Overview

Giga-tronics produces instruments, subsystems and sophisticated microwave components that have broad applications in both defense electronics and wireless telecommunications. In 2009 Giga-tronics' business consisted of two operating and reporting segments: Giga-tronics Division and Microsource.

The Company's business is highly dependent on government spending in the defense electronics sector and on the wireless telecommunications market. Defense orders have improved on a year-to-date basis for fiscal 2009 versus fiscal 2008 whereas on a year-to-date basis, commercial orders are slightly down in fiscal 2009 versus fiscal 2008.

The Company continues to monitor costs, including reductions in personnel, facilities and other expenses, to more appropriately align costs with revenues. In April 2007, the Company restored the prior salary reductions. In March 2007, the Company moved ASCOR's engineering, sales and marketing, and administrative activities to the San Ramon, California facility, effectively vacating its Fremont, California facility. As a result, the Company has accrued its future lease obligations through June 2009. Microsource sales and marketing and engineering activities were also consolidated into the San Ramon facility to better integrate its component development activities with the Company's overall new product plans. The Microsource facility in Santa Rosa, California, however, remains open as a manufacturing operation.

Results of Operations

New orders by segment are as follows for the fiscal years ended:

New Orders                                                             % change
                                                                   2009       2008
                                                                    vs.        vs.
(Dollars in thousands)       2009         2008         2007        2008       2007
Giga-tronics             $ 11,599     $ 13,795     $ 13,067         (16 %)       6 %
Microsource                 7,399        3,625        3,091         104 %       17 %
Total                    $ 18,998     $ 17,420     $ 16,158           9 %        8 %

New orders received in fiscal 2009 increased 9% to $18,998,000 from the $17,420,000 received in fiscal 2008. New orders increased primarily due to an increase in military orders.

New orders received in fiscal 2008 increased 8% to $17,420,000 from the $16,158,000 received in fiscal 2007. New orders increased primarily due to an increase in military orders.

In fiscal 2009, orders at Giga-tronics Division decreased primarily due to a decrease in commercial demand for its products. Microsource increased primarily due to an increase in military demand for its products.

In fiscal 2008, orders at Giga-tronics Division increased primarily due to an increase in commercial demand for its products. Microsource increased primarily due to an increase in military demand for its products.

The following table shows order backlog and related information at fiscal year-end:

Backlog                                                                                 % change
                                                                                  2009            2008
                                                                                   vs.             vs.
(Dollars in thousands)                 2009          2008          2007           2008            2007
Backlog of unfilled orders        $   9,105     $   7,528     $   8,439             21 %           (11 %)
Backlog of unfilled orders
shippable within one year             6,810         4,604         5,294             48 %           (13 %)
Previous fiscal year end (FYE)
long term backlog
reclassified during year as
shippable within one year             1,640           425           303            286 %            40 %
Net cancellations during year
of previous FYE
one-year backlog                          -             -           904              -               -

The increase in backlog at year-end 2009 of 21% was primarily due to orders exceeding shipments.

The decrease in backlog at year-end 2008 of 11% was primarily due to shipments exceeding orders.

The allocation of net sales was as follows for the fiscal years shown:

Allocation of Net Sales                                                    % change
                                                                     2009          2008
                                                                      vs.           vs.
(Dollars in thousands)        2009         2008         2007         2008          2007
Commercial                $  6,303     $  7,020     $  7,054          (10 %)          0 %
Government / Defense        11,118       11,311       10,994           (2 %)          3 %
   Total                  $ 17,421     $ 18,331     $ 18,048           (5 %)          2 %

The allocation of net sales by segment was as follows for the fiscal years shown:

Allocation of Net Sales by Segment                                            % change
                                                                        2009         2008
                                                                         vs.          vs.
(Dollars in thousands)           2009         2008         2007         2008         2007
Giga-tronics Division
Commercial                   $  4,694     $  5,282     $  5,355          (11 %)        (1 %)
Government / Defense            6,989        9,264        7,183          (25 %)        29 %
   Total                     $ 11,683     $ 14,546     $ 12,538          (20 %)        16 %

Microsource
Commercial                   $  1,609     $  1,738     $  1,699           (7 %)         2 %
Government / Defense            4,129        2,047        3,811          102 %        (46 %)
   Total                     $  5,738     $  3,785     $  5,510           52 %        (31 %)

Fiscal 2009 net sales were $17,421,000, a 5% decrease from the $18,331,000 of net sales in 2008. The decrease in sales was primarily due to a decrease in commercial shipments. Sales at Giga-tronics Division decreased 20% or $2,863,000. Microsource sales increased 52% or $1,953,000.

Fiscal 2008 net sales were $18,331,000, a 2% increase from the $18,048,000 of net sales in 2007. The increase in sales was primarily due to improved military deliveries. Sales at Giga-tronics Division increased 16% or $2,008,000. Microsource sales decreased 31% or $1,725,000.

Cost of sales was as follows for the fiscal years shown:

Cost of Sales                                                            % change
                                                                  2009          2008
                                                                   vs.           vs.
(Dollars in thousands)      2009         2008         2007        2008          2007
Cost of sales            $ 9,917     $ 10,583     $ 10,502          (6 %)          1 %

In fiscal 2009, cost of sales decreased 6% to $9,917,000 from $10,583,000 in fiscal 2008, driven by a reduction in sales. However, the percentage rate increased by 0.8% from 42.3% in fiscal 2008 to 43.1% in fiscal 2009, due to the change in product mix.

In fiscal 2008, cost of sales increased 1% to $10,583,000 from $10,502,000 in fiscal 2007.

Operating expenses were as follows for the fiscal years shown:

Operating Expenses                                                                             % change
                                                                                      2009              2008
                                                                                       vs.               vs.
(Dollars in thousands)                     2009          2008          2007           2008              2007
Engineering                           $   1,975     $   2,248     $   3,731            (12 %)            (40 %)
Selling, general and administrative       5,939         5,538         5,456              7 %               2 %
Restructuring                                 -           153           361           (100 %)            (58 %)
Total                                 $   7,914     $   7,939     $   9,548              0 %             (17 %)

Operating expenses decreased $25,000 in fiscal 2009 over 2008 due to a decrease of $273,000 in product development expenses excluding NRE costs and a decrease of $153,000 in restructuring charges, offset by an increase of $401,000 in selling, general and administrative expense. The increase in selling, general and administrative expense is a result of higher marketing expense of $394,000 and higher administrative expense of $194,000 offset by lower commission expense of $187,000. As a result of adopting SFAS 123(R) in fiscal 2007, the Company recorded $270,000 of expense in fiscal 2009.

Operating expenses decreased 17% or $1,609,000 in fiscal 2008 over 2007 due to a decrease of $1,483,000 in product development expense and a decrease of $208,000 in restructuring charges, offset by an increase of $82,000 in selling, general and administrative expense. The increase in selling, general and administrative expense is a result of higher marketing expense of $251,000 and higher commission expense of $199,000, offset by lower administrative expense of $368,000. As a result of adopting SFAS 123(R) in fiscal 2007, the Company recorded $211,000 of expense in fiscal 2008. Included in the operating expenses for fiscal 2008 was a one-time restructuring charge of $73,000 to reserve the remaining lease obligation on the Fremont facility and $80,000 in severance cost, for a total of $153,000.

Net interest income in 2009 decreased from $36,000 to $7,000 due to a lower average cash balance throughout the year.

Net interest income in 2008 decreased from $108,000 to $36,000 due to a lower average cash balance throughout the year.

Giga-tronics recorded a net loss of $330,000 or $0.07 per fully diluted share for fiscal 2009 versus a net loss of $234,000 or $0.05 per fully diluted share in fiscal 2008.

Giga-tronics recorded a net loss of $234,000 or $0.07 per fully diluted share for fiscal 2008 versus a net loss of $1,867,000 or $0.39 per fully diluted share in fiscal 2007.

Inventories consist of the following:

Net Inventories                                    % change
                                                       2009
                                                        vs.
(Dollars in thousands)       2009        2008          2008
Raw materials             $ 3,263     $ 2,767            18 %
Work-in-progress            1,127       1,501           (25 %)
Finished goods                559         369            51 %
Demonstration inventory       460         371            24 %
Total                     $ 5,409     $ 5,008             8 %

Inventories increased by $401,000 at fiscal year end 2009 compared to the prior fiscal year end, primarily due to a return of goods from a customer.

Financial Condition and Liquidity

As of March 28, 2009, Giga-tronics had $1,518,000 in cash and cash-equivalents, compared to $1,845,000 as of March 29, 2008.

Working capital for the 2009 fiscal year end was $7,131,000, compared to $7,231,000 in 2008 and $7,280,000 in 2007. The decrease in working capital at 2009 from 2008 was primarily due to the operating loss in the year. The decrease in working capital at 2008 from 2007 was primarily due to the operating loss in the year and other fiscal year-end liabilities offset by a reduction in net inventories.

The Company's current ratio (current assets divided by current liabilities) at March 28, 2009 was 3.1 compared to 3.7 on March 29, 2008 and 3.1 on March 31, 2007. At March 28, 2009 the decrease was primarily the result of an increase in accounts payable at quarter end and an increase in deferred revenue offset by an equal increase in accounts receivable. At March 29, 2008, the increase in this ratio was primarily the result of a decrease in net inventories offset by other fiscal year-end liabilities.

Cash used in operations amounted to $300,000 in 2009. Cash provided by operations amounted to $220,000 in 2008. Cash used in operations amounted to $1,406,000 in 2007. Cash used in operations in 2009 was primarily attributed to the operating loss for the year. Cash provided by operations in 2008 was primarily attributed to the decrease in inventories, partially offset by the operating loss in the year. Cash used in operations in 2007 was primarily attributed to the operating loss in the year.

Additions to property and equipment were $69,000 in 2009 compared to $206,000 in 2008 and $204,000 in 2007. The capital equipment spending in fiscal 2009 was due to an upgrade of capital equipment enabling the manufacture of new products being released. The capital equipment spending in fiscal 2008 was due to the implementation of the Enterprise Resource Plan (ERP) system at Giga-tronics and Microsource. The capital equipment spending in fiscal 2007 was due to an upgrade of capital equipment enabling the manufacture of new products being released.

Other cash inflows in 2008 consisted of $22,000 from the sale of common stock in connection with the exercise of stock options.

Contractual Obligations

The Company leases various facilities under operating leases that expire through May 2013. Total future minimum lease payments under these leases amount to approximately $3,487,000.

The Company leases equipment under capital leases that expire through September 2012. The future minimum lease payments under these leases amount to approximately $45,000.

The Company is committed to purchase certain inventory under non-cancelable purchase orders. As of March 28, 2009, total non-cancelable purchase orders were approximately $1,152,000 through fiscal 2010 and $202,000 beyond fiscal 2010 and were scheduled to be delivered to the Company at various dates through May 2010.

The following table disclosed the amount of payments due under certain contractual obligations in the specified time periods.

                                                                     One to     Three to five     More than five
(Dollars in thousands)                       Under one year     three years             years              years
Operating leases                           $          1,067     $     1,458     $         962     $            0
Capital lease                                            18              18                 9                  -
Purchase obligations                                  1,152             202                 -                  -
Total                                      $          2,237     $     1,678     $         971     $            0

Critical Accounting Policies

The Company's discussion and analysis of its financial condition and the results of operations are based upon the consolidated financial statements included in this report and the data used to prepare them. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and management is required to make judgments, estimates and assumptions in the course of such preparation. The Summary of Significant Accounting Policies included with the consolidated financial statements describes the significant accounting policies and methods used in the preparation of the consolidated financial statements. On an ongoing basis, the Company re-evaluates its judgments, estimates and assumptions, including those related to revenue recognition, product warranties, allowance for doubtful accounts, valuation of inventories and valuation allowance on deferred tax assets. The Company bases its judgment and estimates on historical experience, knowledge of current conditions, and its beliefs of what could occur in the future considering available information. Actual results may differ from these estimates under different assumptions or conditions. Management of Giga-tronics has identified the following as the Company's critical accounting policies:

Revenue Recognition

Revenues are recognized when there is evidence of an arrangement, delivery has occurred, the price is fixed or determinable, and collectability is reasonably assured. This generally occurs when products are shipped and the risk of loss has passed. Revenue related to products shipped subject to customers' evaluation is recognized upon final acceptance.

Product Warranties

The Company's warranty policy generally provides one to three years of coverage depending on the product. The Company records a liability for estimated warranty obligations at the date products are sold. The estimated cost of warranty coverage is based on the Company's actual historical experience with its current products or similar products. For new products, the required reserve is based on historical experience of similar products until sufficient historical data has been collected on the new product. Adjustments are made as new information becomes available.

Accounts Receivable

Accounts receivable are stated at their net realizable value. The Company has estimated an allowance for uncollectible accounts based on analysis of specifically identified problem accounts, outstanding receivables, consideration of the age of those receivables, and the Company's historical collection experience.

Inventory

Inventories are stated at the lower of cost or market. Cost is determined on a first-in, first-out basis. The Company periodically reviews inventory on hand to identify and write down excess and obsolete inventory based on estimated product demand.

Deferred Income Taxes

Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred 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 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 management is unable to conclude that its deferred tax assets will more likely than not be realized from the results of operations. The Company has recorded a valuation allowance to reflect the estimated amount of deferred tax assets that may not be realized. The ultimate realization of deferred tax assets is dependent upon generation of future taxable income during the periods in which those temporary differences become deductible. Management considers 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 has established a valuation allowance against its net deferred tax assets as of March 28, 2009 and March 29, 2008.

The Company considers all tax positions recognized in its financial statements for the likelihood of realization. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the positions taken or the amounts of the positions that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.

Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above, if any, would be reflected as a liability for unrecognized tax benefits in the accompanying condensed balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company recognizes accrued interest and penalties, if any, related to unrecognized tax benefits as a component of the provision for income taxes in the consolidated statements of operations.

Product Development Costs

The Company incurs pre-production costs on certain long-term supply arrangements. The costs, which represent non-recurring engineering and tooling costs, are capitalized as other assets and amortized over their useful life when reimbursable by the customer. All other pre-production and product development costs are expensed as incurred.

Share-Based Compensation

The Company has a stock incentive plan that provides for the issuance of stock options to employees. The Company calculates compensation expense under SFAS 123(R) using a Black-Scholes-Merton option pricing model. In so doing, the Company makes certain key assumptions in making estimates used in the model. The Company believes the estimates used, which are presented in Note 1 of Notes to Consolidated Financial Statements, are appropriate and reasonable.

Off-Balance-Sheet Arrangements

The Company has no other off-balance-sheet arrangements (including standby letters of credit, guaranties, contingent interests in transferred assets, contingent obligations indexed to its own stock or any obligation arising out of a variable interest in an unconsolidated entity that provides credit or other support to the Company), that have or are likely to have a material effect on its financial conditions, changes in financial conditions, revenue, expense, results of operations, liquidity, capital expenditures or capital resources.

Management believes that the Company has adequate resources to meet its anticipated operating and capital expenditure needs for the foreseeable future. Giga-tronics intends to maintain research and development expenditures for the purpose of broadening its product base. From time to time, Giga-tronics considers a variety of acquisition opportunities to also broaden its product lines and expand its markets. Such acquisition activity could also increase the Company's operating expenses and require the additional use of capital resources.