As Reported
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid and other current assets
|
|
$
|
53
|
|
|
$
|
1,411
|
|
|
$
|
1,464
|
|
Inventories, net
|
|
|
5,273
|
|
|
|
(2,091
|
)
|
|
|
3,182
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred revenue
|
|
$
|
2,458
|
|
|
$
|
(2,207
|
)
|
|
$
|
251
|
|
Stockholders' Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated deficit
|
|
$
|
(29,637
|
)
|
|
$
|
1,046
|
|
|
$
|
(28,591
|
)
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
6,762
|
|
|
$
|
861
|
|
|
$
|
7,623
|
|
Cost of s
ales
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales
|
|
$
|
2,682
|
|
|
$
|
1,685
|
|
|
$
|
4,367
|
|
Net loss
|
|
$
|
(262
|
)
|
|
|
(824
|
)
|
|
$
|
(1,086
|
)
|
Net loss per share, basic and fully diluted
|
|
$
|
(0.02
|
)
|
|
$
|
(0.07
|
)
|
|
$
|
(0.10
|
)
|
(
2
) Going Concern and Management’s Plan
The Company incurred net losses of
$517,000
for the
third
quarter and
$1.1
million for the
first
nine
months of fiscal
2019,
respectively. These losses have contributed to an accumulated deficit of
$28.6
million and shareholders’ equity of
$1.2
million as of
December 29, 2018.
The Company used cash flow in operations totaling
$1.7
million in the
first
nine
months of fiscal
2019.
Although EW test system products have shipped to several customers in prior fiscal years,
no
significant EW test system orders were received during the
first
nine
-months of fiscal
2019,
nor were there any significant EW shipments during this period which contributed significantly to the Company’s losses for the
first
nine
-months of fiscal
2019.
The longer than anticipated sales cycles could significantly contribute to additional future losses and decreases in working capital.
To help fund operations, the Company relies on advances under a line of credit with Bridge Bank which expires on
May 6, 2019.
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 judgement. As of
December 29, 2018,
the line of credit had an outstanding balance of
$455,000,
and additional borrowing capacity of
$411,000.
In
April 2017,
the Company entered into a
$1.5
million loan agreement with Partners For Growth, V L.P. (“PFG”) to provide additional cash to fund our operations. As a result of experiencing continued delays in receiving EW test system product orders in fiscal
2018,
the Company was unable to maintain compliance with certain financial covenants required by the PFG loan and, as a result, the Company was subject to a default interest rate between
June 2017
and
March 2018.
On
March 26, 2018,
and concurrent with the execution of certain stock purchase agreements for the sale of new Series E Convertible Preferred Stock and conditional upon the sale of at least
$1.0
million in gross proceeds thereof, the Company and PFG entered into a modification agreement which provided for the restructuring of certain terms of the PFG loan including resetting of the financial covenants for the remaining loan term (see Note
6,
Term Loans, Revolving Line of Credit and Warrants).
In
December 2018,
the Company and PFG entered into an additional modification agreement which conditionally extended the maturity date of the loan from
April 27, 2019
to
November 1, 2019,
though the Company is required to pay all accrued interest on
May 1, 2019
and beginning on that date must make monthly prepayments of principal of
$75,000
and accrued interest until maturity. The effectiveness of the modification was conditioned on the Company raising
$500,000
in additional capital by
January 8, 2019,
which date was extended to
February 8, 2019.
The Company satisfied this condition on
February 8, 2019
and the modification is now effective.
In order to raise additional working capital and to restructure the PFG loan, on
March 26, 2018,
the Company entered into a Securities Purchase Agreement for the sale of
43,800
shares of a newly designated series of
6.0%
Series E Senior Convertible Voting Perpetual Preferred Stock (“Series E Shares”) to approximately
15
private investors. The purchase price for each Series E Share was
$25.00.
Gross proceeds received by the Company were approximately
$1.095
million (the “Placement”). Net proceeds to the Company after fees and expenses of the placement agent were approximately
$1.0
million. Each Series E Share is initially convertible into common stock at the option of the holder at the conversion price of
$0.25
per share, which is equivalent to
100
shares of the Company’s common stock for each Series E Share (see Note
13,
Preferred Stock and Warrants – Series E Senior Convertible Voting Perpetual Preferred Stock). Between
April 1, 2018
and
December 29, 2018,
the Company sold an additional
36,600
Series E shares for additional gross proceeds of
$915,000.
To assist with the upfront purchases of inventory required for future product deliveries, the Company entered into advance payment arrangements with certain customers, whereby the customers reimburse the Company for raw material purchases prior to the shipment of the finished products. The Company will continue to seek similar terms in future agreements with these customers and other customers.
Management will continue to review all aspects of its business including, but
not
limited to, the contribution of its individual business segments, in an effort to improve cash flow and reduce costs and expenses, while continuing to invest, to the extent possible, in new product development for future revenue streams.
Management will also continue to seek additional working capital and liquidity through debt (including debt refinancing), equity financing or possible product line sales or cessation of unprofitable business product lines, however there are
no
assurances that such financings or product line sales will be available at all, or on terms acceptable to the Company.
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, as well as with potential delays in the refinement of certain features or requisition of certain components and/or our ability to efficiently manufacture it in a timely manner.
The accompanying consolidated financial statements have been prepared assuming that 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 following table presents changes in the Company’s contract assets and liabilities for the
nine
months ended
December 29, 2018.
|
|
Balance
at
Beginning
of
the Period
|
|
|
Additions
|
|
|
Deductions
|
|
|
Balance
at
the end
of
the Period
|
|
|
|
(in thousands)
|
|
Contract Assets
|
|
$
|
189
|
|
|
$
|
1,295
|
|
|
$
|
(73
|
)
|
|
$
|
1,411
|
|
Contract Liabilities: Deferred Revenue
|
|
$
|
(806
|
)
|
|
$
|
(1,293
|
)
|
|
$
|
1,852
|
|
|
$
|
(247
|
)
|
During the
nine
months ended
December 29, 2018,
the Company recognized the following revenues (in thousands).
Revenue recognized in the period from:
|
|
|
|
|
Amounts included in contract liabilities at the beginning of the period:
|
|
|
|
|
Performance obligations satisfied
|
|
$
|
816
|
|
New activities in the period:
|
|
|
|
|
|
|
|
|
|
Changes in estimates
|
|
|
280
|
|
|
|
|
|
|
Performance obligations satisfied
|
|
|
6,111
|
|
Total services revenue
|
|
$
|
7,207
|
|
As of
December 29, 2018,
the aggregate amount of the transaction price allocated to remaining performance obligations was
$6.0
million, of which the Company expects to recognize
$4.2
million into revenue within the next
twelve
months and
$1.8
million after the next
twelve
months.
(
4
) Inventories
Inventories consisted of the following:
(In thousands)
|
|
December
29
, 201
8
|
|
|
March
31
, 201
8
|
|
Raw materials
|
|
$
|
935
|
|
|
$
|
2,290
|
|
Work-in-progress
|
|
|
1,569
|
|
|
|
2,100
|
|
Finished goods
|
|
|
255
|
|
|
|
561
|
|
Demonstration inventory
|
|
|
423
|
|
|
|
536
|
|
Total
|
|
$
|
3,182
|
|
|
$
|
5,487
|
|
(
5
)
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. On
May 23, 2017,
the Company renewed this credit line (which expired on
May 7, 2017)
through
May 6, 2019.
The loan agreement 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 6, 2019
and bears an interest rate, equal to
1.5%
over the bank’s prime rate of interest. Interest is payable monthly with principal due upon maturity. The Company paid an annual commitment fee of
$12,500
in both
May 2017
and
May 2018.
The loan agreement 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
150%
(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
December 29, 2018,
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
December 29, 2018,
the Company’s total outstanding borrowings under the Bridge Bank line of credit were
$455,000.
(
6
)
Term Loan, Revolving Line of Credit and Warrants
On
April 27, 2017,
the Company entered into a
$1.5
million loan agreement with PFG, which was funded by PFG on
April 28, 2017 (
the
“2017
Loan”). The
2017
Loan, which matures on
April 27, 2019,
provides for interest only payments during the term of the loan with principal and any accrued interest and fees due upon maturity. The
2017
Loan bears interest at a fixed aggregate per annum rate equal to
16%
per annum, of which
9.5%
per annum rate is payable monthly in cash and
6.5%
per annum rate is accrued monthly and due upon maturity. In addition, the Company agreed to pay PFG a cash fee of up to
$100,000
payable upon maturity (the “back-end fee”),
$76,000
of which was earned on
April 27, 2017,
and
$24,000
of which is earned at the rate of
$1,000
per month on the
first
day of each month if the loan principal (or any amount thereof) is outstanding during any day of the prior month.
Additionally, the
2017
Loan provides for the Company’s issuance of up to
250,000
common shares to PFG, of which
190,000
was earned by PFG upon signing (
April 27, 2017)
and
60,000
of which is earned at the rate of
2,500
per month on the
first
day of each month if the loan principal (or any amount thereof) is outstanding during any day of the prior month. The
2017
Loan provided for certain financial covenants related to the revenue achievement and maintenance of tangible net worth. PFG can accelerate the maturity of the loan in case of a default and the Company can prepay the loan before maturity without interest prepayments or penalty. The Company has pledged all of its assets as collateral for the
2017
Loan, including all its accounts, inventory, equipment, deposit accounts, intellectual property and all other personal property. The
2017
Loan is subordinate to the Bridge Bank line of credit (see Note
5,
Accounts Receivable Line of Credit).
The requirement to issue
60,000
shares of the Company’s common stock over the term of the loan is an embedded derivative (an embedded equity forward). The Company evaluated the embedded derivative in accordance with ASC
815
-
15
-
25.
The embedded derivative is
not
clearly and closely related to the debt host instrument and therefore is being separately measured at fair value, with subsequent changes in fair value being recognized in the consolidated statements of operations.
The proceeds received upon issuing the loan were allocated to: (i) common stock, for the fair value of the
190,000
shares of common stock initially issued to the lender; (ii) the fair value of the embedded derivative; and (iii) the loan host instrument. Upon issuance of the loan, the Company recognized
$1.6
million of principal payable to PFG, representing the stated principal balance of
$1.5
million plus the initial back-end fee of
$76,000.
The initial carrying value of the loan was recognized net of debt discount aggregating approximately
$326,000,
which is comprised of the following:
Fees paid to the lender and third parties
|
|
$
|
44,000
|
|
Backend fee
|
|
|
76,000
|
|
Estimated fair value of embedded equity forward
|
|
|
49,000
|
|
Fair value of 190,000 shares of common stock issued to lender
|
|
|
157,000
|
|
Aggregate discount amount
|
|
$
|
326,000
|
|
The bifurcated embedded derivative and the debt discount are presented net with the related loan balance in the consolidated balance sheets. The debt discount is being amortized to interest expense over the loan’s term using the effective interest method. During the fiscal year ended
March 31, 2018,
the Company amortized discounts of approximately
$127,000
to interest expense. As of
December 29, 2018,
the Company had issued to PFG
375,000
common shares under the loan.
PFG’s ability to call the debt on default (contingent put) and its ability to assess interest rate at a default rate (contingent interest) are embedded derivatives, which the Company evaluated. The fair value of these embedded features was determined to be immaterial and was
not
bifurcated from the debt host for accounting purposes.
Between
June 24, 2017
and
March 25, 2018,
the Company was
not
in compliance with the loan’s revenue and tangible net worth financial covenants and was subject to a default interest rate of
22%
per annum which it accrued and paid when due during this period.
On
March 26, 2018,
concurrent with the execution of the Securities Purchase Agreement for the Series E Shares (see Note
13
– Preferred Stock and Warrants - Series E Senior Convertible Voting Perpetual Preferred Stock), the Company and PFG entered into a modification agreement providing for the restructuring of certain terms associated with approximately
$1.7
million in indebtedness under the
2017
Loan. Subject to the sale of at least
$1.0
million in Series E Shares, PFG agreed to waive all current defaults and cease applying the applicable default interest rate, returning to the stated non-default rate of
16%,
and to lower the revenue and tangible net worth covenants for the remaining term of the loan. As consideration for the modifications, the Company reduced the exercise price of outstanding warrants previously granted to PFG pursuant to a
2014
loan agreement and credit line to purchase
260,000
shares of the Company’s common stock from
$1.42
to
$0.25
per share and extended the exercisability of the warrants by
one
year to
March 13, 2020.
The amendments to the
2017
Loan were recognized as a loan modification. The change in fair value of the warrants of
$43,700,
resulting from the reduced strike price and extension of term, was recognized as a discount to the
2017
Loan and is being amortized to interest expense over the remaining term of the
2017
Loan.
In
December 2018,
the Company and PFG entered into an additional modification agreement which conditionally extended the maturity date of the loan from
April 27, 2019
to
November 1, 2019,
though the Company is required to pay all accrued interest on
May 1, 2019
and beginning on that date must make monthly prepayments of principal of
$75,000
and accrued interest until maturity. The effectiveness of the modification was conditioned on the Company raising
$500,000
in additional capital by
January 8, 2019,
which date was extended to
February 8, 2019.
The Company satisfied this condition on
February 8, 2019
and the modification is now effective.
The Company anticipates it will need to achieve significant EW test system shipments and resulting cash inflows and or seek additional funds through the issuance of new debt, equity securities or product line sales in order to repay the
2017
Loan (including accrued interest and back end fees) in full upon maturity or otherwise enter into a refinancing agreement with PFG. However, there can be
no
assurances that such significant EW test system shipments and resulting cash flows inflows will be achieved on a timely basis or that such financings, re-financing or product line sales will be available at all, or on terms acceptable to the Company.
(
7
)
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:
|
•
|
Level
1
—Valuations are based on quoted prices in active markets for identical assets or liabilities and readily accessible by us at the reporting date. Examples of assets and liabilities utilizing Level
1
inputs are certain money market funds, U.S. Treasuries and trading securities with quoted prices on active markets.
|
|
•
|
Level
2
—Valuations based on inputs other than the quoted prices in active markets that are observable either directly or indirectly in active markets. Examples of assets and liabilities utilizing Level
2
inputs are U.S. government agency bonds, corporate bonds, commercial paper, certificates of deposit and over-the- counter derivatives.
|
|
•
|
Level
3
—Valuations based on unobservable inputs in which there are little or
no
market data, which require us to develop our own assumptions.
|
The carrying amounts of the Company’s cash and cash-equivalents and line of credit approximate their fair values at each balance sheet date due to the short-term maturity of these financial instruments, and generally result in inputs categorized as Level
1
within the fair value hierarchy. The carrying value of the outstanding PFG loan approximates the estimated aggregate fair value and classified with the loan host. The fair value estimate of the embedded equity forward is based on the closing price of the Company’s common stock on the measurement date, the risk-free rate, the date of expiration, and any expected cash distributions of the underlying asset before expiration. The estimated fair value of the embedded equity forward represents a Level
2
measurement.
On
March 26, 2018,
the Company and PFG agreed to eliminate the cash put provision contained in warrants in exchange for the Company issuing
150,000
shares of the Company’s common stock. Upon removal of the put, the warrants were re-valued using the Black-Scholes option-pricing model with the following assumptions: (i) remaining term of
0.96
years, (ii) expected volatility of
85%,
(iii) risk-free interest rate of
2.12%,
and (iv)
no
expected dividends. The resulting change in fair value of the warrants, along with the fair value of the common stock issued to PFG, was recognized as an adjustment of warrant liability in the consolidated statements of operations.
There were
no
assets measured at fair value on a recurring basis and there were
no
assets or liabilities measured on a non-recurring basis at
December 29, 2018
and
March 31, 2018.
(
8
)
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. Shares excluded from the diluted EPS calculation because they would be anti-dilutive are as follows:
|
|
Three Month Periods Ended
|
|
|
Nine
Month Periods Ended
|
|
(In thousands)
|
|
Decem
ber 29,
2018
|
|
|
Decemb
er 30,
2017
|
|
|
Dec
ember 29,
2018
|
|
|
Dece
mber 30,
2017
|
|
Common shares issuable upon exercise of stock options
|
|
|
2,610
|
|
|
|
772
|
|
|
|
2,610
|
|
|
|
772
|
|
Restricted stock awards
|
|
|
338
|
|
|
|
375
|
|
|
|
338
|
|
|
|
375
|
|
Issuable shares for interest on loan
|
|
|
10
|
|
|
|
40
|
|
|
|
10
|
|
|
|
40
|
|
Common shares issuable upon conversion of convertible preferred stock
|
|
|
9,893
|
|
|
|
1,853
|
|
|
|
9,893
|
|
|
|
1,853
|
|
Common shares issuable upon exercise of warrants
|
|
|
3,452
|
|
|
|
3,737
|
|
|
|
3,452
|
|
|
|
3,737
|
|
The stock options, restricted stock, convertible preferred stocks and warrants
not
included in the computation of diluted earnings per share (EPS) for the
nine
-month period ended
December 29, 2018
and
December 30, 2017
is a result of the Company’s net loss and, therefore, the effect of these instruments would be anti-dilutive.
(
9
) Share Based Compensation
On
September 20, 2018,
our shareholders approved our new
2018
Equity Incentive Plan under which we
may
issue up to
2,500,000
shares of common stock upon the exercise of options, stock awards and grants. With the adoption of the
2018
Equity Incentive Plan,
no
further awards will be issued under the Company’s
2005
Equity Incentive Plan, though all awards under the
2005
Equity Incentive Plan that are outstanding will continue to be governed by the terms, conditions and procedures set forth in the plan and any applicable award agreement. Option grants under the Company’s
2000
Stock Option Plan are
no
longer available.
Options granted generally vest in
one
or more installments in a
four
or
five
-year period and must be exercised while the grantee is employed by the Company (or while providing services under a service arrangement in the case of non-employees) or within a certain period after termination of employment or service arrangement in the case of non-employees. Options granted to employees shall
not
have terms in excess of
10
years from the grant date. Holders of options
may
be granted 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
December 29, 2018,
no
SAR’s have been granted under any option plan. As of
December 29, 2018,
the total number of shares of common stock available for issuance was
2,086,000.
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:
|
|
Three Month Periods Ended
|
|
Nine
Month Periods Ended
|
|
|
|
December
29
,
201
8
|
|
December
30
,
201
7
|
|
December
29
,
201
8
|
|
|
December
30
,
201
7
|
|
Dividend yield
|
|
|
—
|
|
None
|
|
|
—
|
|
|
|
—
|
|
Expected volatility
|
|
|
96.21
|
%
|
None
|
|
|
95.29
|
%
|
|
|
89.82
|
%
|
Risk-free interest rate
|
|
|
2.84
|
%
|
None
|
|
|
2.83
|
%
|
|
|
1.77
|
%
|
Expected term (years)
|
|
|
8.28
|
|
None
|
|
|
8.30
|
|
|
|
8.36
|
|
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
nine
-month period ended
December 29, 2018
and the fiscal year ended
March 31, 2018
is as follows:
|
|
Shares
|
|
|
Weighted
Average
Exercise Price
|
|
|
Weighted
Average
Remaining
Contractual
Terms (Years)
|
|
|
Aggregate
Intrinsic
Value
(in thousands)
|
|
Outstanding at March 25, 2017
|
|
|
1,104,500
|
|
|
$
|
1.41
|
|
|
|
6.1
|
|
|
$
|
3
|
|
Granted
|
|
|
856,000
|
|
|
|
0.34
|
|
|
|
10.0
|
|
|
|
|
|
Forfeited / Expired
|
|
|
(481,800
|
)
|
|
|
1.34
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2018
|
|
|
1,478,700
|
|
|
$
|
0.56
|
|
|
|
8.0
|
|
|
$
|
—
|
|
Granted
|
|
|
1,254,000
|
|
|
|
0.31
|
|
|
|
9.8
|
|
|
|
|
|
Forfeited / Expired
|
|
|
(123,000
|
)
|
|
|
0.87
|
|
|
|
|
|
|
|
|
|
Outstanding at December 29, 2018
|
|
|
2,609,700
|
|
|
$
|
0.42
|
|
|
|
8.4
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 29, 2018
|
|
|
502,550
|
|
|
$
|
0.79
|
|
|
|
3.9
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 29, 2018, expected to vest in the future
|
|
|
1,513,418
|
|
|
$
|
0.34
|
|
|
|
9.51
|
|
|
$
|
—
|
|
As of
December 29, 2018,
there was
$358,000
of total unrecognized compensation cost related to non-vested options. That cost is expected to be recognized over a weighted average period of
3.43
years. There were
6,350
options and
14,350
options that vested during the quarters ended
December 29, 2018
and
December 30, 2017,
respectively. The total grant date fair value of options vested during the quarters ended
December 29, 2018
and
December 30, 2017
was
$5,000
and
$14,000
respectively. There were
29,100
and
107,200
options that vested during the
nine
-month periods ended
December 29, 2018
and
December 30, 2017,
respectively. The total grant date fair value of options vested during the
nine
-month periods ended
December 29, 2018
and
December 30, 2017
was
$34,000
and
$119,000,
respectively.
No
shares were exercised during the
three
and
nine
-month periods ended
December 29, 2018
and
December 30, 2017.
Share based compensation cost recognized in operating results for the
three
-month periods ended
December 29, 2018
and
December 30, 2017
totaled
$28,000
and
$22,000,
respectively. Share based compensation cost recognized in operating results for the
nine
-month periods ended
December 29, 2018
and
December 30, 2017
totaled
$85,000
and
$101,000,
respectively.
Restricted Stock
There were
160,000
restricted awards issued during the
three
-month period ended
December 29, 2018.
The Company granted
160,000
restricted awards during the
nine
-month period ended
December 29, 2018.
No
restricted awards were granted during the
three
-month period ended
December 30, 2017.
The Company granted
386,450
restricted awards during the
nine
-month period ended
December 30, 2017.
The restricted stock awards are considered fixed awards as the number of shares and fair value at the grant date are amortized over the requisite service period net of estimated forfeitures. As of
December 29, 2018,
there was
$45,000
of total unrecognized compensation cost related to non-vested awards. That cost is expected to be recognized over a weighted average period of
0.34
years and will be adjusted for subsequent changes in estimated forfeitures. Compensation cost recognized for the restricted and unrestricted stock awards during the
third
quarter and
first
nine
months of fiscal of
2019
was
$26,000
and
$83,000.
Compensation cost recognized for the restricted and unrestricted stock awards during the
third
quarter and
first
nine
months of fiscal of
2018
was
$33,000
and
$73,000.
A summary of the changes in non-vested restricted stock awards outstanding for the
nine
-month period ended
December 29, 2018
and the fiscal year ended
March 31, 2018
is as follows:
|
|
Shares
|
|
|
Weighted
Average
Fair Value
|
|
Non-Vested at March 25, 2017
|
|
|
—
|
|
|
$
|
—
|
|
Granted
|
|
|
586,950
|
|
|
|
0.66
|
|
Vested
|
|
|
(51,000
|
)
|
|
|
(0.60
|
)
|
Forfeited or cancelled
|
|
|
(236,000
|
)
|
|
|
(0.68
|
)
|
Non-Vested at March 31, 2018
|
|
|
299,950
|
|
|
$
|
0.65
|
|
Granted
|
|
|
160,000
|
|
|
|
—
|
|
Vested
|
|
|
(100,000
|
)
|
|
|
(0.36
|
)
|
Forfeited or cancelled
|
|
|
(22,000
|
)
|
|
|
—
|
|
Non-Vested at December 29, 2018
|
|
|
337,950
|
|
|
$
|
0.56
|
|
(
1
0
)
Significant Customer and
Industry Segment Information
The Company has
two
reportable segments: Giga-tronics Division and Microsource.
|
●
|
The Giga-tronics Division produces RADAR and EW testing and simulation products. The Giga-tronics Division historically produced a broad line of test and measurement equipment used primarily for the design, production, repair and maintenance of products in aerospace, telecommunications, RADAR, and electronic warfare but has divested of these product lines.
|
|
●
|
Microsource primarily develops and manufactures YIG RADAR filters used in fighter jet aircraft for
two
prime contractors.
|
The tables below present information for the
two
reportable segments:
|
|
|
|
|
|
Three Month Period
Ended
|
|
|
|
|
|
|
Three Month Period
Ended
|
|
(In thousands)
|
|
Dec
.
29
, 201
8
|
|
|
Dec
.
29
, 201
8
|
|
|
Dec
.
30
, 201
7
|
|
|
Dec
.
30
, 201
7
|
|
|
|
Assets
|
|
|
Net Sales
|
|
|
Net
Income
(Loss)
|
|
|
Assets
|
|
|
Net Sales
|
|
|
Net Income
(Loss)
|
|
Giga-tronics Division
|
|
$
|
4,020
|
|
|
$
|
67
|
|
|
$
|
(1,254
|
)
|
|
$
|
5,042
|
|
|
$
|
1,922
|
|
|
$
|
(807
|
)
|
Microsource
|
|
|
2,570
|
|
|
|
1,826
|
|
|
|
737
|
|
|
|
3,134
|
|
|
|
1,298
|
|
|
|
494
|
|
Total
|
|
$
|
6,590
|
|
|
$
|
1,893
|
|
|
$
|
(517
|
)
|
|
$
|
8,176
|
|
|
$
|
3,220
|
|
|
$
|
(313
|
)
|
|
|
|
|
|
|
Nine
Month Period Ended
|
|
|
|
|
|
|
Nine
Month Period Ended
|
|
(In thousands)
|
|
Dec
.
29
, 201
8
|
|
|
Dec
.
29
, 201
8
|
|
|
Dec
.
30
, 201
7
|
|
|
Dec
.
30
, 201
7
|
|
|
|
Assets
|
|
|
Net Sales
|
|
|
Net Income
(Loss)
|
|
|
Assets
|
|
|
Net Sales
|
|
|
Net Income
(Loss)
|
|
Giga-tronics Division
|
|
$
|
4,020
|
|
|
$
|
246
|
|
|
$
|
(4,150
|
)
|
|
$
|
5,042
|
|
|
$
|
2,661
|
|
|
$
|
(4,429
|
)
|
Microsource
|
|
|
2,570
|
|
|
|
7,377
|
|
|
|
3,064
|
|
|
|
3,134
|
|
|
|
4,792
|
|
|
|
1,777
|
|
Total
|
|
$
|
6,590
|
|
|
$
|
7,623
|
|
|
$
|
(1,086
|
)
|
|
$
|
8,176
|
|
|
$
|
7,453
|
|
|
$
|
(2,652
|
)
|
During the
third
quarter of fiscal
2019,
two
customers accounted for approximately
97%
of the Company’s consolidated revenues. One of the customers accounted for
68%
of the Company’s consolidated revenue and was included in the Microsource segment. A
second
customer accounted for
29%
of the Company’s consolidated revenue and was included in the Microsource segment. During the
third
quarter of fiscal
2018,
two
customers accounted for
87%
of the Company’s consolidated revenues. One of the customers accounted for
55%
of the Company’s consolidated revenue and was included in the Giga-tronics Division. A
second
customer accounted for
32%
of the Company’s consolidated revenue and was included in the Giga-tronics Division.
During the
first
nine
months of fiscal
2019,
two
customers accounted for approximately
97%
of the Company’s consolidated revenues. One of the customer accounted for
64%
of the Company’s consolidated revenues and was primarily included in the Microsource segment. A
second
customer accounted for
33%
of the Company’s consolidated revenue and was also included in the Microsource segment. During the
first
nine
months of fiscal
2018,
three
customers accounted for approximately
84%
of the Company’s consolidated revenues. One of the customers accounted for
37%
of the Company’s consolidated revenues and was primarily included in the Microsource segment. A
second
and
third
customer accounted for a total of
47%
of the Company’s consolidated revenue and were included in the Microsource segment and the Giga-tronics Division.
(
1
1
) 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
$42,000
of income tax expense for the
nine
months ended
December 29, 2018
and
$2,000
of income tax expense for the
nine
months ended
December 30, 2017.
In
November 2018,
the Franchise Tax Board (“FTB”) issued their final bill regarding their audit findings. As a result, the Company adjusted the accrued state tax liability along with the accrued interest to
$110,000.
The Company has an agreement with the FTB to pay the balance over
six
months and have made the
first
payment of
$10,000
in
December 2018.
The accrued state tax liability as of
December 2018
is
$100,000.
The effective tax rate for the
nine
months ended
December 29, 2018
and
December 30, 2017
was
0%
each year, primarily due to a valuation allowance recorded against the net deferred tax asset balance.
As of
December 29, 2018,
the Company had recorded
$122,000
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.
On
December 22, 2017,
the U.S. enacted the Tax Cuts and Jobs Act (the “Act”), which significantly changed U.S. tax law. The Act lowered the Company’s U.S. statutory federal income tax rate from
35%
to
21%
effective
January 1, 2018,
and imposes new limitations on the utilization of losses incurred in tax years beginning after
December 31, 2017.
However, the enactment of the legislative changes has
not
affected the Company’s overall effective tax rate of
0%,
due to, as previously noted, a full valuation allowance recorded against the net deferred tax asset balance.
(
1
2
) 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 for product sales.
|
|
Three Month
Periods
Ended
|
|
|
Nine
Month
Periods
Ended
|
|
(In thousands)
|
|
December
29
,
2018
|
|
|
December
30
,
201
7
|
|
|
December
29
,
201
8
|
|
|
December
30
,
201
7
|
|
Balance at beginning of period
|
|
$
|
85
|
|
|
$
|
135
|
|
|
$
|
164
|
|
|
$
|
123
|
|
Provision, net
|
|
|
(40
|
)
|
|
|
28
|
|
|
|
(65
|
)
|
|
|
232
|
|
Warranty costs incurred
|
|
|
-
|
|
|
|
(6
|
)
|
|
|
(54
|
)
|
|
|
(198
|
)
|
Balance at end of period
|
|
$
|
45
|
|
|
$
|
157
|
|
|
$
|
45
|
|
|
$
|
157
|
|
(
1
3
) Preferred Stock and Warrants
Series E Senior Convertible Voting Perpetual Preferred Stock
On
March 26, 2018,
the Company entered into a Securities Purchase Agreement for the sale of
43,800
shares of a newly designated series of
6.0%
Series E Senior Convertible Voting Perpetual Preferred Stock (“Series E Shares”) to approximately
15
private investors. The sale was completed and the Series E Shares were issued on
March 28, 2018.
The purchase price for each Series E Share was
$25.00.
Gross proceeds received by the Company were approximately
$1.095
million (the “Placement”). Net proceeds to the Company after fees and expenses of the Placement were approximately
$1.0
million. Placement agent fees incurred in connection with the transaction were
5%
of gross proceeds or approximately
$57,000
in cash, plus warrants to purchase
5%
of the number of common shares into which the Series E shares can be converted (
223,000
shares) at an exercise price of
$0.25
per share.
Each Series E Share is initially convertible (at the option of the holder) at a conversion price of
$0.25
per share of common stock, representing
100
shares of the Company’s common stock per each Series E Share. The conversion ratio is subject to adjustments for stock splits, stock dividends, recapitalizations and similar transactions. As of
March 31, 2018,
if all
43,800
issued Series E Shares were immediately converted, holders of such shares would acquire
4,380,000
shares of common stock of the Company, or
31%
of the pro forma number of shares of common stock that would be outstanding if the conversion had occurred on this date,
27%
of the pro forma number of shares of common stock that would be outstanding upon the conversion of the Company’s outstanding shares of Series B, Series C and Series D Convertible Preferred Stock (collectively, the “Previously Issued Preferred Shares”) and
22%
of the pro forma number of shares of common stock that would be outstanding if all shares of preferred stock were converted and all warrants exercised as of this date. The Company is entitled to redeem Series E Shares at a price equal to
300%
of the Series E Share purchase price, or
$75.00
per share, subject to potential adjustment, but the right to redeem is subject to satisfaction of certain conditions related to the market price and trading volume of the Company’s common stock.
Each Series E Share has a liquidation preference of
150%
of the purchase price or
$37.50,
subject to adjustment. In the event of any liquidation, dissolution or winding up of the affairs of the Company, whether voluntary or involuntary, a merger, or a sale of the Company’s MSI business line or Simulation and Electronics Warfare business line or their related assets, before any payment or distribution to holders of junior shares (including common stock and Previously Issued Preferred Stock), holders of Series E Shares will be entitled to receive an amount of cash per share of Series E Shares up to the liquidation preference plus all accumulated accrued and unpaid dividends thereon. Upon a sale of the Company’s MSI business line or Simulation and Electronics Warfare business line or their related assets, holders of Series E Shares shall be entitled to receive a pro rata portion of the net sale proceeds after reasonable transaction expenses and amount payable to the Company’s secured creditors for releases of their liens on such assets, up to the liquidation preference plus accrued and unpaid dividends. If the payment per Series E Shares is less than the Series E Shares’ liquidation preference, the liquidation preference and the Series E Share redemption price will be reduced by the amount of the payment received.
Holders of Series E Shares are entitled to receive, when, as and if declared by the Company’s Board of Directors, cumulative preferential dividends, payable semiannual in cash at a rate per annum equal to
6.0%
of the initial purchase price of
$25.00
per share or in-kind (at the Company’s election) through the issuance of shares of the Company’s common stock, based on the
10
day volume weighted average price of the common stock.
Holders of Series E Shares generally vote together with the common stock on an as-converted basis on each matter submitted to the vote or approval of the holders of common stock, and vote as a separate class with respect to certain actions that adversely affect the rights of the holders of Series E Shares and on other matters as required by law. In addition, the approval of the Holders of the Series E shares is generally required prior to the Company’s issuance of any securities having rights senior to or in parity with the Series E Shares with respect to dividends or liquidation preferences. The Series E Shares’ right to approve parity securities will terminate at such time that (
1
) fewer than
22,300
Series E Shares, which is
50%
of the number of Series E Shares
first
issued, remain outstanding or (
2
) the volume weighted average closing price of the Company’s common stock for any
20
trading days within any
30
trading day period is
$0.75
or more, the average daily trading volume over such
30
trading day period is
100,000
shares or more and there is either an effective registration statement covering resale of the shares of common stock that holders of Series E Shares would be entitled to receive upon conversion and any shares received as pay-in-kind dividends, or such share could be freely sold pursuant to Rule
144
under the Securities Act of
1933,
as amended.
The Company and each Series E investor entered into an Investor Rights Agreement. Under this agreement, the Company agreed to, among other things, use best efforts to file certain registration statements for the resale of common stock of the Company that the investor
may
acquire upon conversion of the Series E Shares and
may
potentially receive as payment-in-kind dividends during the
two
years following the date of the agreement. The Company also agreed that it would
not
issue additional debt without the approval by holders of at least
66.6%
of the Series E Shares, other than trade debt incurred in the normal course and commercial bank working capital debt, whether revolving or term debt. Concurrent with the execution of the Securities Purchase Agreement for the Series E Shares, the Company and PFG entered into a modification agreement providing for the restructuring of certain terms associated with approximately
$1.7
million in indebtedness owed to PFG (see Note
6
– Term Loans, Revolving Line of Credit and Warrants).
In connection with the sale of Series E Shares, the Company agreed to reduce the exercise price of certain warrants issued in connection with the Company’s private placement in
January 2016,
in which the Company sold (in part)
2,787,872
warrants (a
“2016
Warrant”). Each
2016
Warrant entitled the holder to purchase
0.75
shares of the Company’s common stock at the price of
$1.15
per whole share. The Company agreed to reduce the exercise price of
2016
Warrants that are held by the
2016
Investors purchasing Series E Shares from
$1.15
to
$0.25
per share as follows: A
2016
Investor purchasing an amount equal to or exceeding the lesser of
$200,000
or
50%
of the amount it invested in the
2016
Private Placement will have the exercise price of all of its
2016
Warrants reduced to
$0.25,
and
2016
Investors purchasing less than the lesser of
$200,000
or
50%
of the amount it invested in the
January 2016
Private Placement will have the exercise price of a ratable percentage of the
2016
Warrants reduced to
$0.25.
In connection with its sale of the Series E Shares, the Company reduced the exercise price of
1,759,268
of the outstanding
2016
Warrants to
$0.25.
The fair value attributable to re-pricing the
2016
Warrants, provided to the participating
2016
Investors, of approximately
$203,000,
was deducted from the Series E gross proceeds to arrive at the initial discounted carrying value of the Series E Shares. The initial discounted carrying value resulted in recognition of a beneficial conversion feature of approximately
$557,000,
further reducing the initial carrying value of the Series E Shares. The discount to the aggregate stated value of the Series E Shares, resulting from recognition of the beneficial conversion feature, was immediately accreted as a reduction of common stock and an increase in the carrying value of the Series E Shares. The accretion is presented as a deemed dividend in the consolidated statements of operations.
In addition, warrants to purchase
292,727
shares of common stock held by the placement agent in connection with the
January
private placement, were amended to reduce the exercise price from
$1.15
per share to
$0.25
per share. The fair value attributable to re-pricing the placement agent warrants of approximately
$53,000
was recognized as additional Series E issuance costs and recognized net in the carrying value of Series E Shares.
For the
nine
months ending
December 29, 2018,
the Company issued an additional
36,600
Series E shares to new investors at a purchase price of
$25.00
per share for total gross proceeds of
$915,000.
The table below presents information as of
December 29, 2018:
Preferred Stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Shares
|
|
|
Shares
|
|
|
Liquidation
Preference
|
|
|
|
Designated
|
|
|
Issued
|
|
|
Outstanding
|
|
|
(in thousands)
|
|
Series B
|
|
|
10,000.00
|
|
|
|
9,997.00
|
|
|
|
9,997.00
|
|
|
$
|
2,309
|
|
Series C
|
|
|
3,500.00
|
|
|
|
3,424.65
|
|
|
|
3,424.65
|
|
|
|
500
|
|
Series D
|
|
|
6,000.00
|
|
|
|
5,111.86
|
|
|
|
5,111.86
|
|
|
|
731
|
|
Series E
|
|
|
100,000.00
|
|
|
|
80,400.00
|
|
|
|
80,400.00
|
|
|
|
3,015
|
|
Total at December 29, 2018
|
|
|
119,500.00
|
|
|
|
98,933.51
|
|
|
|
98,933.51
|
|
|
$
|
6,555
|
|
(
1
4
)
Subsequent Events
Since
December 29, 2018,
the Company issued an additional
10,000
shares of Series E Senior Convertible Voting Perpetual Preferred Stock at a purchase of
$25.00
per share for total gross proceeds of
$250,000.