Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Some of the statements made by us in this Quarterly Report on Form 10-Q are forward-looking in nature, including but not limited to, statements relating to our future revenue, product development, demand, acceptance and market share, gross margins, levels of research and development, our management's plans and objectives for our current and future operations, and other statements that are not historical facts. Forward-looking statements include, but are not limited to, statements that are not historical facts, and statements including forms of the words "intend," "believe," "will," "may," "could," "expect," "anticipate," "plan," "possible," and similar terms. Actual results could differ materially from the results implied by the forward-looking statements due to a variety of factors, many of which are discussed throughout this Quarterly Report and particularly in the section titled "Additional Factors That May Affect Future Results" which is included in this section. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly release any revisions to these forward-looking statements that may reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Factors that could cause actual results to differ materially from those expressed in any forward-looking statement made by us include, but are not limited to:

· our ability to finance our activities and maintain our financial liquidity;

· our ability to attract and retain qualified, knowledgeable employees;

· the impact of general economic conditions on our business;

· postponements, reductions, or cancellations in orders from new or existing customers;

· the limited number of potential customers for our products;

· the variability in gross margins on our products;

· our ability to design and market new products successfully;

· our failure to acquire new customers in the future;

· deterioration of business and economic conditions in our markets;

· intensely competitive industry conditions with increasing price competition; and

· the rate of growth in the defense markets.

In this document, the words "we," "our," "ours," and "us" refer to AML Communications, Inc. and our sub division, Microwave Power, Inc. and our wholly owned subsidiary, Mica-Tech, Inc.

Overview

Our business is comprised of three reportable segments, AML Communications, Inc. ("AML"), Microwave Power, Inc. ("MPI"), and Mica-Tech, Inc ("Mica-Tech"). AML and MPI design, manufacture, and market RF and microwave amplifiers and subsystems serving, primarily, the Defense Electronic Warfare Market. AML and MPI represented 82.2% and 13.4% of our 2009 net revenue, respectively. Mica-Tech designs, manufactures, and markets an intelligent communication system to provide Supervisory Control and Data Acquisition (SCADA) of the electric power grid. Mica-Tech represented 4.4% of our 2009 net revenue.

Our AML segment includes low noise, power amplifiers and integrated sub assemblies with frequencies that range from 50 kHz to 26 GHz. In February 2001, we made a strategic decision to focus our resources on the defense markets. As such, we moved rapidly to utilize our knowledge base in defense microwave related design and manufacturing to offer new products, as well as variations of existing products. The results of this strategy have been an increase in revenues for defense related products, from $3.7 million in fiscal 2003 to $12.7 million in fiscal 2009.

We consider the AML segment to be our core business since it has a larger revenue base, and investments have been made in this segment that address long term growth. We devote most of our management time and other resources to improving the prospects for this segment. Most of our sales and marketing expenses are from the AML segment. The majority of our research and development spending is dedicated to this segment as well.

Our MPI segment includes solid state microwave amplifiers operating in the frequency range from 1 to 40 GHz with output power from 10mW to 500 W. In June 2004, we acquired MPI and have since operated it as a division of AML. The MPI division operates independently, with its own marketing, production, and general management team.

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Our Mica-Tech segment designs and manufactures the UltraSatNet, an Intelligent Satellite Utility Communication Solution for the monitoring and control of power grid distribution. The operating software and hardware are designed in-house with support from outside consultants. Since completion of the acquisition of the remaining interest in Mica-Tech in February 2008, steps are being taken to bolster Mica-Tech's financial structure while the company pursues the utility SCADA market.

Results of Operations

Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008

Net sales. Net sales for the three months ended June 30, 2009 were approximately $3.4 million, compared to approximately $3.3 million for the three months ended June 30, 2008, representing an increase of $91,000. The primary reason for the increase between the two periods is due to an increase in revenues from MPI and Mica-Tech, which were offset by a decrease from AML. Specifically, AML's revenues decreased by $34,000, as compared to the same period last year. Revenue for the three months ended June 30, 2009 reflects low production rates that did not benefit from the increased bookings seen during the last six months. With engineering and production preparations for these orders complete, we have recently commenced high level production. Depending on the level of production that we can achieve, the financial impacts are forecasted to occur during the balance of the current fiscal year. Revenues from our MPI division increased by $37,000 due to increased incidental orders. Mica-Tech's revenues increased by $88,000 as a result of increased customer orders for engineering services.

Gross profit. Gross profit for the three months ended June 30, 2009 was approximately $1.4 million, or 41.2% of net sales, compared to a gross profit for the three months ended June 30, 2008, of approximately $1.5 million, or 45.3% of net sales. Gross profit, as a percentage of net sales, decreased by $77,000 between the two periods due to higher direct material costs and production inefficiency. Direct material costs vary from month to month due to the product mix. Our products are customer specific and therefore, the material content for these units will vary.

Selling, general, and administrative costs. Selling, general and administrative costs for the three months ended June 30, 2009 were $694,000, or 20.7% of net sales, compared to $734,000, or 22.5% of net sales, for the three months ended June 30, 2008, representing a decrease of $40,000. Selling, general and administrative costs for AML and MPI increased by $37,000, compared to the same period of the prior year, due to increased spending in investor relations and an employee's moving expense. Mica-Tech's administrative cost has been reduced by $77,000 mainly due to a reduction in payroll related expenses and building lease expenses as a result of cost management and reduced headcounts at Mica-Tech. To reduce operating costs, we relocated the Mica-Tech operation to the AML facility in May 2008.

Research and development costs. Research and development costs for the three months ended June 30, 2009 were $535,000, or 16.0% of net sales, compared to $481,000, or 14.8% of net sales, for the three months ended June 30, 2008, representing an increase of $54,000. AML's R&D expenses increased by $73,000 as a result of increased payroll related expenses due to additional headcount and pay increase, and increased spending in R&D materials and supplies. R&D costs for MPI and Mica-Tech decreased by $19,000 due to a reduction in payroll related expenses. We are committed to continue our investment in R&D projects to address customer needs for short and long term program orders.

Other net income. We recorded a net other income of $2,000 for the three months ended June 30, 2009 and a net other income of $488,000 for the three months ended June 30, 2008. During the three months ended June 30, 2009, AML recorded a gain on assets disposed of $21,000, offset by interest expenses of $19,000. During the three months ended June 30, 2008, Mica-Tech realized a special gain of $521,000 from the settlement of a promissory note. The special gain from the settlement of a promissory note is considered a one-time event.

Income before income tax. Income before income tax was $154,000 for the three months ended June 30, 2009, compared to income before income tax of $751,000 for the three months ended June 30, 2008. The significant reduction in income before income tax, as compared to the same period of prior year, is mainly due to the special gain of $521,000 recognized during the three months ended June 30, 2008 and due to increased material costs during this period.

Income before income tax in the AML segment was $1,000 for the three months ended June 30, 2009, compared to $296,000 for the three months ended June 30, 2008. This decrease is mainly attributable to increased direct material costs and manufacturing overhead costs.

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Income before income tax in the MPI segment was $132,000 for the three months ended June 30, 2009, compared to $76,000 for the three months ended June 30, 2008. This increase is mainly attributable to increased revenue during this period.

Income before income tax in the Mica-Tech segment was $21,000 for the three months ended June 30, 2009, compared to income before income tax of $379,000 for the three months ended June 30, 2008. The significant reduction in income before income tax, as compared to the same period of prior year, is mainly due to the special gain recognized during the three months ended June 30, 2008.

Provision for income taxes. During the three months ended June 30, 2009, the company utilized its deferred tax assets reserve to record income tax expenses of $62,000. The company has no tax liability as of June 30, 2009 due to the deferred tax benefits accounted for in the prior years. The company utilized its deferred tax assets reserve to record income tax expenses of $300,000 during the three months ended June 30, 2008.

Net income. Net income was $92,000 or $0.01 per share for the three months ended June 30, 2009, compared to net income of $451,000, or $0.04 per share for the three months ended June 30, 2008.

Net income from the AML segment was $0 for the three months ended June 30, 2009 and $296,000 for the three months ended June 30, 2008.

Net income from the MPI segment was $79,000 for the three months ended June 30, 2009 and $76,000 for the three months ended June 30, 2008.

Net income from the Mica-Tech segment was $13,000 for the three months ended June 30, 2009 and $79,000 for the three months ended June 30, 2008.

In 2010, we expect total operating expenses to increase as we continue to invest in infrastructure and new product development. We expect operating expenses generally will increase more slowly than increases in revenue.

Liquidity and Capital Resources

Historically, we have financed our operations primarily from internally generated funds and, to a lesser extent, loans from stockholders, and capital lease obligations.

At June 30, 2009, AML had a line of credit agreement with Bridge Bank. On September 16, 2008, we signed a Business Financing Modification Agreement (the "Modification Agreement") with Bridge Bank to renew our line of credit, with a credit facility of $1.3 million. Of this $1.3 million, $1.0 million may be used for cash advances against accounts receivables and $0.3 million may be used for equipment advances. Our ability to borrow under this agreement varies based upon eligible accounts receivable and eligible equipment purchases. We are obligated to pay the bank a finance charge at a rate per year equal to the prime rate, which in no event shall be less than 5.00%, plus 0.25% with respect to cash advances, and a rate of such prime rate plus 1.0% with respect to equipment advances. We were obligated to pay a facility fee of $2,500 upon execution of the Modification Agreement and annually thereafter. We were also obligated to pay a one-time equipment loan facility fee of $2,500 upon execution of the Modification Agreement. We must maintain certain financial requirements, including a minimum Asset Coverage Ratio of 1.50 to 1.00. We are also required to stay within 80% of our planned quarterly revenue. We were in compliance with these requirements at June 30, 2009; however, there is no assurance that we will be in compliance at future dates. This agreement to provide cash advances against accounts receivables terminates on August 15, 2010 or upon a date that the bank or AML chooses to terminate the agreement. Any unpaid balance is due and payable pursuant to the agreement on the termination date. At June 30, 2009, we had an outstanding balance of $0 under the accounts receivable agreement and $361,000 under the equipment financing agreement, which includes amounts owed under prior lines of credit with Bridge Bank. Our remaining borrowing capacity is approximately $1,000,000 under the accounts receivable agreement and $0 under the equipment financing agreement as the availability period for the equipment term loan expired on December 31, 2008.

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At June 30, 2009, we had $1.2 million in cash and cash equivalents. For the three months ended June 30, 2009, our operating activities used cash of approximately $227,000 as compared to $88,000 cash used in our operating activities for the three months ended June 30, 2008. Net cash used in investing activities, primarily for the acquisition of production equipment, amounted to $36,000 for the three months ended June 30, 2009 and $35,000 for the three months ended June 30, 2008. Net cash used in financing activities was $115,000 for the three months ended June 30, 2009 and $105,000 for the three months ended June 30, 2008 due to paying $88,000 toward outstanding notes payable, capital lease obligation, and existing line of credit and paying $27,000 to repurchase 38,600 shares of common stock at the weighted average price of $0.71 per share during the three months ended June 30, 2009.

We anticipate capital expenditures of approximately $500,000 in fiscal year 2010. We believe that funds for these expenditures will be provided by our operating activities. However, we may choose to finance some of these expenditures through our financing agreement with Bridge Bank. At June 30, 2009, our remaining borrowing capacity under this agreement was $1,000,000.

We may attempt to procure additional sources of financing in the event that the capital available as of June 30, 2009 is insufficient for our operating needs and capital expenditures. These sources may include, but are not limited to, additional sales of our securities. There are, however, no assurances that we will be able to successfully obtain additional financing at terms acceptable to us. Failure to obtain such financing could have a material adverse effect on our ability to operate as a going concern.

Successful completion of our development program and attaining profitable operations are dependent upon our maintaining a level of sales adequate to support our cost structure. In addition, realization of a major portion of the assets in the accompanying balance sheet is dependent upon our ability to meet our financing requirements and the success of our plans to sell our products. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classifications of liabilities that might be necessary should we be unable to continue in existence.

Critical Accounting Policies

Our discussion and analysis of our financial conditions and results of operations are based upon our financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of financial statements requires managers to make estimates and disclosures on the date of the financial statements. On an on-going basis, we evaluate our estimates, including, but not limited to, those related to revenue recognition. We use authoritative pronouncements, historical experience, and other assumptions as the basis for making judgments. Actual results could differ from those estimates. We believe that the following critical accounting policies affect our more significant judgments and estimates in the preparation of our financial statements.

Revenue recognition. We generate our revenue through the sale of products. Our policy is to recognize revenue when the applicable revenue recognition criteria have been met, which generally include the following:

· Persuasive evidence of an arrangement exists;

· Delivery has occurred or services have been rendered;

· Price is fixed or determinable; and

· Collectibility is reasonably assured.

Revenue from the sale of products is generally recognized after both the goods are shipped to the customer and acceptance has been received, if required. Our products are custom made for our customers, who primarily consist of original engineer manufacturers (OEMs), and we do not accept returns. Our products are shipped complete and ready to be incorporated into higher level assemblies by our customers. The terms of the customer arrangements generally pass title and risk of ownership to the customer at the time of shipment.

Recording revenue from the sale of products involves the use of estimates and management judgment. We must make a determination at the time of sale whether the customer has the ability to make payments in accordance with arrangements. While we do utilize past payment history, and, to the extent available for new customers, public credit information in making our assessment, the determination of whether collectibility is reasonably assured is ultimately a judgment decision that must be made by management.

Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts receivable based on customer-specific allowances, as well as a general allowance. Specific allowances are maintained for customers that are determined to have a high degree of collectibility risk based on such factors, among others, as: (i) the aging of the accounts receivable balance; (ii) the customer's past payment experience; and (iii) a deterioration in the customer's financial condition, evidenced by weak financial condition and/or continued poor operating results, reduced credit ratings, and/or a bankruptcy filing. In addition to the specific allowance, we maintain a general allowance for all our accounts receivables which are not covered by a specific allowance. The general allowance is established based on such factors, among others, as: (i) the total balance of the outstanding accounts receivable, including considerations of the aging categories of those accounts receivable; (ii) past history of uncollectible accounts receivable write-offs; and (iii) the overall creditworthiness of the customer base. A considerable amount of judgment is required in assessing the realizability of accounts receivables. Should any of the factors considered in determining the adequacy of the overall allowance change, an adjustment to the provision for doubtful accounts receivable may be necessary.

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Inventory. Inventories are stated at the lower of cost or market, cost being determined on the first-in, first-out method. Inventories are written down if the estimated net realizable value is less than the recorded value. We review the carrying cost of our inventories by product each quarter to determine the adequacy of our reserves for obsolescence. In accounting for inventories, we must make estimates regarding the estimated net realizable value of our inventory. This estimate is based, in part, on our forecasts of future sales and age of the inventory.

Intangible Assets. We test intangible assets with indefinite lives for impairment on an annual basis or more frequently if certain events occur. If the assets are considered to be impaired, the impairment to be recognized will be measured by the amount in which the carrying amount exceeds the fair value of the assets. For our intangible assets with finite lives, including our customer lists, existing technology, and patents, we amortize the costs of the assets over their useful lives and assess impairment at least annually or whenever events and circumstances suggest the carrying value of an asset may not be recoverable. Determining the life of the assets with finite lives is judgmental in nature and involves the use of estimates and assumptions. These estimates and assumptions involve a variety of factors, including future market growth and conditions, forecasted revenues and costs and a strategic review of our business and operations. We base our fair value estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates. In the event we determine that an intangible asset is impaired in the future, an adjustment to the value of the asset would be charged to earnings in the period such determination is made.

Existing Technology. Our existing technology is based on a patent issued in 1990, which continues to be the main technology of MPI. It is a substrate deposition technology that is mature and with no replacement technology forecasted.

Additional Factors That May Affect Future Results

Future operating results may be impacted by a number of factors that could cause actual results to differ materially from those stated herein, which reflect management's current expectations. These factors include:

· industry-specific factors (including the reliance upon growth of the defense microwave market, significant competition characterized by rapid technological change, new product development, product obsolescence, and significant price erosion over the life of a product);

· our ability to timely develop and produce commercially viable products at competitive prices;

· our ability to produce products which meet the quality standards of both existing and potential new customers;

· our ability to accurately anticipate customer demand;

· our ability to manage expense levels, in light of varying revenue streams;

· the availability and cost of components;

· the impact of worldwide economic and political conditions on our business; and

· the ability to integrate potential future acquisitions into our existing operations.

We believe that, to the extent that foreign sales are recognized, we may face increased risks associated with political and economic instability, compliance with foreign regulatory rules governing export requirements, tariffs and other trade barriers, differences in intellectual property protections, longer accounts receivable cycles, currency fluctuations and general trade restrictions. If any of these risks materialize, they could have a material adverse effect on our business, results of operations, and financial condition.

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We have evaluated the credit exposure associated with conducting business with foreign customers and have concluded that such risk is acceptable. Nevertheless, any significant change in the economy or deterioration in United States trade relations or the economic or political stability of foreign markets could have a material adverse effect on our business, results of operations, and financial condition.

Sales to foreign customers are invoiced in U.S. dollars. Accordingly, we currently do not engage in foreign currency hedging transactions. However, as we expand further into foreign markets, we may experience greater risk associated with general business, political and economic conditions in those markets. At such time, we may seek to lessen our exposure through currency hedging transactions. We cannot assure you that a currency hedging strategy would be successful in avoiding currency exchange related losses. In addition, should the relative value of the U.S. dollar in comparison to foreign currencies increase, the resulting increase in the price of our products to foreign customers could result in decreased sales which could have a material adverse impact on our business, results of operations, and financial condition.

We experience significant price competition and expect price competition in the sale of our products to remain intense. We cannot assure you that our competitors will not develop new technologies or enhancements to existing products or introduce new products that will offer superior price or performance features. We expect our competitors will offer new and existing products at prices necessary to gain or retain market share. Several of our competitors have substantial financial resources, which may enable them to withstand sustained price competition or a downturn in the pricing of their products in the future. Substantially all of our competitors have, and potential future competitors could have, substantially greater technical, marketing, distribution and other resources than we do and have, or could have, greater name recognition and market acceptance of their products and technologies.

The markets in which we compete are characterized by rapidly changing technology and continuous improvements in products and services. Our future success depends on our ability to enhance our current products and to develop and introduce, in a timely manner, new products that keep pace with technological developments that meet or exceed industry standards, which compete effectively on the basis of price, performance and quality, that adequately address OEM customer and end-user customer requirements, and that achieve market acceptance. We believe that to remain competitive in the future we will need to continue to develop new products, which will require the investment of significant financial resources in new product development. In the event our newly developed products are not timely developed or do not gain market acceptance, our business, results of operations and financial condition could be materially adversely affected.

Our quarterly and annual results have in the past been, and will continue to be, subject to significant fluctuations due to a number of factors, any of which could have a material adverse effect on our business, financial condition and results of operations. There can be no assurance that we will not experience such fluctuations in the future. We establish our expenditure levels for product development and other operating expenses based on expected revenues, and expenses are relatively fixed in the short term. As a result, variations in timing of revenues can cause significant variations in quarterly results of operations. There can be no assurances that we will be profitable on a quarter-to-quarter basis in the future. We believe that period-to-period comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of future performance. Due to these factors, it is likely that in some future quarter or quarters our revenues or operating results will not meet the expectations of public stock market analysts or investors. In such event, the market price of our common stock would be materially adversely affected.