ITEM 1. BUSINESS
General
Giga-tronics Incorporated manufactures specialized electronics equipment for use in both military test and airborne operational applications. Our operations consist of two business segments, those of our wholly owned subsidiary, Microsource, Inc. (“Microsource”) and those of our Giga-tronics Division. Our Microsource segment designs and manufactures custom microwave products for military airborne, sea, and ground applications while the Giga-tronics Division designs and manufactures high fidelity signal simulation and recording solutions for RADAR and Electronic Warfare (“EW”) (“RADAR/EW”) test applications.
Giga-tronics was incorporated on March 5, 1980. We acquired Microsource on May 18, 1998.
The Company’s principal executive offices are located at 5990 Gleason Drive, Dublin, California 94568, and our telephone number at that location is (925) 328-4650. Our website address is https://www.gigatronics.com.
Reverse Split
On December 12, 2019, we completed a one-for-fifteen reverse stock split of our common stock. All shares and per share amounts included in this report, including the financial statements, have been adjusted to reflect the effect of the reverse stock split unless otherwise indicated.
Reporting Segments
Our business has two reporting segments: Microsource and the Giga-tronics Division.
Microsource
Microsource primarily develops custom microwave products for use in military airborne, sea and ground applications. Microsource’s two largest customers are prime contractors for which we develop and manufacture sophisticated RADAR filters used in fighter aircraft. Revenues from Microsource comprised a majority of our revenues for the fiscal years ended March 27, 2021 and March 28, 2020.
Giga-tronics Division
Our Giga-tronics Division designs, manufactures, and markets a family of functional test products and integrates those test products along with third-party hardware and software to create full test solutions for the RADAR/EW segment of the defense electronics market. Our RADAR/EW test solutions are used to evaluate and improve the performance of RADAR/EW systems. Giga-tronics Division customers include major United States (“U.S.”) defense prime contractors, the U.S. armed services and research institutes.
Products and Markets
Microsource
Microsource’s primary business is the production of Yttrium-Iron-Garnet (“YIG”) based microwave components designed specifically for the intended operational application. Microsource produces a line of tunable, synthesized Band Reject Filters for solving interference problems in RADAR/EW applications as well as low noise oscillators used on shipboard and land-based self-protection systems. Microsource designs components based upon the Company’s proprietary YIG technology, for each customer’s unique requirement, generally at the customer’s expense.
While our YIG technology may be used in a variety of operational applications and as components in microwave instruments and devices, Microsource’s two largest customers are prime contractors for whom we develop, and manufacture RADAR filters used in fighter aircrafts. Microsource serves the market for operational hardware associated with the U.S. Government’s RADAR Modernization Program for prior generation fighter aircrafts (i.e., the F-15D, F-16, and F/A-18E jets) to extend their useful lives. These RADAR filters are designed to withstand the rigors of operating under extreme conditions. Microsource also delivers YIG hardware for shipboard and land-based Close-In-Weapon-Systems (“CIWS”) used to defend against missile attacks.
Our customers require that Microsource be certified to the stringent AS9100D aerospace quality standard. Microsource routinely maintains a top-quality rating as measured quarterly by its customers, and over the years has received multiple “Gold Supplier” awards, as well as a “Supplier of the Year” award from one of our prime customers.
Microsource handles sensitive information and must maintain a certified Cyber-Security program to protect against network intrusion and theft of customer data, as well as loss of its own proprietary information. Our IT infrastructure team is working toward a Cybersecurity Maturity Model Certification Level 3. In addition, test equipment and systems used in the manufacture of our microwave components must be audited periodically by the Department of Defense for continued authorization to operate.
Microsource’s revenues have grown over time as prime contractors began upgrading additional aircraft variants. Initially Microsource supplied filters for one fighter jet, the F/A-18E. During our 2014 fiscal year, the prime contractor added a second aircraft, the F-15D and during our 2017 fiscal year, a second prime contractor added a third aircraft, the F-16. As a result, Microsource’s revenue was $9.4 million for our fiscal year ended March 27, 2021 as we delivered filters for approximately 170 aircrafts. We believe there are over 3,000 potential domestic and foreign F-15D, F-16 and F/A-18E aircrafts that have not been upgraded. Microsource is a sole-source supplier of filters for these three fighter jets, and we expect that the business will continue to be a significant source of our future revenue.
Revenue associated with Microsource’s CIWS components may increase in future years as foreign demand for U.S. missile defense systems grows.
Giga-tronics Division
Our Giga-tronics Division designs, manufactures, and markets a family of functional test systems for the RADAR/EW segment of the defense electronics market. Our RADAR/EW test systems are used to evaluate and improve the performance of RADAR systems and EW counter measures, such as jammers. Giga-tronics Division customers include major U.S. defense prime contractors, the armed services (primarily in the United States) and research institutes.
Our goal is to become a leading supplier of test solutions for evaluating defense RADAR/EW systems. The same digital technology that has revolutionized commercial communications, consumer and automotive electronics is now being applied to advanced RADAR/EW systems. This shift in technology limits the effectiveness of traditional test solutions that are unable to actively interact with the RADAR/EW systems being tested. In contrast to traditional test systems, we specifically architected the Giga-tronics testing platform like a RADAR system to offer sophisticated control and real-time behavior that supports active interaction with the devices being tested. To our knowledge, no other RADAR/EW test system offers real time responses and closed loop behavior in the same manner as our technology.
The Test Challenge
The Giga-tronics RADAR/EW test system enables users to test RADAR/EW systems by simulating multiple, dynamic RADAR/EW signals that a fighter jet experiences in combat situations.
Traditional open loop test systems operate by sending a pre-recorded set of signals to the RADAR/EW system being tested. Thus, these traditional systems are unable to interact with the new adaptive RADAR/EW systems. Therefore, we believe that prime contractors and government test facilities are seeking new test solutions that deliver a closer correlation between laboratory testing and field testing by better simulating the changing and reacting signals that exist in combat situations.
Giga-tronics’ Solution
We designed our Giga-tronics RADAR/EW test system to address this challenge. Our RADAR/EW test system employs a RADAR-like architecture, allowing it to accurately simulate RADAR/EW signals for testing. In addition, our RADAR/EW test system is architected to interact with the system under test by modifying its signals in response to signals generated by the system under test, creating a “closed-loop” testing environment that simulates the behavior of RADAR/EW systems in combat situations. We believe that our Giga-tronics RADAR/EW test system is the first commercial RADAR/EW test system architected to offer this closed-loop behavior, which interacts with the system being tested. This closed-loop design also permits our RADAR/EW test system to digitally record the signals generated during testing for later analysis.
We believe our RADAR/EW test solution offers several competitive advantages:
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It is specifically designed for generating realistic RADAR signals for testing purposes.
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It is architected to offer real-time, dynamic, closed-loop behavior that can interact with the devices under test for fully evaluating and improving RADAR/EW performance.
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It features digital processing hardware and firmware, creating a test solution that may be customized with relative ease compared to traditional test systems.
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It is scalable, allowing us to build test systems with multiple channels that scale well both in terms of size and costs compared to traditional systems.
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Its size allows for portable operation.
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We believe that government test facilities are potentially a significant source of revenue because our solutions are portable and can be mounted in trucks for use on military bases and in remote locations. Test engineers are using our equipment to generate realistic RADAR signals for air-crew training and in-flight evaluation of EW system effectiveness. We have delivered portable threat emulation solutions to both the U.S. Navy and the U.S. Air Force. This portable application represents a market expansion for our threat emulation solution and is expected to be a growth driver in fiscal year 2022.
Sources and Availability of Raw Materials and Components
Substantially all the components required by Giga-tronics to make its assemblies are available from more than one source. We occasionally use sole source arrangements to obtain leading-edge technology or favorable pricing or supply terms, but not in any material volume. In our opinion, the loss of any sole source arrangement we have would not materially affect our operations. Some suppliers are also competitors of Giga-tronics. In the event a competitor-supplier chooses not to sell its products to us, production delays could occur as we seek new suppliers or re-design components of our products.
Although extended delays in receipt of components from our suppliers could result in longer product delivery schedules for us, we attempt to mitigate this risk by dealing with well-established suppliers and maintaining good relationships with such suppliers.
Proprietary Technology and Intellectual Property
Our competitive position is largely dependent upon our ability to provide performance specifications for our instruments and systems that (a) effectively and reliably meet customers’ needs and (b) selectively surpass competitors’ specifications in competing products. While patents may provide protection of proprietary designs, with the rapid progress of technological development in our industry, such protection is often short-lived. Therefore, although we occasionally pursue patent coverage, we place major emphasis on the development of new products with superior performance specifications and the upgrading of existing products toward this same end.
Our products are primarily based on our own designs, which are derived from our own engineering abilities. If our new product engineering efforts fall behind, our competitive position weakens. Conversely, effective product development greatly enhances our competitive status.
We have maintained four non-provisional patents related to our legacy 2500B parametric signal generator product line, which was not among the legacy product lines that have been sold. These patents describe advanced synthesis techniques and can be extended for use with the Giga-tronics Advanced Signal Generator & Analyzer (“ASGA”) system and to a number of Microsource synthesizer components. In February of 2020, the Company was granted a non-provisional U.S. patent relating to its ASGA system. The patent describes the internal design of the Advanced Signal Generator (“ASG”) and Advanced Signal Analyzer (“ASA”) along with the architecture of how all the components work together to facilitate building multi-channel test systems with reduced size, weight and cost as compared to present solutions. A second non-provisional patent was granted in November of 2020 describing uses of the ASGA system in high channel-count situations. A third non-provisional patent application which was filed in April of 2020 describing how the ASGA achieves its low noise performance is currently pending before the U.S. Patent and Trademark Office.
We are not substantially dependent on trademarks, licenses, or franchises. While we utilize certain software licenses in certain functional aspects for some of our products, such licenses are generally readily available, non-exclusive and are obtained at either no cost or for a relatively small fee.
Working Capital Practices
We generally strive to maintain adequate levels of inventory and we generally sell to customers on 30-day payment terms in the U.S. and generally allow more time for our international customers. Typically, we receive payment terms of 30 days from our suppliers. We believe that these practices are consistent with typical industry practices.
Dependence on a Limited Number of Customers
We are a supplier of RADAR filters for fighter jet aircrafts and RADAR/EW testing solutions to various U.S. government defense agencies, as well as to their prime contractors. We anticipate that revenue from U.S. government agencies and their prime contractors will remain the source of substantially all of our revenue in fiscal 2022. U.S. and international defense-related agencies accounted for 100% of net revenue in fiscal 2021 and 99% of net revenue in fiscal 2020. Commercial business accounted for 0% and 1% of net revenue in fiscal 2021 and 2020, respectively.
At the Giga-tronics Division, U.S. defense agencies and their prime contractors accounted for over 99% and commercial business accounted for less than 1% of net revenue in fiscal 2021 and 95% and 5% of net revenue in fiscal 2020, respectively. Microsource reported 100% of net revenue to prime contractors of U.S. defense agencies in fiscal 2021 and fiscal 2020.
During fiscal 2021, two prime contractors in the Microsource segment accounted for 66% of our consolidated revenues. A third customer accounted for 14% of our consolidated revenues during fiscal 2021 and was included in the Giga-tronics Division reporting segment.
During fiscal 2020, two prime contractors in the Microsource segment accounted for 64% of our consolidated revenues. A third customer accounted for 18% of our consolidated revenues during fiscal 2020 and was included in the Giga-tronics Division reporting segment.
We could experience a material adverse effect on our financial stability if there was a significant loss of one of our U.S. defense customers.
Both Microsource and our Giga-tronics Division products are largely dependent on U.S. defense spending and budgets and are subject to expansion and contraction between fiscal year periods. Revenues from Microsource products and services often span several years with deliveries varying between both interim and annual fiscal year periods. Additionally, the Giga-tronics Division’s RADAR/EW testing system is a relatively new product platform with fewer targeted customers and significantly longer sales cycles and greater average selling prices when compared to our prior general-purpose test and measurement equipment product lines. We therefore expect that a major customer in one year may not be a major customer in the following year. Accordingly, our net revenue and earnings may vary significantly from one period to the next and will decline if we are unable to find new customers or cannot increase our business with other existing customers to replace declining net revenue from the previous year’s major customers.
Backlog of Orders
On March 27, 2021, our backlog of unfilled orders was approximately $5.1 million compared to approximately $6.8 million at March 28, 2020. Orders for our products include program orders from prime contractors with extended delivery dates. Accordingly, the backlog of orders may vary substantially from year to year and the backlog entering any single fiscal quarter may not be indicative of revenue for any period. In addition, effective April 1, 2018, the Company recognizes revenue for certain contracts as it incurs costs, as opposed to when units are delivered and, as a result, our backlog is reduced when revenue is recognized for those orders.
Backlog includes only those customer orders for which a binding agreement exists, a delivery schedule has been agreed upon between us and our customer and, in the case of U.S. government orders, for which funding has been appropriated.
Competition
The Company primarily competes in two different markets: Microsource’s YIG components and Giga-tronics RADAR/EW test systems.
Microsource is a sole source supplier serving the market for filter components associated with the U.S. Government’s RADAR Modernization Program for certain prior generation fighter jet aircrafts (F-15D, F-16 and F/A-18E jets) and for oscillators in shipboard and land-based missile defense systems. Our Microsource segment supplies RADAR filters specifically designed for military aircraft to solve an interference problem created when newer, more powerful RADARs are installed on older aircrafts and also provides oscillators for RADARs used to track incoming missiles. Only a few other companies possess the technical know-how to design and manufacture YIG components of this nature, such as Teledyne and Micro-Lambda Wireless, but we believe the expense of developing and requalifying new components is prohibitive to the point where an existing prime customer would only undertake such an effort if major issues were to arise, such as significant technical deficiencies or our inability to deliver products on time.
Microsource has regularly received a gold-supplier rating from its customers and we believe our sole source position is secure.
The Giga-tronics Division serves the defense electronics market with a microwave test platform used in the evaluation of military RADAR/EW systems. This application represents a niche segment within the broader test equipment market. While this niche market segment of RADAR/EW testing is large enough to be meaningful to Giga-tronics, we believe it is too small to attract larger competitors, such as Keysight, Rohde & Schwarz and National Instruments who, to our knowledge, do not approach these markets with new dedicated solutions.
We have developed a unique architecture to address the RADAR/EW test requirements that are adaptive/cognitive. We believe that testing these new RADAR and jamming (i.e. interference) signals is best solved by a real time, closed loop, dynamic simulation system. We believe our Giga-tronics RADAR/EW architecture presents a paradigm shift providing for a closed loop test capability that to our knowledge is currently unavailable elsewhere. Our competitors often have greater resources in research, development and manufacturing and substantially broader product lines and channels. To compete, we place strong emphasis on maintaining a high degree of technical competence as it relates to the development of new microwave products, are highly selective in establishing technological objectives and focus sales and marketing activities in the selected niche areas that are weakly served or underserved by our competitors. Competitors that make alternative equipment to the Giga-tronics ASGA system include ELCOM (a division of Frequency Electronics Inc.), VIAVI, and EWST (a division of Ultra Electronics Plc). Two larger companies, Northrop Grumman/Amherst and Textron/AAI sell open loop test equipment that competes with the Giga-tronics solutions, though their solutions are much larger in size and have a much higher selling price. We do not believe that either of these suppliers are likely to offer an adaptive closed loop testing system or a solution that can be used on portable platforms on open air ranges, such as our solution.
Sales and Marketing
Microsource and the Giga-tronics Division sell their products primarily direct to U.S. defense agencies and their prime defense contractors. The Company primarily relies on its internal sales teams to identify leads and complete sales. It also engages independent sales representatives who are perceived to have expertise with targeted markets and/or customers.
Product Development
Products manufactured by Giga-tronics historically have had relatively long product life cycles. However, the electronics industry is subject to rapid technological changes at the component level. Our future success is dependent on our ability to steadily incorporate new functionality and advancements in component technologies into our new products. In fiscal 2021 and fiscal 2020, product development expenses totaled approximately $2.2 million and $1.6 million, respectively.
Our product development activities have historically been funded internally, through product line sales, or through outside equity investment and debt financing. Product development activities are expensed as incurred.
We expect to continue to make significant investments in research and development, the majority of which is focused within the Giga-tronics Division, though we expect some continuing investment in Microsource in order to develop concepts that lead to future customer funded projects and ultimately quantity production. There can be no assurance that future technologies, processes or product developments will not render our current product offerings obsolete or that we will be able to develop and introduce new products or enhancements to existing products that satisfy customer needs in a timely manner or achieve market acceptance. Failure to do so could adversely affect our business.
Manufacturing
The Company assembles and tests Microsource and Giga-tronics Division products at its Dublin, California headquarters facility. Microsource develops and manufactures RADAR filters used in fighter jet aircrafts and low noise oscillators used in CIWS. Our Giga-tronics Division manufactures a family of functional test products and integrates those test products along with third-party hardware and software to create full test solutions for the RADAR/EW segment of the defense electronics market.
Environment
To the best of our knowledge, we are in compliance with all federal, state and local laws and regulations involving the protection of the environment.
Employees
As of March 27, 2021 and March 28, 2020, we employed 42 individuals on a full-time basis. We believe that our future success depends on our ability to attract and retain skilled personnel. Competition for skilled personnel in our markets is competitive. While our size and capital resources constrain our ability to attract and retain employees with cash compensation, we attempt to compensate for this constraint by offering equity awards and opportunities for training and internal promotion. None of our employees are represented by a labor union, and we consider our employee relations to be good.
Information about Foreign Operations
We have limited revenues internationally. We sell to our international customers through a network of foreign technical sales representative organizations. All transactions with our international customers are in U.S. dollars.
Geographic Distribution of Net Revenues by Fiscal Year
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(Dollars in thousands)
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Category
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2021
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2020
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Domestic
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$
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13,040
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100
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%
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$
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11,635
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99
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%
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International
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12
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0
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%
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133
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1
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%
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Total
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$
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13,052
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100
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%
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$
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11,768
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100
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%
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ITEM 1A. RISK FACTORS
The outbreak of the novel coronavirus ("COVID-19") pandemic has adversely affected our business activities, financial condition and results of operations and may continue to do so.
The spread of COVID-19 and the resulting “shelter in place” and “stay at home” orders, travel restrictions and other precautions have caused severe disruptions in the U.S. economy, which have disrupted our business and may continue to do so for an undeterminable amount of time. These restrictions and measures and our efforts to act in the best interests of our employees have affected our business and operations by, among other things, causing temporary facility closures, production delays and capacity limitations; requiring modifications to our business processes; limiting our access to customers, and their sites and physical facilities; requiring the implementation of social distancing measures that require changes to existing manufacturing processes; disrupting business travel; and increasing the risk that supply chains may be disrupted. These impacts have caused and may continue to cause delays in the receipt of customer orders, delays in product shipments and decreases in revenue, profitability and cash flows from operations, which have caused and are expected to cause an adverse effect on our results of operations that may be material. With the availability of vaccines, we expect the negative impacts of the pandemic to continue to diminish going forward. However, the potential duration, future trajectory of reported cases and impact of the pandemic on the U.S. economy and on our business are difficult to predict and cannot be estimated with any degree of certainty.
We have significant working capital requirements and have experienced operating losses. If we continue to experience operating losses, it could have a material adverse effect on our business, financial condition and results of operations.
We are dependent upon obtaining revenues from sales of our products and raising additional capital from investors to meet our working capital needs. Since 2011, we have relied on a series of sales of our preferred stock and common stock, product line sales and loans to fund our operating cash flow deficits. There is no assurance that we will generate the necessary net income or positive net operating cash flows to meet our working capital requirements and pay our debts as they become due in the future.
We incurred net losses of $393,000 in fiscal 2021 and $687,000 in fiscal 2020. These losses have contributed to an accumulated deficit of $31.0 million as of March 27, 2021. Through March 27, 2021, we have incurred expenditures of approximately $23.0 million for the development of our RADAR/EW system product platform. Although we have shipped RADAR/EW system products to several customers, potential delays in the development of additional product features and upgrades, longer than anticipated sales cycles, or the ability to generate shipments in significant quantities, could contribute to additional future losses and reduced liquidity.
If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our current operations and to respond to business challenges would be significantly limited. The lack of adequate working capital from any inability to generate positive net cash flow from operations or to raise equity or debt financing could force us to discontinue, delay or suspend R&D, product lines, business segments or otherwise substantially curtail or cease operations and would, therefore, have an adverse effect on our business and financial condition. As a result, we may also be required to further reduce expenses if our RADAR/EW product platform sales goals are not achieved and could, for example, choose to focus solely on our Microsource segment, which we expect to be more predictable and profitable than our Giga-tronics business segment, to generate revenue and cash from operating activities. As part of such a restructuring, management believes the microwave components which the Company developed for the RADAR/EW test systems in the Giga-tronics business segment could be a source of growth for the Microsource segment.
We may require additional capital to support our current operations and this capital may not been readily available.
To support our operations and to bring our RADAR/EW product platform to its full potential, we may need to seek additional working capital; however, there are no assurances that such working capital will be available, or on terms acceptable to us. Our recent history of losses, changes to our product focus and the development of new products makes it difficult to evaluate our current business outlook and future prospects. Accordingly, investors should consider our prospects in light of the costs, uncertainties, delays and difficulties frequently encountered by companies developing new products as we have, in fact, encountered. In particular, there is a significant risk that we will not be able to:
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implement or execute our current business plan;
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successfully and timely sell, manufacture and ship our products;
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raise sufficient funds in the capital markets to carry out our business plan.
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If we raise additional funds through further issuances of equity or convertible debt securities, our existing shareholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our existing capital stock. Any debt financing secured by us in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities. In addition, to the extent we satisfy our working capital needs by incurring additional debt, our operating cash flow may suffer in order to satisfy debt service obligations.
Furthermore, we cannot assure that any necessary financing, if available, would be available on attractive terms. If our financial condition were to worsen and we were unable to attract additional equity or debt financing or enter into other strategic transactions, we could become insolvent or be forced to declare bankruptcy, and we would not be able to execute our growth strategy.
Our sales cycles can be long and unpredictable, and our sales efforts require considerable time and expense. As a result, our sales and revenue are difficult to predict and may vary substantially from period to period, which may cause our operating results to fluctuate significantly.
The timing of our revenues is difficult to predict. Factors that may contribute to these fluctuations include our dependence on the defense industry, a limited number of customers, the nature and length of our sales cycles for our products and services, the duration and delivery schedules within our customer contracts and our ability to timely develop, produce and upgrade our products.
Most of our revenues result from a limited number of relatively large orders that we receive from prime defense contractors and government agencies. We spend substantial time and resources on our sales efforts without any assurance that our efforts will produce any sales. In addition, purchases of our products are frequently subject to budget constraints (including constraints imposed by governmental agencies), multiple approvals, and unplanned administrative, processing and other delays. Even if we receive a purchase order from a customer, there may be circumstances or terms relating to the purchase that delay our ability to recognize revenue from that purchase, which makes our revenue difficult to forecast. As a result, it is difficult to predict whether a sale will be completed, the particular fiscal period in which a sale will be completed or the fiscal period in which revenue from a sale will be recognized. For these reasons, our operating results may vary significantly from quarter to quarter. Such unpredictable operating results may adversely impact the trading price of our common stock.
Our sales are substantially dependent on the defense industry and a limited number of customers.
All of our current product and service offerings are directed towards the defense marketplace, which has a limited number of customers. If the defense market demand decreases, our sales may be less than projected shipments with a resulting decline in revenues. As a result, our business depends upon continued U.S. government expenditures on defense for which we provide support. These expenditures have not remained constant over time and have been reduced in some periods. Our business, prospects, financial condition, operating results, and the trading price of our common stock could be materially harmed, among other causes, by the following:
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budgetary constraints, including mandated automatic spending cuts, affecting across-the-board government spending, or specific agencies in particular, and changes in available funding;
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a shift in expenditures away from defense programs that we support;
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efforts to improve efficiency and reduce costs affecting government programs;
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U.S. government shutdowns due to, among other reasons, a failure by elected officials to fund the government and other potential delays in the appropriations process;
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delays in the payment of our invoices by government payment offices;
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changes in the political climate and general economic conditions, including a slowdown of the economy or unstable economic conditions and responses to conditions, such as emergency spending, that reduce funds available for other government priorities.
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Additionally, the loss of any one customer may have a material adverse effect on future operating results and financial condition. Our product backlog also has a number of risks and uncertainties such as the cancellation or deferral of orders, dispute over performance of our products and our ability to collect amounts due under these orders. If any of these events were to occur, actual shipments could be lower than projected shipments and revenues could decline which would have an adverse effect on our operating results and liquidity.
If our reputation or relationships with the U.S. Federal Government or the limited number of defense contractors with whom we work were harmed, our future revenues and cash flows would be adversely affected.
We derive substantially all of our revenue from the U.S. Federal Government, its agencies and several defense contractors that supply them. Approximately $24.8 million of our total combined revenues for the two fiscal years ended March 27, 2021 and March 28, 2020 were derived from contracts with the U.S. Federal Government and its agencies, either directly or through defense contractors with whom we have contracted. Our reputation and relationships with various U.S. government entities and agencies, in particular with the U.S. Department of Defense and the U.S. Navy, and the limited number of defense contractors serving these agencies, are key factors in maintaining and growing these revenues and winning bids for new business. Negative press reports or publicity, regardless of accuracy, could harm our reputation. If our reputation or relationships with government agencies were to be negatively affected, or if we are suspended or debarred from contracting with government agencies for any reason, the amount of business with government and other customers would decrease and our financial condition and results of operations could be adversely affected.
Our failure to comply with a variety of complex procurement rules and regulations could result in delays of sales or shipments or our liability for penalties, including termination of our government contracts, disqualification from bidding on future government contracts and suspension or debarment from government contracting.
We must comply with various laws and regulations relating to the formation, administration and performance of government contracts, which affect how we do business with our customers and may impose added costs on our business. Our customers may also require that we adopt and maintain procedures affecting our operations, such as information security measures. If we experience difficulty or are unable to comply with these requirements, we could face delays in the receipt of orders, production of products and performance of services and sales, or the loss of any of these.
Some U.S. federal statutes and regulations provide for penalties, including automatic debarment based on actions such as violations of the U.S. False Claims Act or the U.S. Foreign Corrupt Practices Act. The suspension or debarment in any particular case may be limited to a facility, contract or subsidiary involved in the violation or could be applied to our entire Company in severe circumstances. Even a narrow scope suspension or debarment could result in negative publicity that could adversely affect our ability to renew contracts and to secure new contracts, both with governments and private customers, which could materially and adversely affect our business, financial condition and results of operations.
Our markets involve rapidly changing technology and standards.
The market for electronics equipment is characterized by rapidly changing technology and evolving industry standards. We believe that our future success will depend in part upon our ability to develop, manufacture and successfully introduce new products and product lines with improved performance capabilities, and to continue to upgrade or enhance our existing products. There can be no assurance that we will successfully complete the development or enhancement of current or future products, or that such products will achieve sufficient market acceptance. The inability to develop new products or enhance existing products in a timely manner and to achieve sustained commercial market acceptance could have a material adverse impact on our operating performance and liquidity.
Performance problems in our products or problems arising from the use of our products together with other vendors’ products may harm our business and reputation.
Products as complex as those we produce may contain unknown and undetected defects or performance problems. For example, it is possible that one of our products might not comply with stipulated specifications under all circumstances. In addition, our customers generally use our products together with their own products and products from other vendors. As a result, when problems occur in a combined equipment environment, it may be difficult to identify the source of the problem. A defect or performance problem could result in lost revenues, increased warranty costs, diversion of engineering and management time and effort, impaired customer relationships and injury to our reputation generally.
Our RADAR/EW testing system products are complex and could have unknown defects or errors, which may increase our costs, harm our reputation with customers, give rise to costly litigation, or divert our resources from other purposes.
Our RADAR/EW testing system products are extremely complex. Despite testing, our initial products contained defects and errors and may in the future contain defects, errors, or performance problems following its sale or when new versions or enhancements are released, or even after these products have been used by our customers for a period of time. These problems could result in expensive and time-consuming design modifications or warranty charges, delays in the introduction of new products or enhancements, significant increases in our service and maintenance costs, diversion of our personnel’s attention from our product development and sales efforts, exposure to liability for damages, damaged customer relationships, and harm to our reputation, any of which could have a material adverse impact on our results of operations. In addition, increased development and warranty costs could be substantial and could reduce our operating margins.
Our products contain components produced by suppliers which may be discontinued, subject to supply constraints or no longer available in future periods, which could require that we redesign product components, lead to production delays and adversely impact our operating results and financial condition.
Certain components produced by our suppliers may be discontinued, subject to supply constraints or no longer available to us to produce our products. Such discontinuations or lack of supply could require us to seek replacement components that may take longer and cost more than initially expected to procure, redesign our products for different components and/or delay production of our products unless supplies become available, any of which could lead to delays in product sales and deliveries.
If we fail to maintain satisfactory compliance with quality certifications and classified processing, cybersecurity and control standards, product deliveries may be delayed or cancelled which would adversely impact our business, operating result and financial condition.
Some of our customer contracts require that we maintain quality certifications and classified processing, cybersecurity and control standards. If we were unable to maintain such certifications and standards, our product shipments may be delayed or orders could be delayed or cancelled, any of which would cause us to lose business or brand reputation, resulting in a material adverse effect on our business operating results and financial condition.
If we are deemed to infringe on the proprietary rights of third parties, we could incur unanticipated expense and be prevented from providing our products and services to customers.
We could be subject to intellectual property infringement claims as the number of our competitors grows and if our products or the functionality of our products overlap with patents of our competitors. While we do not currently believe that we have infringed or are infringing on any proprietary rights of third parties, we cannot assure you that infringement claims will not be asserted against us or that those claims will be unsuccessful. We could incur substantial costs and diversion of management resources defending any infringement claims whether or not such claims are ultimately successful, even if such claims are meritless. Furthermore, a party making a claim against us could secure a judgment awarding substantial damages, as well as injunctive or other equitable relief that could effectively block our ability to provide products or services. We may not prevail in litigation given the complex technical issues and inherent uncertainties in intellectual property litigation. If litigation results in an adverse ruling, we could be required to:
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pay substantial damages for past, present and future use of the infringing technology;
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cease manufacture, use or sale of infringing products;
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discontinue the use of infringing technology;
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expend significant resources to develop non-infringing technology;
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pay substantial damages to our customers or end-users to discontinue use or replace infringing technology with non-infringing technology;
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license technology from the third-party claiming infringement, which license may not be available on commercially reasonable terms, or at all; or
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relinquish intellectual property rights associated with one or more of our patents claims if such claims are held invalid or otherwise unenforceable.
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We face risks related to production delays, delays of customer orders and high selling price of our RADAR/EW testing platform.
Our RADAR/EW testing platform has been our primary product development focus for the last several years, however, delays in completing its initial development, together with early design and manufacturing issues and longer than anticipated sales cycles have contributed to our losses and increased our accumulated deficit as of March 27, 2021. Additionally, the average selling price of our RADAR/EW system is considerably higher than our prior general-purpose test and measurement products, which in turn requires additional internal approvals on the part of the customer and generally leads to longer sales cycles. Our financial condition may also cause potential customers to delay, postpone or decide against placing orders for our products. Continued longer than anticipated sales cycles in future fiscal years, or delays in production and shipping volume quantities, could have a material adverse impact on our operating results and liquidity.
Our business depends on our intellectual property rights, and if we are unable to protect them, our competitive position may suffer.
Our business plan is predicated on our proprietary technology. Accordingly, protecting our intellectual property rights is critical to our continued success and our ability to maintain our competitive position. Our goal is to protect our proprietary rights through a combination of patent, trademark, trade secret and copyright law, confidentiality agreements and technical measures. We generally enter into non-disclosure agreements with our employees, consultants and suppliers and limit access to our trade secrets and technology. We cannot provide assurance that the steps we have taken will prevent misappropriation of our technology. Misappropriation of our intellectual property would have an adverse effect on our competitive position, financial condition, and results of operations.
Our competitors have greater resources.
Several of our competitors, including, among others, Northrup Grumman/Amherst, Textron/AAI, Keysight, Rohde & Schwarz and National Instruments have substantially greater research and development, manufacturing, marketing, financial, and technological personnel and managerial resources than us. These resources also make these competitors better able to withstand difficult market conditions than us. We cannot provide assurance that any products developed by these competitors will not gain greater market acceptance than any developed by us.
Business interruptions could delay or prevent our business activities, which could have a material adverse effect on our business, financial condition and results of operations.
Our primary facility and headquarters is located in the San Francisco Bay Area near known earthquake fault zones and is vulnerable to significant damage from earthquakes. We are also vulnerable to other natural disasters, epidemics, such as the COVID-19 pandemic, and other events that could disrupt our operations that may be beyond our control. We do not carry insurance for earthquakes and we may not carry sufficient business interruption insurance to compensate us for losses that may occur. Any losses or damages we incur could have a material adverse effect on our operating results, cash flows, and success as an overall business.
If we experience a significant cybersecurity attack or disruption in our IT systems, our business, reputation, and operating results could be adversely affected.
We rely on an internal IT system monitored by certain internal employees to maintain our IT systems; maintain financial records; retain sensitive data, such as intellectual property, proprietary business information, and data related to customers, and suppliers; process orders; manage inventory; process shipments to customers; and operate other critical functions. The ongoing maintenance and security of this information is critical to the classified processing and control standards that our suppliers require us to maintain and the success of our business operations and our strategic goals.
Despite our implementation of network security measures, our network may be vulnerable to cybersecurity attacks, computer viruses, break-ins and similar disruptions. Our network security measures include, but are not limited to, the implementation of firewalls, antivirus protection, patches, log monitors, routine backups, offsite storage, network audits, and routine updates and modifications. Despite our efforts to create these security barriers, we may not be able to keep pace as new threats emerge and it is virtually impossible for us to entirely eliminate this risk. Cybersecurity attacks are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and corruption of data. Any such event could have a material adverse effect on our business, reputation, operating results and financial condition, and no assurance can be given that our efforts to reduce the risk of such attacks will be successful.
In addition, our IT systems may be susceptible to damage, disruptions or shutdowns due to power outages, hardware failures, telecommunication failures, user errors, catastrophes or other unforeseen events. Such events could result in the disruption of business processes, network degradation and system downtime, along with the potential that a third-party will exploit our critical assets such as intellectual property, proprietary business information and data related to our customers, suppliers and business partners. To the extent that such disruptions occur, our customers and suppliers may lose confidence in our solutions and we may lose business or brand reputation, resulting in a material and adverse effect on our business operating results and financial condition.
Risks Related to Investing in Our Securities
Our common stock is quoted on the Over-the-Counter Market and trading volumes have been limited.
As compared to a larger stock market with greater liquidity, our common stock is quoted on the OTCQB™, which is the middle tier of the Over-the Counter Market, or the OTC, reserved for companies that are registered and reporting with the SEC or a U.S. banking regulator. The volume of trading of our common stock on the OTCQB has been very thin. Therefore, an investor might find it more difficult than it would be on a larger stock exchange to dispose of, or to obtain accurate quotations as to the market value of, our securities.
We cannot be certain that a more active trading market will develop or, if developed, be sustained. We also cannot be certain that purchasers of our common stock will be able to resell their common stock at prices equal to or greater than their purchase price. The development of a public market having the desirable characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace of a sufficient number of willing buyers and sellers at any given time. We do not have any control over whether there will be sufficient numbers of buyers and sellers. Accordingly, we cannot be certain that an established and liquid market for our common stock will develop or be maintained. The market price of our common stock could experience significant fluctuations in response to our operating results and other factors. In addition, the stock market in recent years has experienced extreme price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of individual companies. These fluctuations, and general economic and market conditions, may cause the market price of our common stock to decline substantially.
The trading price of our common stock may make it more difficult for you to trade shares of our common stock.
We could become subject to the SEC’s “penny stock” rule if we fail to meet certain financial criteria set forth in the rule. If we become subject to the SEC’s penny stock rule, the rule would impose various sales practice requirements on broker-dealers who sell our securities to persons other than established customers and accredited investors. For these types of transactions, the broker-dealer would have to make a special suitability determination for the purchaser and receive the purchaser’s written consent to the transaction prior to sale. Consequently, if it were to apply to us, the rule could have an adverse effect on the ability of broker-dealers to sell our securities and could affect the ability of our shareholders to buy and sell our securities in the secondary market. If our common stock were to become a “penny stock” within the meaning of the rule, additional burdens imposed upon broker-dealers may discourage broker-dealers from effecting transactions in penny stocks, which could reduce the liquidity of our common stock and have a material adverse effect on the trading market for our common stock.
While our common stock is not subject to the SEC’s penny stock rule, some broker-dealers may nonetheless choose to not allow incoming transfers of our shares from other brokerage accounts or limit your ability to trade shares of our common stock, which could make it more difficult for you to sell your shares, as well as having a material adverse effect on the trading market for our common stock.
Our common stock ranks junior to all of our preferred stock and indebtedness.
As of March 27, 2021, our outstanding preferred shares had an aggregate liquidation preference of $3.7 million and we had an aggregate of $3.6 million in debt and other liabilities including long term lease obligations.
In the event of our bankruptcy, liquidation or winding-up, our assets will be available to make payments to holders of our common stock only after all of our indebtedness and other liabilities and all of the liquidation preferences on any then outstanding Series B, Series C, Series D and Series E preferred stock have been paid. Consequently, if we are forced to liquidate our assets to pay our creditors, we may not have sufficient assets remaining to pay amounts to the holders of shares of our common stock then issued and outstanding.
We have a significant number of outstanding warrants, options and shares of convertible preferred stock, which may cause significant dilution to our shareholders, adversely impact the market price of our common stock and make it more difficult for us to raise funds through future equity offerings.
As of March 27, 2021, we had 2,635,856 shares of common stock outstanding. In addition, as of that date we had outstanding warrants to acquire 45,599 shares of common stock, options to acquire 374,808 shares of common stock and shares of convertible preferred stock convertible into an aggregate of 179,878 shares of common stock. The issuance of shares of common stock upon the exercise of warrants or options or conversion of preferred stock would dilute the percentage ownership interest of all holders of our common stock, might dilute the book value per share of our common stock and would increase the number of our publicly traded shares, which could depress the market price of our common stock.
The fact that our shareholders, warrant holders and option holders could sell substantial amounts of our common stock in the public market, whether or not sales have occurred or are occurring, could make it more difficult for us to raise additional funds through the sale of equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate, or at all.
We may issue additional shares of common or preferred stock in the future, which could dilute a shareholder’s ownership of common stock.
Our articles of incorporation authorize our board of directors, generally without shareholder approval, to, among other things, issue additional shares of common or preferred stock. The issuance of any additional shares of common or preferred stock would be dilutive to an existing shareholder’s ownership of our common stock. The issuance of preferred stock could impair the voting, dividend and liquidation rights of common shareholders without their approval. To the extent that we issue options or warrants to purchase common stock in the future and the options or warrants are exercised, our shareholders may experience further dilution. Holders of shares of our common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, shareholders may not be permitted to invest in future issuances of our common or preferred stock.
We do not intend to pay cash dividends to our shareholders, so you will not receive any return on your investment in our common stock prior to selling your interest in the Company.
We have never paid any dividends to our common shareholders and do not foresee doing so. We currently intend to retain any future earnings for funding growth and, therefore, do not expect to pay any cash dividends in the foreseeable future. If we determine that we will pay cash dividends to the holders of our common stock, we cannot assure that such cash dividends will be paid on a regular basis. The success of your investment in our common stock will likely depend entirely upon any future appreciation. As a result, you will not receive any return on your investment prior to selling your common stock and, for the other reasons discussed in this “Risk Factors” section and in the “Risk Factors” section of the documents incorporated herein by reference, you may not receive any return on your investment even when you sell your shares.
General Risk Factors
The preparation of our financial statements requires the use of estimates that may vary from actual results.
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make significant estimates that affect the financial statements. For example, we are required to make estimates about, among other things, accruals, inventory reserves, revenue and lease accounting as well as other long-lived assets. Due to the inherent nature of these estimates, we may be required to significantly increase or decrease such estimates upon determination of the actual results. Any required adjustments could have a material adverse effect on us, our results of operations and the trading price of our common stock.
We are dependent on our management team and development and operations personnel, and the loss of one or more key employees or groups could harm our business and prevent us from implementing our business plan in a timely manner.
Our success depends substantially upon the continued services of our executive officers and other key members of management. From time to time, there may be changes in our executive management team resulting from the hiring or departure of executives. Such changes in our executive management team may be disruptive to our business. We are also substantially dependent on the continued service of our existing development and operations personnel because of the complexity of our service and technologies. Staffing due to the loss of one or more of our key employees or groups can be expensive, divert management’s attention from executing our business plan and could seriously harm our business. Furthermore, possible shortages of key personnel, including engineers, in the area surrounding our facilities could require us to pay more to hire and retain key personnel, thereby increasing our costs.
If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. Any inability to accurately and timely report and file our financial results could harm our reputation and adversely impact the trading price of our common stock.
Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. If we cannot provide reliable financial reports or prevent fraud, we may not be able to manage our business as effectively as we would if an effective control environment existed, and our business and reputation with investors may be harmed. As a result, any internal control deficiencies may adversely affect our financial condition, results of operations and access to capital.
Our stock price is volatile.
The market price of our common stock has been and is likely to be highly volatile and could fluctuate widely in price in response to various factors, many of which are beyond our control, including the following:
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our ability to execute our business plan;
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changes in our industry;
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competitive pricing pressures;
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our ability to obtain working capital financing;
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additions or departures of key personnel;
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increases in the number of shares of common stock outstanding as our preferred stock converts to common stock, or as warrants are exercised, or both;
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sales of our common stock by us or our shareholders;
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operating results that fall below expectations, including actual or anticipated variations in our quarterly results;
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regulatory developments;
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economic and other external factors;
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period-to-period fluctuations in our financial results;
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the public’s response to press releases or other public announcements by us or third parties, including filings with the SEC;
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changes in financial estimates or ratings by any securities analysts who follow our common stock, our failure to meet these estimates or failure of those analysts to initiate or maintain coverage of our common stock;
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changes in expected national defense spending or budgets;
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operating and stock price performance of other companies that investors deem comparable to us;
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domestic and international economic factors unrelated to our performance;
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new technology used, or services offered, by competitors;
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the development and sustainability of an active trading market for our common stock; and
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any future sales of our common stock by our officers, directors and shareholders.
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In addition, the securities markets have from time-to-time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. Our stock at any time has historically traded on low volume on the OTCQB Market and, previously, on the NASDAQ Capital Market. Market and volume fluctuations may also materially and adversely affect the market price of our common stock.
Shares eligible for future sale may adversely affect the market.
From time to time, our shareholders may decide to sell some or all of their shares of common stock that they currently hold or could acquire upon the conversion of our preferred stock or exercise of warrants or other derivative securities by means of ordinary brokerage transactions in the open market. Any substantial sale of our common stock may have a material adverse effect on the market price of our common stock.