Summary of LOGIC DEVICES INC

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Reported financial results may not be indicative of the financial results of future periods. All non-historical information contained in the following discussion constitutes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are not guarantees of future performance and involve a number of risks and uncertainties, including those identified in "Item 1A - Risk Factors" of this Annual Report on Form 10-K. We undertake no obligation to revise or update these forward-looking statements to reflect events or circumstances after the date of this report.

Overview

LOGIC Devices Incorporated develops and markets high-speed digital integrated circuits that perform high-density storage and signal/image processing functions. Our products enable high definition video display, transport, editing, composition, and special effects. We also provide solutions for digital filtering in television broadcast stations and image enhancement in medical diagnostic scanning and imaging equipment.

Our products are used in the broadcast, medical, military and consumer electronics markets. Our products address storage and digital signal processing (DSP) requirements that involve high-performance arithmetic computation. We focus on developing proprietary catalog products to address specific functional application needs or performance levels that are not otherwise commercially available. We seek to provide related groups of circuits that original equipment manufacturers (OEMs) incorporate into high-performance electronic systems.

Liquidity and Capital Resources

Our operations used net cash of $386,300, despite a large net loss of $3,965,000 for fiscal 2008. Inventory write-downs totaling $2,059,700 and a write-off of property and equipment no longer in use totaling $129,900 increased our net loss but did not affect cash flows. Sales of existing inventories produced $904,700 of cash for operations, while timing of invoices resulted in an increase in accounts payable of $126,200. Prior to the collapse of the auction rate securities market, we liquidated $112,000 of our investment. Capital expenditures of $274,200 included mask tooling and production tooling for new products.

Despite having a net loss of $1,487,700 for fiscal 2007, our operations produced net cash of $272,600. During fiscal 2007, we wrote-off $555,600 of inventories, $400,200 of capitalized test software, and $142,600 of property and equipment no longer in use, all of which increased the net loss but did not affect cash flows from operations. During the year, we also increased our inventory valuation allowance by $402,700, while writing off $1,551,000 of inventories against this valuation allowance. We also continue to purchase additional available-for-sale securities as a means to increase the return on our cash and cash equivalents balances, with purchases of $554,900 in fiscal 2007. Capital expenditures of $391,100 included leasehold improvements for our new facilities into which we moved on September 1, 2007.

While producing a net income of $129,400 during fiscal 2006, our operations produced net cash of $977,700. During the year, we increased the inventory valuation allowance by $1,036,900 and wrote-off $200,000 of capitalized test software, both of which reduced net income but not cash flows. In addition, LOGIC collected $45,000 from a property tax refund and had increases in its accrued payroll and vacation and other accrued expenses totaling $81,200 due to the timing of these expenses. Capital expenditures of $196,700 for fiscal 2006 were substantially less than fiscal 2005, which totaled $540,700.

Working Capital

Our investment in inventories has been significant and will continue to be significant in the future. However, during the past few years, we have been able to reduce our levels of inventories as we shift from more competitive second source products to proprietary sole source products. We seek to further streamline our inventories as we continue to shift to sole source proprietary products.

We rely on third party suppliers for our raw materials, particularly our processed wafers, for which we currently rely primarily on two suppliers, and as a result, maintain substantial inventory levels to protect against disruption in supplies. We have periodically experienced disruptions in obtaining wafers. As we continue to shift towards higher margin proprietary products, we expect to be able to reduce inventory levels by streamlining our product offerings.

Periodically, we review inventory to determine recoverability of items on-hand using the lower-of-cost-or-market (LOCOM) and excess methods. We group and evaluate our products based on their underlying die or wafer type (our raw materials, silicon wafers, can generally be used to make multiple products), to determine the total quantity on-hand and average unit costs. Management uses judgment in comparing historical sales quantities to the quantity on-hand at the end of the fiscal year. If the quantity on-hand exceeds the sales quantities, we provide a valuation allowance for the potentially obsolete or slow-moving items. For the LOCOM analysis, we compare the average historical sales price to the average unit cost of inventories at the end of the fiscal year. If the average unit cost exceeds the average sales price, we provide a valuation allowance.

With continuing low revenue levels, management felt it necessary to also review our raw materials and work-in-process. Our products generally exhibit an active sales product life cycle of ten or more years. However, due to rapid changes in process technology, we are generally unable to obtain wafers for our products for as long a period as their life cycles. As a result, early in a product's life, we are often required to estimate the sales expectations for the entire life cycle and purchase materials upfront. On some occasions, our expectations become lower and we provide a reserve for potential excess materials. In fiscal 2008, we wrote down inventory against our inventory valuation allowance of $1,573,700 and additional inventory totaling $2,059,300. In fiscal 2007, we increased our inventory valuation allowance by $402,700 for potential excess materials, while writing down $1,551,000 of inventory against this previously established allowance. In addition, during fiscal 2007, we scrapped other inventory of $555,600. We believe our current inventory valuation provides a reasonable estimate of the recoverability of inventories at the end of fiscal 2008.

Although current levels of inventory impact our liquidity, we believe that this is a less costly alternative to owning a wafer fabrication facility or continuously redesigning our products to newer process technologies, which would divert limited engineering resources from new product development. We continue to evaluate alternative suppliers to diversify our risk of supply disruption. However, this requires a significant investment in product development to tool masks with new suppliers. Such efforts compete for our limited product development resources. We seek to achieve on-going reductions in inventory, although there can be no assurance we will be successful. In the event economic conditions remain slow, we may consider identifying additional portions of inventory to write-off at a future date.

Historically, due to customer order scheduling, up to 70% of our quarterly revenues were often shipped in the last month of the quarter, so a large portion of the shipments included in year-end accounts receivable were not yet due per our net 30-day terms. This results in year-end accounts receivable balances being at their highest point for the respective period.

Financing

On November 10, 2008, we obtained a no net-cost line of credit from UBS Bank USA for the $975,000 par value of our Auction Rate Securities (ARS). We drew down the entire $975,000 available balance on November 21, 2008 so we would have the cash readily available rather than held in the illiquid ARS at UBS Financial Services Inc. (UBS). This loan is considered no net-cost as the interest charged is the lesser of the LIBOR rate plus an established percentage rate or the interest and/or dividends earned on our ARS. Therefore, our interest paid can be no more than the interest and/or dividends we earn on the ARS. In addition, on October 16, 2008, we signed an agreement with UBS for ARS Rights to sell our ARS to UBS at par value within a two-year period beginning January 2, 2009. At the time we exercise these ARS Rights, we will pay back the no net-cost loan from UBS Bank USA and the line will be closed.

We believe the cost reductions we have undertaken in the past few years will allow us to use this cash, along with cash from future revenues, to fund current operations and future capital needs. However, we continue to evaluate our debt and equity financing opportunities.

Contractual Obligations

Our only contractual obligation is our facility operating lease. The following table summarizes the future fixed payments under this lease as of September 30, 2008. Payment timing may be subject to change.

Payments due by period:
Total Within 1 year 1-3 years After 3 years

Building $1,442,500 $223,200 $719,200 $500,100

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

Results of Operations

Comparison of Fiscal Years Ended September 30, 2008 and 2007

Net revenues for fiscal 2008 decreased 28 percent from $4,686,400 in fiscal 2007 to $3,352,100. This decrease was the result of the older products, including the digital cinema project, dropping off with no new product revenues replacing them during fiscal 2008.

Cost of revenues for fiscal 2008 increased 47 percent from $2,846,700 in fiscal 2007 to $4,196,600, mainly the result of write-downs of inventory totaling $2,059,300. Sales of products previously written down to zero were 27% of revenues in fiscal 2008 compared to 15% in fiscal 2007.

Research and development expenses decreased 14 percent from $1,811,800 in fiscal 2007 to $1,563,400 in fiscal 2008. This decrease is primarily the result of the one-time $400,200 write-off of capitalized test software done in fiscal 2007. During the last quarter of fiscal 2008, we made a few minor staffing cuts but believe the current team can complete the new products we currently have in development.

Selling, general, and administrative expenses decreased four percent from $1,546,400 in fiscal 2007 to $1,483,200. This decrease was mainly the result of general cost cutting in fiscal 2008 and the expensing of certain prepaids in fiscal 2007 that did not recur in fiscal 2008.

Interest income decreased 25 percent from $75,900 in fiscal 2007 to $56,700, primarily as a result of a smaller balance in available-for-sale securities and a lower cash balance in fiscal 2008. Other expense in fiscal 2008 consisted of the write-off of property and equipment no longer in use.

As a result of the decreased revenues and large write-down of inventory, we had a net loss of $3,965,000 in fiscal 2008, compared to a net loss of $1,487,700 in fiscal 2007.

Comparison of Fiscal Years Ended September 30, 2007 and 2006

Net revenues for fiscal 2007 increased one percent from $4,640,600 in fiscal 2006 to $4,686,400. This slight increase is the result of one customer increasing its order rate to an amount that offset decreases in older product sales.

Cost of revenues for fiscal 2007 increased 32 percent from $2,153,700 in fiscal 2006 to $2,846,700, mainly the result of write-offs of inventory totaling $555,600 and a decrease in sales of products previously written down to zero-value (15% in fiscal 2007 compared to 26% in fiscal 2006).

Research and development expenses increased 85 percent from $981,700 in fiscal 2006 to $1,811,800. While this increase includes the write-off of $400,200 of capitalized test software development costs, the remaining increase is the result of our continued commitment to expand our product development team, in both numbers and expertise. While the expenses, net of the write-off of capitalized test software development costs, are outside our goal of 20 to 25 percent of net revenues (30%), we believe we must continue at this current level as new product development is the key to our future growth and success. Future new product introductions will result in future revenue increases that will begin to offset these expenditures down to our goal level.

Selling, general, and administrative expenses increased nine percent from $1,421,900 in fiscal 2006 to $1,546,400. While we attempted to identify areas for cost-cutting during the fiscal year, the need for outside consultants and the expensing of certain prepaid expenses whose useful life had expired early in the normal course of business resulted in the total increase.

Interest income increased 101 percent from $37,800 in fiscal 2006 to $75,900. The increase is the result of more funds being invested in available-for-sales securities during fiscal 2007 and from the fact that the investments existed for the full fiscal year compared to only four months of fiscal 2006.

As a result of the foregoing, we had a net loss of $1,487,700 for fiscal 2007, compared to net income of $129,400 in fiscal 2006.

Critical Accounting Policies

Management's discussion and analysis of our financial condition and the results of operations are based upon the financial statements included in this report and the data used to prepare them. The financial statements have been prepared in accordance with the accounting principles generally accepted in the United States of America and we are required to make judgments, estimates, and assumptions in the course of such preparation. The Summary of Accounting Policies included with the financial statements describes the significant accounting policies and methods used in the preparation of the financial statements. On an ongoing basis, we reevaluate our judgments, estimates, and assumptions, including those related to revenue recognition, allowance for doubtful accounts, valuation of inventories, and valuation of long-lived assets. We base our judgments and estimates on historical experience, knowledge of current conditions, and our beliefs of what could occur in the future considering available information. Actual results may differ from these estimates under different assumptions or conditions. The following are the critical accounting policies we believe are affected by significant judgments, estimates, and assumptions used in the preparation of the financial statements.

Revenue Recognition

Revenue is generally recognized upon shipment of product. Sales to distributors are made pursuant to agreements that provide the distributors certain rights of return and price protection on unsold merchandise. Revenues from such sales are recognized upon shipment, with a provision for estimated returns and allowances recorded at that time, if applicable. While distributors are allowed to return items for stock rotation, they are required to place an order of equal or greater value at the same time. Therefore, no allowance for returns is recorded. Because we generally do not change the pricing of our products more than once a year, there have not been any pricing issues in the past several years; therefore, there is no allowance for price protection recorded.

Allowance for Doubtful Accounts

We establish a general allowance for doubtful accounts based on analyzing historical bad debts, specific customer creditworthiness, and current economic conditions. Historically, we have not experienced significant losses related to receivables.

Inventories

We write down our inventories for lower of cost or market reserves, aged inventory reserves, and obsolescence reserves. As a result of production requirements and constraints, we are often required to estimate the sales expectations for the entire life cycle of a product (which can be ten or more years) and purchase materials upfront. If actual product demand or selling prices are less favorable than estimated, additional inventory write-downs may be required in the future. Conversely, if demand increases for product types that have been fully reserved, future margins may be higher.

Long-Lived Assets

Long-lived assets, including property and equipment, goodwill, and other intangible assets, are assessed for possible impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable, or whenever management has committed to a plan to dispose of the assets. Such assets are carried at the lower of book value or fair value as estimated by management based on appraisals, current market value, and comparable sales value, as appropriate. Assets to be held and used affected by such impairment loss are depreciated or amortized at their new carrying amounts over the remaining estimated life; assets to be sold or otherwise disposed of are not subject to further depreciation or amortization. In determining whether an impairment exists, we use undiscounted future cash flows without interest charges compared to the carrying value of the assets.

Deferred Income Taxes

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

Based on the historical taxable income and projections for future taxable income over the periods in which the deferred tax assets become deductible, management believes it more likely than not that we will not realize benefits of these deductible differences as of September 30, 2008. Accordingly, we have established a valuation allowance against our net deferred income tax assets as of September 30, 2008.

Impact of New Financial Accounting Standards

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which provides guidance for using fair value to measure assets and liabilities. The pronouncement clarifies (1) the extent to which companies measure assets and liabilities at fair value; (2) the information used to measure fair value; and
(3) the effect that fair value measurements have on earnings. SFAS No. 157 will apply whenever another standard requires (or permits) assets or liabilities to be measured at fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact this statement will have on our financial statements, if any.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. This statement also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact this statement will have on our financial statements, if any.