ITEM 1. DESCRIPTION OF BUSINESS
General
Giga-tronics Incorporated (Giga-tronics, or the Company) includes operations of Giga-tronics Instrument Division, ASCOR, Inc. (ASCOR), and Microsource, Inc. (Microsource). In the first quarter of fiscal 2004, Giga-tronics elected to discontinue the operations of DYMATiX, which was a joint venture and principal activity of the Company’s former subsidiaries Viking Semiconductor Equipment, Inc. (Viking) and Ultracision, Inc. (Ultracision).
Giga-tronics designs, manufactures and markets through its Giga-tronics Instrument Division, a broad line of test and measurement equipment used in the development, test and maintenance of wireless communications products and systems, flight navigational equipment, electronic defense systems and automatic testing systems. These products are used primarily in the design, production, repair and maintenance of commercial telecommunications, radar, and electronic warfare equipment.
Giga-tronics was incorporated on March 5, 1980, its principal executive offices are located at 4650 Norris Canyon Road, San Ramon, California, and its telephone number at that location is (925) 328-4650.
Effective July 23, 1996, Giga-tronics acquired ASCOR. ASCOR, located in Fremont, California, designs, manufactures, and markets a line of switching and connecting devices that link together many specific purpose instruments that comprise a portion of automatic test systems. ASCOR offers a family of switching and interface test adapters as standard VXI configured products, as well as complete system integration services to the Automatic Test Equipment market.
Effective June 27, 1997, Giga-tronics completed a merger with Viking by issuing approximately 420,000 shares of the Company’s common stock in exchange for all of the common stock of Viking. Viking manufactured and marketed a line of optical inspection equipment used to manufacture and test semiconductor devices. Products included die attachments, automatic die sorters, tape and reel equipment, and wafer inspection equipment.
Effective December 2, 1997, Giga-tronics completed a merger with Ultracision by issuing approximately 517,000 shares of the Company’s common stock in exchange for all of the common stock of Ultracision. Ultracision was a manufacturer of automation equipment for the test and inspection of silicon wafers. Ultracision also produced a line of probers for the testing and inspection of silicon devices.
With the discontinuance and sale of DYMATiX, Giga-tronics has dissolved Viking and Ultracision.
Effective May 18, 1998, Giga-tronics acquired Microsource. All the outstanding shares of Microsource were acquired for $1,500,000 plus contingent payments based on earnings from Microsource from 1998 to 2000, which amounts were nominal. Microsource, located in Santa Rosa, California, develops and manufactures a broad line of YIG (Yttrium, Iron, Garnet) tuned oscillators, filters and microwave synthesizers, which are used by its customers in manufacturing a wide variety of microwave instruments or devices.
Giga-tronics intends to broaden its product lines and expand its market, both by internal development of new products and through the acquisition of other business entities. From time to time, the Company considers a variety of acquisition opportunities.
Industry Segments
The Company manufactures products used in test, measurement and handling. The Company operates primarily in four operating and reporting segments, Giga-tronics Instrument Division, ASCOR Inc., Microsource Inc. and Corporate.
Products and Markets
Giga-tronics Instrument Division
The Giga-tronics Instrument Division segment produces signal sources, generators and sweepers, and power measurement instruments for use in the microwave and RF frequency range (10 kHz to 75 GHz). Within each product line are a number of different models and options allowing customers to select frequency range and specialized capabilities, features and functions. The end-user markets for these products can be divided into three broad segments: commercial telecommunications, radar and electronic warfare. This segment’s instruments are used in the design, production, repair and maintenance and calibration of other manufacturers’ products, from discrete components to complex systems.
ASCOR Inc.
The ASCOR Inc. segment produces switch modules and interface adapters that operate with a bandwidth from direct current (DC) to 18 GHz. This segment’s switch modules may be incorporated within its customers’ automated test equipment. The end-user markets for these products are primarily related to defense, aeronautics, communications, satellite and electronic warfare.
Microsource Inc.
The Microsource segment develops and manufactures a broad line of YIG tuned oscillators, filters and microwave synthesizers, which are used by its customers in manufacturing a wide variety of microwave instruments or devices.
Sources and Availability of Raw Materials and Components
Substantially all of the components required by Giga-tronics to make its assemblies are available from more than one source. The Company occasionally uses sole source arrangements to obtain leading-edge technology or favorable pricing or supply terms, but not in any material volume. In the Company’s opinion, the loss of any sole source arrangement it has would not be material to its operations.
Although extended delays in receipt of components from its suppliers could result in longer product delivery schedules for the Company, the Company believes that its protection against this possibility stems from its practice of dealing with well-established suppliers and maintaining good relationships with such suppliers.
Patents and Licenses
The Company’s competitive position is largely dependent upon its ability to provide performance specifications for its instruments and systems that (a) easily, effectively and reliably meet customers’ needs and (b) selectively surpass competitors’ specifications in competing products. Patents may occasionally provide some short-term protection of proprietary designs. However, because of the rapid progress of technological development in the Company’s industry, such protection is most often, although not always, short-lived. Therefore, although we occasionally pursue patent coverage, we place major emphasis on the development of new products with superior
performance specifications and the upgrading of existing products toward this same end. This is reflected in a substantial allocation of budget to project development costs.
The Company’s products are based on its own designs, which in turn derive from its own engineering abilities. If the Company’s new product engineering efforts fall behind, its competitive position weakens. Conversely, effective product development greatly enhances its competitive status.
The Company presently holds 22 patents. None of these is critical to the Company’s ongoing business, and the Company does not actively maintain them. Capitalized costs relating to these patents were both incurred and fully amortized prior to March 1, 2003. Accordingly, these patents have no recorded value included in the Company’s fiscal 2005 and 2006 consolidated financial statements.
The Company is not dependent on trademarks, licenses or franchises. We do utilize certain software licenses in certain functional aspects for some of our products. Such licenses are readily available, non-exclusive and are obtained at either no cost or for a relatively small fee.
Seasonal Nature of Business
The business of the Company is not seasonal.
Working Capital Practices
The Company generally strives to maintain at least 60 days worth of inventory and generally sells to customers on 30 day payment terms. Typically, the Company receives payment terms of 30 days. The Company believes that these practices are consistent with typical industry practices.
Importance of Limited Number of Customers
Commercial business accounted for 57% and 62% of net sales in fiscal 2006 and 2005, respectively. The Company is a leading supplier of microwave and RF test instruments to various U.S. government defense agencies, as well as to their prime contractors. Management anticipates sales to U.S. government agencies and their prime contractors will remain significant in fiscal 2007. Defense-related agencies accounted for 43% and 38% of net sales in fiscal 2006 and 2005, respectively. Prior to the last four years, in which the defense business has improved, sales to the defense industry in general and direct sales to the United States and foreign government agencies in particular had declined. Any decline of defense orders could have a negative effect on the business, operating results, financial condition and cash flows of Giga-tronics.
During fiscal 2006 and 2005, the U.S. government defense agencies and their prime contractors made up 19% and 32%, respectively, of the Giga-tronics Instrument Division’s revenues.
During fiscal 2006, ASCOR derived 41% of its revenues from the U.S. government defense agencies and their prime contractors and another 45% from foreign defense agencies and their prime contractors. During fiscal 2005, ASCOR derived 25% of its revenues from the U.S. government defense agencies and their prime contractors, 15% from a communications equipment manufacturer, and another 39% from an automated test equipment manufacturer.
During fiscal 2006, Microsource derived 51% of its revenue from an electronic instrument manufacturer, 31% of its revenues from the U.S. government defense agencies and their prime contractors, and another 12% from foreign defense agencies and their prime contractors. During fiscal 2005, Microsource derived 47% of its revenues from the U.S. government defense agencies and their prime contractors, an electronic instrument manufacturer comprised 36% and an international communications equipment company comprised 14%
Other than U.S. government agencies and their defense contractors, one other customer accounted for 10% or more of consolidated revenues of the Company in fiscal 2006. The Company did 16% of its fiscal 2006
consolidated revenue with an electronic instrument manufacturer. In prior years, the Company did less than 10% of its business with this customer.
Other than U.S. government agencies and their defense contractors, no customer accounted for 10% or more of consolidated revenues of the Company in fiscal 2005, and no customer who accounted for 10% or more of revenues of any one segment accounted for 10% or more of any other segment.
Other than U.S. government agencies and their prime contractors, the Company has no customer the loss of which would, in management’s opinion, have a material adverse effect on the Company and its subsidiaries as a whole.
The Company’s products are largely capital investments for its customers, and the Company’s belief is that its customers have economic cycles in which capital investment budgets for the kinds of products that the Company produces expand and contract. The Company, therefore, expects that a major customer in one year will often not be a major customer in the following year. Accordingly, the Company’s revenues and earnings will decline if the Company is unable to find new customers or increase its business with other existing customers to replace declining revenues from the previous year’s major customers. A substantial decline in revenues from U.S. government defense agencies and their prime contractors would also have a material adverse effect on the Company’s revenues and results of operations unless replaced by revenues from the commercial sector.
Backlog of Orders
On March 25, 2006, the Company’s backlog of unfilled orders was approximately $10,329,000 compared to approximately $15,792,000 at March 26, 2005. As of March 25, 2006, there were approximately $4,466,000 in unfilled orders that were scheduled for shipment beyond a year, as compared to approximately $7,631,000 at March 26, 2005. Orders for the Company’s products include program orders from both the U.S. government and defense contractors with extended delivery dates. Accordingly, the backlog of orders may vary substantially from quarter to quarter and the backlog entering any single quarter may not be indicative of sales for any period.
Backlog includes only those customer orders for which a delivery schedule has been agreed upon between the Company and the customer and, in the case of U.S. government orders, for which funding has been appropriated.
Competition
Giga-tronics serves the broad market for electronic instrumentation with applications ranging from the design, test, calibration and maintenance of other electronic devices to providing sophisticated components for complex electronic systems to sub-systems capable of sorting and identifying high frequency communication signals. These applications cut across the commercial, industrial and military segments of the broad market. The Company has a variety of competitors. Several of its competitors are much larger than the Company and have greater resources and substantially broader product lines. Others are of comparable size with more limited product lines.
Competition from numerous existing companies is intense and potential new entrants are expected to increase. The Company’s instrument, switch, oscillator and synthesizer products compete with Agilent, Anritsu, Racal, IFR and Rohde & Schwarz. Many of these companies have substantially greater research and development, manufacturing, marketing, financial, technological, personnel and managerial resources than Giga-tronics. There can be no assurance that any products developed by these competitors will not gain greater market acceptance than any developed by Giga-tronics.
To compete effectively in this circumstance, the Company (a) places strong emphasis on maintaining a high degree of technical competence as it relates to the development of new products and the upgrading of existing products and (b) is highly selective in establishing technological objectives. The Company does not attempt to compete ‘across the board’, but selectively based upon its particular strengths and the competitors’ perceived limitations.
Specification requirements of customers in this market vary widely. The Company is able to compete by offering products that meet a customer’s particular specification requirements; by being able to offer certain product specifications at lower cost resulting from the Company’s past production of products with those of similar specifications; and by being able to offer certain product specifications at a higher quality level. All of these advantages are attributable to the Company’s continuing investment in research and development and in a highly trained engineering staff.
The customer’s decision is most often based on the best match of its particular requirements and the supplier’s operating specifications. In most cases, attracting and retaining customers does not require the Company to offer the best overall product with respect to each of the customer’s requirements, but rather the best product relative to the specifications that are most important to the customer.
Occasionally price is a competitive consideration. In that circumstance, the Company believes it has more flexibility in making pricing decisions than its larger and more structured competitors.
Sales and Marketing
Giga-tronics Instrument Division, ASCOR, and Microsource market their products through various distributors and representatives to commercial and government customers, although not necessarily through the same distributors and representatives.
Product Development
Products of the type manufactured by Giga-tronics historically have had relatively long product life cycles. However, the electronics industry is subject to rapid technological changes at the component level. The future success of the Company is dependent on its ability to steadily incorporate advancements in component technologies into its new products. Product development expenses totaled approximately $3,760,000 and $3,370,000 in fiscal 2006 and 2005, respectively.
Activities included the development of new products and the improvement of existing products. It is management’s intention to maintain or increase expenditures for product development at levels required to sustain its competitive position. All of the Company’s product development activities are internally funded and expensed as incurred.
Giga-tronics expects to continue to make significant investments in research and development. There can be no assurance that future technologies, processes or product developments will not render Giga-tronics’ current product offerings obsolete or that Giga-tronics will be able to develop and introduce new products or enhancements to existing products, which satisfy customer needs, in a timely manner or achieve market acceptance. The failure to do so could adversely affect Giga-tronics’ business.
Manufacturing
The assembly and testing of Giga-tronics Instrument Division microwave, RF and power measurement products are done at its San Ramon facility. The assembly and testing of ASCOR’s switching and connecting devices are done at its Fremont facility. The assembly and testing of Microsource’s line of YIG tuned oscillators, filters and microwave synthesizers are done at its Santa Rosa facility.
Environment
To the best of its knowledge, the Company is in compliance with all federal, state and local laws and regulations involving the protection of the environment.
Employees
As of March 25, 2006, Giga-tronics employed 120 individuals on a full time basis. Management believes that the future success of the Company depends on its ability to attract and retain skilled personnel. None of the Company’s employees are represented by a labor union, and the Company considers its employee relations to be good.
Information about Foreign Operations
The Company sells to its international customers through a network of foreign technical sales representative organizations.
| Geographic Distribution of Sales | ||||||||||||||||
| (Dollars in thousands) | 2006 | Percent | 2005 | Percent | ||||||||||||
Domestic |
$ | 11,549 | 56.0 | % | $ | 15,356 | 71.5 | % | ||||||||
International |
9,071 | 44.0 | % | 6,121 | 28.5 | % | ||||||||||
See footnote 5 of the financial statements for further breakdown of international sales for the last two years.
The Company has no foreign-based operations or material amounts of identifiable assets in foreign countries. Its gross margins on foreign and domestic sales are similar.
Certain Factors Which May Adversely Affect Future Operations Or An Investment In Giga-tronics
Business climate is volatile
Giga-tronics has a significant number of defense-related orders. If the defense market should soften, shipments in the current year could decrease more than current projected shipments with a concurrent decline in earnings. The Company’s commercial product backlog has a number of risks and uncertainties such as the cancellation or deferral of orders, dispute over performance and our ability to collect amounts due under these orders. If any of these events occurs, then shipments in the current year could fall below currently projected shipments and earnings could decline.
Giga-tronics sales are substantially dependent on the wireless industry
Giga-tronics sells directly or indirectly to customers and equipment manufacturers in the wireless industry. Currently, this industry is undergoing dramatic and rapid change. As such, the business that Giga-tronics records could decrease or existing recorded backlog could be stretched or deferred resulting in less than projected shipments. Reduced shipments may have a material adverse effect on operations.
Giga-tronics’ markets involve rapidly changing technology and standards
The market for electronics equipment is characterized by rapidly changing technology and evolving industry standards. Giga-tronics believes that its future success will depend in part upon its ability to develop and commercialize its existing products, develop new products and applications, and in part to develop, manufacture and successfully introduce new products and product lines with improved capabilities and to continue to enhance existing products. There can be no assurance that Giga-tronics will successfully complete the development of current or future products or that such products will achieve market acceptance.
Liquidity
Based on current levels of sales and expenses, management believes that cash and cash equivalents remain adequate to meet anticipated operating needs for the next two years. However, this estimate is based on projections that may or may not be realized, and therefore actual cash usage could be greater than projected. To operate beyond
that term would require the Company to earn additional cash from operations, renew or obtain a line of credit or obtain additional funds from other sources. The Company maintains a line of credit for $2,500,000, which expires June 19, 2006. The Company is in the process of negotiating a new line of credit, however, the Company does not believe that it needs the line of credit for operating purposes.
Giga-tronics acquisitions may not be effectively integrated and their integration may be costly
As part of its business strategy, Giga-tronics may broaden its product lines and expand its markets, in part through the acquisition of other business entities. Giga-tronics is subject to various risks in connection with any future acquisitions. Such risks include, among other things, the difficulty of assimilating the operations and personnel of the acquired companies, the potential disruption of the Company’s business, the inability of management to maximize the financial and strategic position of the Company by the successful incorporation of acquired technology and rights into its product offerings, the maintenance of uniform standards, controls, procedures and policies, and the potential loss of key employees of acquired companies. The Company has not made any acquisitions in the past seven years. No assurance can be given that any acquisition by Giga-tronics will or will not occur, that if an acquisition does occur, that it will not materially harm the Company or that any such acquisition will be successful in enhancing the Company’s business. The Company currently contemplates that future acquisitions may involve the issuance of additional shares of common stock. Any such issuance may result in dilution to all Giga-tronics shareholders, and sales of such shares in significant volume by the shareholders of acquired companies may depress the price of its common stock.
Giga-tronics’ common stock price is volatile
The market price of the Company’s common stock could be subject to significant fluctuations in response to variations in quarterly operating results, shortfalls in revenues or earnings from levels expected by securities analysts and other factors such as announcements of technological innovations or new products by Giga-tronics or by competitors, government regulations or developments in patent or other proprietary rights. In addition, the NASDAQ Capital Market (formerly known as the Small Cap Market) and other stock markets have experienced significant price fluctuations in recent periods. These fluctuations often have seemingly been unrelated to the operating performance of the specific companies whose stocks are traded. Broad market fluctuations, as well as general foreign and domestic economic conditions, may adversely affect the market price of the common stock.
Giga-tronics stock at any time has historically traded on thin volume on NASDAQ. Sales of a significant volume of stock could result in a depression of Giga-tronics share prices.
Performance problems in our products or problems arising from the use of our products together with other vendors’ products may harm our business and reputation
Products as complex as ours may contain unknown and undetected defects or performance problems. For example, it is possible that a product might not comply with stipulated specifications under all circumstances. In addition, our customers generally use our products together with their own products and products from other vendors. As a result, when problems occur in a combined environment, it may be difficult to identify the source of the problem. A defect or performance problem could result in lost revenues, increased warranty costs, diversion of engineering and management time and effort, impaired customer relationships and injury to our reputation generally. To date, performance problems in our products or in other products used together with ours have not had a material adverse effect on our business. However, we cannot be certain that a material adverse impact will not occur in the future.
Competition
The Company’s instrument, switch, oscillator and synthesizer products compete with Agilent, Anritsu, Racal, IFR and Rohde & Schwarz. Many of these companies have substantially greater research and development, manufacturing, marketing, financial, technological, personnel and managerial resources than Giga-tronics. These resources also make these competitors better able to withstand difficult market conditions than the Company.
There can be no assurance that any products developed by these competitors will not gain greater market acceptance than any developed by Giga-tronics.
