Item 2. 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. Words such as "anticipates, appears, expects, intends, hopes, plans, believes, seeks, estimates, may, will," and variations of these words or similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve a number of risks and uncertainties, including but not limited to operating results, new product introductions and sales, competitive conditions, customer demand, capital expenditures and resources, manufacturing capacity utilization, and intellectual property claims and defense. Factors that could cause actual results to differ materially are included in, but not limited to, those identified in "Item 1A - Risk Factors" in the Annual Report on Form 10-K for our fiscal year ended September 30, 2008 and in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" in such Annual Report on Form 10-K and in this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may reflect events or circumstances after the date of this report.

Results of Operations

Revenues

For the quarter and six months ended March 31, 2009, our net revenues decreased by $409,600 (42%) and $832,900 (45%) compared to the same periods of fiscal 2008. This decrease was primarily the result of the revenues from military projects decreasing and further deterioration of the revenue contributions from our older product offerings.

Expenses

Our cost of revenues for the quarter and six months ended March 31, 2009 decreased $737,000 (73%) and $1,064,400 (61%) compared to the same periods of fiscal 2008. This decrease is the result of the decrease in net revenues and a decrease in write-downs of inventory in fiscal 2009. During fiscal 2008, the Company wrote down $1,120,600 of slow-moving and/or obsolete inventory as of March 31, 2008, while in fiscal 2009, the inventory write-downs aggregate $250,200.

Research and development (R&D) expenditures for the quarter and six months ended March 31, 2009 decreased by $53,800 (15%) and $113,300 (16%) compared to the same periods of fiscal 2008. This decrease was the result of a reduction in staffing. As the development of new products is key to future growth, R&D expenses are expected to continue at the current level.

Selling, general, and administrative expenditures for the quarter and six months ended March 31, 2009 decreased by $10,100 (2%) and $68,400 (8%) compared to the same periods of fiscal 2008. This decrease was primarily the result of a reduction in staffing and a non-recurring severance charge in fiscal 2008.

For the quarter and six months ended March 31, 2009, interest income decreased by $15,200 (89%) and $23,400 (69%) compared to the same periods of fiscal 2008. This decrease is the result of lower cash balances and lower interest rates. Write-offs of capital equipment decreased in fiscal 2009 from $129,900 in fiscal 2008 to $4,100.

The decrease in net revenues for the quarter and six months ended March 31, 2009 was partially offset by the decrease in inventory write-downs and operating expenses, resulting in a decrease in the net loss for the quarter and six month periods of $370,900 (47%) and $512,800 (33%), respectively.

Liquidity and Capital Resources

Cash Flows

While the net loss for the six months ended March 31, 2009 was $1,041,700, the net cash used for operations was only $408,100. During the first six months of fiscal 2009, we wrote-off $250,200 of inventory, which increased the net loss but did not affect cash flows. Reductions of accounts receivable resulted in net cash inflows of $290,800 for operations. The liquidating of auction rate securities during January 2009 also resulted in an increase in net cash of $975,000, while the Company used $120,300 for the purchase of capital equipment to prepare for testing of new products.

Although we had a net loss of $1,544,500 for the six months ended March 31, 2008, we used net cash of only $147,200, primarily because the net loss includes write-offs of inventory totaling $1,120,200. The net cash used was largely the result of a increase in accounts receivable and the payment of prepaid expenditures, totaling $175,700. In addition, during the six months ended March 31, 2008, we used $201,000 for capital expenditures (mainly related to new product tooling) and made $112,000 from the sale of available-for-sale securities.

Working Capital

Historically, due to order scheduling by our customers, up to 80% of our quarterly revenues are shipped in the last month of the quarter, so a large portion of shipments included in our quarter-end accounts receivable are not yet due per our net 30 day terms. As a result, quarter-end accounts receivable balances are typically at their highest level for the respective period.

As a fabless semiconductor company with products having longer than normal product life cycles, our investment in inventories has been, and will continue to be, significant. Although high levels of inventory impact liquidity, we believe these costs are a less costly alternative to owning a wafer fabrication facility. Over the past few years, we have attempted to streamline our product offerings, in turn reducing our inventory levels, and we will continue this effort in the upcoming periods.

During fiscal 2008, we reduced our inventory by 67%, or $2,964,000, including write-downs of $2,059,300, and have reduced our inventory by an additional 17%, or $244,000, during the first six months of fiscal 2009. This reduction in fiscal 2009 includes a write-down of $250,200 for slow-moving inventory.

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 was no net-cost as the interest charged was 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 to sell our ARS to UBS at par value within a two-year period beginning January 2, 2009.

At the time these ARS Rights were exercised, we planned to pay back the no net-cost loan from UBS Bank USA and the line would be closed. In December 2008, UBS liquidated $50,000 of our $975,000 of ARS, which we used to pay down the line of credit. In January 2009, the remaining $925,000 of ARS were liquidated and paid down against the line of credit and all UBS accounts were closed in February 2009.

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.

Impact of New Financial Accounting Standards

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 became effective on October 1, 2008 for us and we did not elect to adopt the fair value option for any financial instruments.

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In May 2008, the FASB issued SFAS No.162, The Hierarchy of Generally Accepted Accounting Principles. SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP. SFAS 162 will become effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board amendments to AU
Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. SFAS No. 162 is effective for fiscal years beginning after November 15, 2008. We are currently assessing the impact, if any, SFAS 162 will have on our financial statements.