Summary of ADVANCED PHOTONIX INC

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

Forward-Looking Statements
Certain statements contained in this Management's Discussion and Analysis (MD&A), including, without limitation, statements containing the words "may," "will," "can," "anticipate," "believe," "plan," "estimate," "continue," and similar expressions constitute "forward-looking statements." These forward-looking statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including risks described in the Risk Factors sections and elsewhere in this filing. Except for our ongoing obligation to disclose material information as required by federal securities laws, we do not intend to update you concerning any future revisions to any forward-looking statements to reflect events or circumstances occurring after the date of this report. The following discussion should be read in conjunction with the Risk Factors as well as our financial statements and the related notes.

Critical Accounting Policies and Estimates The discussion and analysis of Company's financial condition and results of operations is based on its condensed consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires us to make judgments and estimates that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statement and the reported amount of revenues and expenses during the reporting period. The Company bases its estimates on historical experience and on various other assumptions that it believes are reasonable under the circumstances. Actual results may differ from such estimates under different assumptions or conditions.

Application of Critical Accounting Policies Application of the Company's accounting policies requires management to make certain judgments and estimates about the amounts reflected in the financial statements. Management uses historical experience and all available information to make these estimates and judgments, although differing amounts could be reported if there are changes in the assumptions and estimates. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts, inventory allowances, valuation of intangible assets and goodwill, depreciation and amortization, warranty costs, taxes and contingencies. Management has identified the following accounting policies as critical to an understanding of its financial statements and/or as areas most dependent on management's judgment and estimates.

Global Economic Conditions
The credit markets and the financial services industry continue to experience a period of significant disruption characterized by the bankruptcy, failure, collapse or sale of various financial institutions, increased volatility in securities prices, severely diminished liquidity and credit availability and a significant level of intervention from the United States and other governments. Continued concerns about the systemic impact of potential long-term or widespread recession, energy costs, geopolitical issues, the availability and cost of credit, the global commercial and residential real estate markets and related mortgage markets and reduced consumer confidence have contributed to increased market volatility and diminished expectations for most developed and emerging economies continuing into 2010. As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Continued turbulence in the United States and international markets and economies could restrict our ability to refinance our existing indebtedness, increase our costs of borrowing, limit our access to capital necessary to meet our liquidity needs and materially harm our operations or our ability to implement our business strategy.

Revenue Recognition
Revenue is derived principally from the sales of the Company's products. The Company recognizes revenue when the basic criteria of SEC Staff Accounting Bulletin No. 104 are met. Specifically, the Company recognizes revenue when persuasive evidence of an arrangement exists, usually in the form of a purchase order, when shipment has occurred since its terms are FOB source, or when services have been rendered, title and risk of loss have passed to the customer, the price is fixed or determinable and collection is reasonably assured in terms of both credit worthiness of the customer and there are no post shipment obligations or uncertainties with respect to customer acceptance.

The Company sells certain of its products to customers with a product warranty that provides warranty repairs at no cost. The length of the warranty term is one year from date of shipment. The Company accrues the estimated exposure to warranty claims based upon historical claim costs. The Company's management reviews these estimates on a regular basis and adjusts the warranty provisions as actual experience differs from historical estimates or as other information becomes available.

The Company does not provide price protection or general right of return. The Company's return policy only permits product returns for warranty and non-warranty repair or replacement and requires pre-authorization by the Company prior to the return. Credit or discounts, which have been historically insignificant, may be given at the discretion of the Company and are recorded when and if determined.

The Company predominantly sells directly to original equipment manufacturers with a direct sales force. The Company sells in limited circumstances through distributors. Sales through distributors represent approximately 6% of total revenue. Significant terms and conditions of distributor agreements include FOB source, net 30 days payment terms, with no return or exchange rights, and no price protection. Since the product transfers title to the distributor at the time of shipment by the Company, the products are not considered inventory on consignment.

Revenue is also derived from technology research and development contracts. We recognize revenue from these contracts as services and/or materials are provided.

Impairment of Long-Lived Assets
As of September 25, 2009 and March 31, 2009, our consolidated balance sheet included $4.6 million in goodwill. Goodwill represents the excess purchase price over amounts assigned to tangible or identifiable intangible assets acquired and liabilities assumed from our business acquisitions.

In accordance with FASB guidance, goodwill and intangible assets that are not subject to amortization shall be tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test shall consist of a comparison of the fair value of the asset with its carrying amount, as defined. This guidance requires a two-step method for determining goodwill impairment. Step one is to compare the fair value of the reporting unit with the unit's carrying amount, including goodwill. If this test indicates that the fair value is less than the carrying value, then step two is required to compare the implied fair value of the reporting unit's goodwill with the carrying amount of the reporting unit's goodwill. If the carrying amount of the asset exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess.

We determine the fair value of our single reporting unit to be equal to our market capitalization plus a control premium. Market capitalization is determined by multiplying the shares outstanding on the assessment date by the average market price of our common stock over a 10-day period before and a 10-day period after each assessment date. We use this 20-day duration to consider inherent market fluctuations that may affect any individual closing price. We believe that our market capitalization alone does not fully capture the fair value of our business as a whole, or the substantial value that an acquirer would obtain from its ability to obtain control of our business. As such, in determining fair value, we add a control premium - which seeks to give effect to the increased consideration a potential acquirer would be required to pay in order to gain sufficient ownership to set policies, direct operations and make decisions related to our company - to our market capitalization.

The Company's evaluation as of March 31, 2009 indicated there were no impairments. As of March 31, 2009, our market capitalization calculated as described as above, had fallen to $17.1 million and our carrying value, including goodwill, had decreased to $17.9 million. We applied a 25% control premium to market capitalization to determine a fair value of $21.4 million. We believe that including a control premium at this level is supported by recent transaction data in our industry. Absent the inclusion of a control premium greater than 4% for FY 2009, our carrying value would have exceeded fair value, requiring a step two analysis which may have resulted in an impairment of goodwill.

We determined in the six-month period ended September 25, 2009 that there were no events or changes in circumstances since the end of fiscal year 2009 requiring an impairment test. Our stock price has fluctuated from a high of $0.87 to a low of $0.55 during the second quarter of FY 2010. The current macroeconomic environment continues to be challenging and we cannot be certain of the duration of these conditions and their potential impact on our stock price performance. If our stock price declines and such a decline persists and our market capitalization falls below our carrying value for a sustained period, it is reasonably likely that a goodwill impairment assessment prior to the next annual review in the fourth quarter of fiscal 2010 would be necessary and an impairment of goodwill may be recorded.

In accordance with FASB guidance, the carrying value of long-lived assets, including amortizable intangibles and property and equipment, are evaluated whenever events or changes in circumstances indicate that a potential impairment has occurred relative to a given asset or assets. Impairment is deemed to have occurred if projected undiscounted cash flows associated with an asset are less than the carrying value of the asset. The estimated cash flows include management's assumptions of cash inflows and outflows directly resulting from the use of that asset in operations. The amount of the impairment loss recognized is equal to the excess of the carrying value of the asset over its then estimated fair value. The Company's evaluation for the fiscal year ended March 31, 2009, indicated there were no impairments.

We determined in the six-month period ended September 25, 2009 that there were no events or changes in circumstances since the end of fiscal year 2009 that would indicate that a potential impairment has occurred. We may subsequently experience unforeseen issues that may adversely affect our business and may trigger an evaluation of the recoverability of the carrying value of our long-lived assets. Future determinations of significant write-offs of our long-lived assets could have a negative impact on our results of operations and financial condition.

Deferred Tax Asset Valuation Allowance
The Company records deferred income taxes for the future tax consequences of events that were recognized in the Company's financial statements or tax returns. The Company records a valuation allowance against deferred tax assets when, in management's judgment, it is more likely than not that the deferred income tax assets will not be realized in the foreseeable future. Consistent with the March 31, 2009 10-K, the Company has a full valuation allowance on its net Deferred Tax Assets as of September 25, 2009.

Inventories
The Company's inventories are stated at the lower of standard cost (which approximates actual cost under the first-in, first-out method) or market. Slow moving and obsolete inventories are reviewed throughout the year. To calculate a reserve for obsolescence, we begin with a review of our slow moving inventory. Any inventory, which has been slow moving within the past 12 months, is evaluated and reserved if deemed appropriate. In addition, any residual inventory, which is customer specific and remaining on hand at the time of contract completion, is reserved for at the standard unit cost. The complete list of slow moving and obsolete inventory is then reviewed by the production, engineering and/or purchasing departments to identify items that can be utilized in the near future. These items are then excluded from the analysis and the remaining amount of slow-moving and obsolete inventory is then reserved for. Additionally, non-cancelable open purchase orders for parts we are obligated to purchase where demand has been reduced may be reserved. Reserves for open purchase orders where the market price is lower than the purchase order price are also established. If a product that had previously been reserved for is subsequently sold, the amount of reserve specific to that item is then reversed.

RESULTS OF OPERATIONS

In anticipation of the economic slowdown, the Company instituted company-wide cost reduction measures to mitigate the impact of the revenue shortfall. These included headcount reductions, benefit reductions and wage freezes. In addition, the Company deferred all non-essential capital expenditures. These measures, combined with prior cost savings through facility consolidations over the past few years, have significantly lowered the Company's breakeven cash flow during this fiscal year. During the first half of the year, these cost reduction measures have saved approximately $1.8 million in cost of goods sold overhead and operating expenses without sacrificing the investments necessary in new product developments that will drive growth as the economy emerges from the recession. Despite a 29% drop in year-to-date revenue, the Company's gross margin percentage remained flat during the 1st half of the year due to the above cost saving measures and product mix.

Revenues
The Company predominantly operates in one industry segment, consisting of light
and radiation detection devices. The Company sells its products to multiple
markets including telecommunications, industrial sensing/non destructive testing
(NDT), military-aerospace, medical, and homeland security.

Revenues by market consisted of the following (dollars in thousands):

                                                                                  Three months ended                                         Six months ended
 Revenues                                                           September 25, 2009           September 26, 2008           September 25, 2009           September 26, 2008
 Telecommunications                                               $     1,489        28%       $     1,490        18%       $      3,189       28%       $      3,689       23%
 Industrial Sensing/NDT                                                 1,864        34%             3,111        38%              3,990       35%              6,322       40%
 Military/Aerospace                                                     1,813        33%             2,480        30%              3,750       33%              4,243       27%
 Medical                                                                  138         3%               492         6%                260        2%                992        6%
 Homeland Security                                                        120         2%               615         8%                169        2%                712        4%
     Total Revenues                                               $     5,424       100%       $     8,188       100%       $     11,358      100%       $     15,958      100%

The Company's revenues for the quarter ended September 25, 2009 were $5.4 million, a decrease of 34% (or $2.8 million) from revenues of $8.2 million for the quarter ended September 26, 2008. Year to date revenues were approximately $11.4 million, 29% lower (or approximately $4.6 million) from the prior year. The Company experienced significant reductions in four of the five markets for the quarter ending September 25, 2009. On a year to date basis, all five markets were lower than the same period in the prior year.

Telecommunications market revenues of $1.5 million for Q2 2010 were flat compared to the prior year quarter. For the six-month period ending September 25, 2009, revenues were $3.2 million, down $500,000 (14%) from the prior year. The Company's telecommunications revenues for the first half of the year continued to reflect the economic slowdown as our customers responded to the recession by implementing inventory reduction programs and delaying second source initiatives for the 40G line side products. During the second quarter, customer inventory reduction programs were largely completed and second source initiatives are slowly coming on line. Customers are purchasing to orders rather than to forecast in response to the uncertain economic conditions. Based on customer guidance, the reduced demand was not the result of changing underlying market demand for 40G infrastructure capacity expansion. During the quarter, the Company announced a HSOR worldwide multi-source agreement (MSA) for the emerging 100G market expected to begin ramping up in calendar year 2011.

Medical market revenues for Q2 2010 were $138,000, a decrease of 72% (or $354,000) from Q2 2009. Revenues for the six-months ending September 25, 2009 were $260,000, down $732,000 (74%) from the prior year. This decrease was primarily a result of the Company's decision to eliminate business at a customer that did not meet its profitability criteria. The Company expects Medical market revenues to be lower for the year as compared to the prior year.

Military/Aerospace market revenues in Q2 2010 were $1.8 million, a decrease of 27% (or $667,000) from the comparable prior period revenues of $2.5 million. Military/Aerospace market revenues for the six-month period were approximately $3.7 million, 12% (or approximately $500,000) lower than the comparable prior year period. The decreases were attributable primarily to lower customer requirements, offset partially by an increase in Terahertz contracts. The Company expects military revenues to be up for the year compared to the prior year.

Industrial Sensing/NDT market revenues decreased to $1.9 million in Q2 2010 and $4.0 million for the six-month period, decreases of 40% (or $1.2 million) and 37% (or $2.3 million) from the comparable prior year periods. The Company's Industrial Sensing/NDT revenue in the second quarter continued to experience a slow down as our customers responded to reduced demand as the result of the recession and our customers delayed capital expenditures which delayed purchases of our terahertz products. The Company expects Industrial Sensing/NDT revenues to improve in the second half of the year as the economy begins its anticipated climb out of the recession; however, we expect an overall decline in the Industrial Sensing/NDT market for fiscal year 2010 compared to the prior year.

Homeland Security revenues in Q2 2010 were $120,000 and $169,000 for the six-month period. The sales in the current fiscal year are attributable to a THz development contract for the nuclear gauge replacement from the Department of Homeland Security. The Company expects Homeland Security revenues for the remainder of the year to be down significantly as compared to the prior year as a result of the terahertz development contract ending in September 2009.

Gross Profit
Gross profit for Q2 2010 was $2.1 million compared to Q2 2009 of $3.6 million, or a decrease of $1.5 million on lower revenue volume of $2.8 million. Gross profit margins decreased to 38% for Q2 2010 compared to 44% of sales for the comparable prior year. The lower gross profit margin was due primarily to lower volume, offset partially by cost reductions now being realized through our FY2010 company-wide cost reduction initiative and prior years' facilities consolidation activities.

Year to date Gross profit was $5.1 million (or 45% of revenue), compared to the first six months of FY 2009 of $7.3 million (or 46% of revenue). The lower gross profit margin was due primarily to lower volume, offset partially by cost reductions now being realized through our FY2010 company-wide cost reduction initiative and prior years' facilities consolidation activities. Despite a 29% drop in revenue, the Company's gross margin percentage remained flat during the 1st half of the year.

Operating Expenses
Total operating expenses were $3.1 million during Q2 2010 as compared to $3.8 million in Q2 2009, a decrease of approximately $700,000. This decrease was primarily driven by SG&A cost savings initiatives, lower sales and marketing expenses related to the decrease in revenue, combined with the completion of the Wafer Fabrication consolidation in Q1 2010. These decreases were partially offset by an increase in R&D expenses.

Total operating expenses for the six-month period ended September 25, 2009 were $6.3 million as compared to $7.3 million for the same prior year period, a decrease of $1 million. This decrease was primarily driven by SG&A cost savings initiatives, lower sales and marketing expenses related to the decrease in revenue, combined with the completion of the Wafer Fabrication consolidation in Q1 2010. These decreases were partially offset by a slight increase in R&D expenses.

Research, development and engineering (RD&E) expenses increased by $86,000 in Q2 2010 compared to Q2 2009, primarily due to higher spending on product development in our high speed optical receiver (HSOR) and Terahertz product platforms.

Research, development and engineering (RD&E) expenses were relatively flat for the six month period ended September 25, 2009 compared to the six month period ended September 26, 2008. The Company plans to continue to invest in the next generation 40G/100G HSOR products and THz applications in FY 2010 in order to gain HSOR market share and move THz from the laboratory to the factory floor.

Sales and marketing expenses decreased $292,000 (or 41%) to $418,000 in Q2 2010, as compared to $710,000 for Q2 2009. The decrease was primarily attributable to lower compensation expenses driven by the Company's cost saving measures implemented in response to the recession and lower sales volume.

Sales and marketing expenses decreased $461,000 (or 35%) to $869,000 for the six month period ended September 25, 2009, compared to $1.3 million for six month period ended September 26, 2008. The decrease was primarily attributable to lower compensation expenses driven by the Company's cost saving measures implemented in response to the recession and lower sales volume.

The Company has and will continue to focus its sales and marketing activity for the growing Telecom and Industrial/NDT markets. However, sales and marketing expense savings are expected to continue for the balance of FY 2010.

Total general and administrative expenses (G&A) had decreased $451,000 (31%), to approximately $981,000 (18% of sales) in Q2 2010 as compared to $1.4 million (17% of sales) in Q2 2009. This 31% decrease was primarily attributable to the Company's cost savings initiatives resulting from labor and other spending reductions.

Total general and administrative expenses (G&A) decreased by $361,000 (14%), to approximately $2.2 million (19% of sales) for the six month period ended September 25, 2009, compared to $2.5 million (16% of sales) for six month period ended September 26, 2008. This 14% decrease was primarily attributable to the Company's cost savings initiatives resulting from labor and other spending reductions.

The Company expects to tightly control G&A expenses for the remainder of the year. Planned FY 2010 expenditures associated with the external reporting requirements of Section 404 of the Sarbanes-Oxley Act by the end of fiscal year 2010 have been delayed as a result of a recent Security & Exchange Commission announcement that delayed the external reporting requirements until the end of fiscal year 2011.

Amortization expense of $518,000 in Q2 2010 was the same as Q2 2009. For the six month period ended September 25, 2009, amortization expense decreased 1% to $1.033 million compared to $1.044 million for the six month period ended September 26, 2008, due to the Company's utilization of the cash flow amortization method on the majority of its intangible assets.

The non-cash expensing of stock option and restricted stock grants included in operating expenses was $130,000 for the three month period ended September 25, 2009 compared to $66,000 for the three months ended September 26, 2008, an increase of $64,000.

The non-cash expensing of stock option and restricted stock grants included in operating expenses was $225,000 for the six month period ended September 25, 2009 compared to $100,000 for the six months ended September 26, 2008, an increase of $125,000.

Other operating expenses incurred related to the previously announced wafer fabrication consolidation to the Company's Ann Arbor facility, which amounted to $40,000 for the six month period ended September 25, 2009, compared to $208,000 for the six month period ended September 26, 2008. Wafer fabrication consolidation was completed in the first quarter of 2010.

Other Income (Expense), net
Interest income decreased in Q2 2010 by $10,000 from Q2 2009, due primarily to lower interest rates and lower bank balances for short term investments.

Interest income for the six month period ended September 25, 2009 totaled approximately $3,000, a decrease of $25,000 from the six month period ended September 26, 2008, due to lower interest rates and lower cash balances available for short-term investments.

Interest expense in Q2 2010 was $84,000 compared to $111,000 in Q2 2009, a decrease of $27,000. The Company incurred lower interest expense to banks and related parties primarily due to the combination of lower debt obligations and lower interest rates.

Interest expense for the six month period ended September 25, 2009 was $165,000, compared to $219,000 for the six month period ended September 26, 2008, a decrease of $54,000. The Company incurred lower interest expense to banks and related parties, primarily due to the combination of lower debt obligations and lower interest rates.

As discussed in Note 7 to the Condensed Consolidated Financial Statements, the adoption of the FASB's guidance on determining whether instruments granted in share-based payment transactions are participating securities on April 1, 2009 requires our outstanding warrants to be recorded as a liability at fair value with subsequent changes in fair value recorded in earnings. The fair value of the warrant is determined using a Black-Scholes option pricing model, and is affected by changes in inputs to that model including our stock price, expected stock price volatility and contractual term. To the extent that the fair value of the warrant liability increases or decreases, the Company records an expense or income in our statements of operations. The expense of $92,000 on the change in fair value of the warrant liability in the second quarter of FY 2010 is primarily due to the change in the expected volatility, interest rates and . . .