(1)(1)          Organization and Significant Accounting Policies

The condensed consolidated financial statements included herein have been prepared by Giga-tronics Incorporated (the “Company”(“Giga-tronics” or the “Company”), pursuant to the rules and regulations of the Securities and Exchange Commission. The consolidated results of operations for the interim periods shown in this report are not necessarily indicative of results to be expected for the fiscal year. In the opinion of management, the information contained herein reflects all adjustments (consisting of normal recurring entries) necessary to make the consolidated results of operations for the interim periods a fair statement of such operations. For further information, refer to the consolidated financial statements and footnotes thereto, included in the Annual Report on Form 10-K,10-K, filed with the Securities and Exchange Commission for the year ended March 25, 2017.31, 2018.

Principles of Consolidation The consolidated financial statements include the accounts of Giga-tronics and its wholly-owned subsidiary.subsidiary, Microsource, Inc. (“Microsource”). All significant intercompany balances and transactions have been eliminated in consolidation.consolidation

Derivatives The Company accounts for certain of its warrants and embedded debt features as derivatives. Changes in fair values are reported in earnings as gain or loss on adjustment of these instruments to fair value. 

Software Development CostsRevenue Recognition and Deferred Revenue Development costs included inBeginning April 1, 2018, the researchCompany follows the provisions of ASU 2014-09 as subsequently amended by the FASB between 2015 and development of new software products2017 and enhancementscollectively known as ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”). Amounts for prior periods are not adjusted and continue to existing software products are expensed as incurred, until technological feasibility in the form of a working model has been established. Capitalized development costs are amortized over the expected life of the product and evaluated each reporting period for impairment.

Discontinued Operations The Company reviews its reporting and presentation requirements for discontinued operationsbe reported in accordance with the Company’s historic accounting practices. The guidance provided by ASC 205-20provides a unified model to determine how revenue is recognized. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

In determining the appropriate amount of revenue to be recognized as it movesfulfills its obligations under its agreements, the Company performs the following steps: (i) identifies the promised goods or services in the contract; (ii) determines whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measures the transaction price, including the constraint on variable consideration; (iv) allocates the transaction price to newer technologythe performance obligations based on estimated selling prices; and (v) recognizes revenue when (or as) the Company satisfies each performance obligation.

The Company generates revenue through the design, manufacture, and sale of products used in defense industry to major prime defense contractors, the armed services (primarily in the U.S.) and research institutes. There is generally one performance obligation in the Company’s contracts with its customers. For highly engineered products, the customer typically controls the work in process as evidenced either by contractual termination clauses or by the Company’s right to payment for costs incurred to date plus a reasonable profit for products or services that do not have an alternative use. In these circumstances, the performance obligation is the design and manufacturing service. As control transfers continuously over time on these contracts, revenue is recognized based on the extent of progress towards completion of the performance obligation using a cost-to-cost method. Engineering services are also satisfied over time and recognized on the cost-to-cost method. These types of revenue arrangements are typical for our defense contracts within the test and measurement market from legacyMicrosource segment for its YIG RADAR filter products used in fighter jet aircrafts.

For the sale of standard or minimally customized products, the performance obligation is the series of finished products which are recognized at the points in time the units are transferred to the newly developedcontrol of the customer, typically upon shipment. This type of revenue arrangement is typical for our commercial contracts within the Giga-tronics segment for its Advanced Signal Generator.Generation and Analysis system products used for testing RADAR and Electronic Warfare (“EW”) equipment.

Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC Topic 606. The disposal of these product line sales represents an evolutionCompany’s performance obligations include:

The majority of the Company’s Giga-tronics Divisioncontracts have a single performance obligation as the promise to a more sophisticatedtransfer the individual goods or services is not separately identifiable from other promises in the contracts and, therefore, not distinct. The Company’s revenue in fiscal 2019 under ASC 606 primarily relates to design and manufacturing services, there was no product offered to the same customer base. supply, and engineering services were $56,000.

Transaction Price

The Company has evaluatedboth fixed and variable consideration. Under the sales ofCompany’s highly engineered design and manufacturing arrangements, advance payments and unit prices are considered fixed, as product lines (see Note 9, Sale of Product Lines) concluding that each product line does not meet the definition of a “component of an entity” as defined by ASC 205-20. The Company is able to distinguish revenue and gross margin information as disclosed in Note 9, Sale of Product Lines to the accompanying financial statements however, operations and cash flow information is not clearly distinguishable returnable and the Company has an enforceable right to reimbursement in the event of a cancellation. For standard and minimally customized products, payments can include variable consideration, such as product returns and sales allowances. The transaction price in engineering services arrangements may include estimated amounts of variable consideration, including award fees, incentive fees, or other provisions that can either increase or decrease the transaction price. Milestone payments are identified as variable consideration when determining the transaction price. At the inception of each arrangement that includes milestone payments, the Company evaluates whether the milestones are considered probable of being achieved and estimates the amount to be included in the transaction price using the most likely amount method. The Company estimates variable consideration at the amount to which they expect to be entitled, and determines whether to include estimated amounts as a reduction in the transaction price based largely on an assessment of the conditions that might trigger an adjustment to the transaction price and all information (historical, current and forecasted) that is unablereasonably available to present meaningful information about resultsthe Company. The Company includes estimated amounts in the transaction price to the extent it is probable that a significant reversal of operationscumulative revenue recognized will not occur when the estimation uncertainty is resolved.

Allocation of Consideration

As part of the accounting for arrangements that contain multiple performance obligations, the Company must develop assumptions that require judgment to determine the stand-alone selling price of each performance obligation identified in the contract. When a contract contains more than one performance obligation, the Company uses key assumptions to determine the stand-alone selling price of each performance obligation. Because of the customized nature of products and services, estimated stand-alone selling prices for most performance obligations are estimated using a cost-plus margin approach. For non-customized products, list prices generally represent the standalone selling price. The Company allocates the total transaction price to each performance obligation based on the estimated relative stand-alone selling prices of the promised goods or service underlying each performance obligation.

Timing of Recognition

Significant management judgment is required to determine the level of effort required under an arrangement and the period over which the Company expects to complete its performance obligations under the arrangement. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. The Company generally uses the cost-to-cost measure of progress as this measure best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. Under the cost-to-cost method, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenue is recognized for design and manufacturing services and for engineering services over time proportionate to the costs that the Company has incurred to perform the services using the cost-to-cost input method and for products at a point in time. Approximately 99% of the Company’s revenue is recognized over time, with the remaining 1% recognized at a point in time.

Changes in Estimates

The effect of a contract modification on the transaction price and the measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.

For contracts using the cost-to-cost method, management reviews the progress and execution of the performance obligations. This process requires management judgment relative to estimating contract revenue and cost, and making assumptions for delivery schedule. This process requires management’s judgment to make reasonably dependable cost estimates. Since certain contracts extend over a longer period of time, the impact of revisions in cost and revenue estimates during the progress of work may adjust the current period earnings through a cumulative catch-up basis. This method recognizes, in the current period, the cumulative effect of the changes on current and prior quarters. Contract cost and revenue estimates for significant contracts are generally reviewed and reassessed quarterly. Revenue recognized over time using the cost-to-cost method represented approximately 99% of revenue for the first quarter of 2019.

The aggregate effects of these changes on contracts in the first quarter of 2019 was nominal.

Balance Sheet Presentation

The timing of revenue recognition, billings and cash flowscollections results in billed accounts receivable, unbilled receivables (contract assets), and deferred revenue (contract liabilities) on the Condensed Consolidated Balance Sheet. Under the typical payment terms of over time contracts, the customer pays either performance-based payments or progress payments. Amounts billed and due from thosecustomers are classified as receivables on the Condensed Consolidated Balance Sheet. Interim payments may be made as work progresses, and for some contracts, an advance payment may be made. A liability is recognized for these interim and advance payments in excess of revenue recognized and is presented as a contract liability which is included within accrued liabilities and other long-term liabilities on the Condensed Consolidated Balance Sheet. Contract liabilities typically are not considered a significant financing component because these cash advances are used to meet working capital demands that can be higher in the early stages of a contract. When revenue recognized exceeds the amount billed to the customer, an unbilled receivable (contract asset) is recorded for the amount the Company is entitled to receive based on its enforceable right to payment.

Remaining performance obligations represent the transaction price of firm orders for which work has not been performed as of the period end date and excludes unexercised contract options and potential orders under ordering-type contracts (e.g., indefinite-delivery, indefinite-quantity).

Recognition Prior to April 1, 2018

Prior to April 1, 2018 under the legacy GAAP, the Company recorded revenue when there was persuasive evidence of an arrangement, delivery had occurred, the price was fixed and determinable, and collectability was reasonably assured. This occurred when products were shipped or the customer accepted title transfer. If the arrangement involved acceptance terms, the Company deferred revenue until product lines.acceptance was received. On certain large development contracts, revenue was recognized upon achievement of substantive milestones.  Advanced payments were recorded as deferred revenue until the revenue recognition criteria described above had been met. Amounts for periods ending prior to April 1, 2018 have not been adjusted for ASC 606 and continue to be reported in accordance with the Company’s previous accounting practices.

New Accounting Standards

In February 2016, the FASB issued ASU 2016-022016-02 (“ASU 2016-02”2016-02”), Leases. ASU 2016-022016-02 requires that lessees recognize assets and liabilities for the rights and obligations for leases with a lease term of more than one year. The amendments in this ASU are effective for annual periods ending after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact of the adoption of ASU 2016-022016-02 on its consolidated financial statements.

In May 2014, the FASB issued ASU 2014-092014-09 (“ASU 2014-09”ASC 606”), Revenue from Contracts with Customers. ASU 2014-09In August 2015 and March, April, May and December 2016, the FASB issued additional amendments to the new revenue guidance relating to reporting revenue on a gross versus net basis, identifying performance obligations, licensing arrangements, collectability, noncash consideration, presentation of sales tax, transition, and clarifying examples. Collectively these are referred to as ASC Topic 606, which replaces all legacy GAAP guidance on revenue recognition and eliminates all industry-specific guidance. ASC 606 establishes a broad principle that would require an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve this principle, an entity identifies the contract with a customer, identifies the separate performance obligations in the contract, determines the transaction price, allocates the transaction price to the separate performance obligations and recognizes revenue when each separate performance obligation is satisfied. ASU 2014-09ASC 606 was further updated in March, April, May, and December 2016 to provide clarification on a number of specific issues as well as requiring additional disclosures. ASU 2014-09ASC 606 may be applied either retrospectively or through the use of a modified-retrospective method. The full retrospective method requires companies to recast each prior reporting period presented as if the new guidance had always existed. Under the modified retrospective method, companies would recognize the cumulative effect of initially applying the standard as an adjustment to opening retained earnings at the date of initial application. On July 9, 2015, the FASB approved a one year deferral of theASC 606 is effective date of ASU 2014-09 tofor annual reporting periods beginning after December 15, 2017, and early adoption is permitted beginning in the first quarter of 2017.

The Company has elected to adopt the standard as of adopted ASC 606 on April 1, 2018 (beginning(beginning of the Company’s fiscal year) using the modified retrospective method. Under this approach, no restatement of fiscal years 2017 or 2018 will be was required. Rather, the effect of the adoption will bewas recorded as a cumulative adjustment todecreasing the opening balance of retained earningsaccumulated deficit at April 1, 2018.

The Company commenced an analysismost significant change relates to the timing of revenue and cost recognition on the Company’s customer contracts. Under ASC 606, revenue is recognized as the customer obtains control of the impact of ASU 2014-09 by evaluatinggoods and services promised in the impact on its contracts at eachcontract. Given the nature of the Company’s business segments. With this baseline understanding,products and terms and conditions in the contracts, the customer typically obtains control as the Company developedperforms work under such contract. Therefore, the Company expects to recognize revenue over time for substantially all of its contracts using the percentage-of-completion cost-to-cost method. As a project planresult, the Company now recognizes revenue for these contracts as it incurs costs, as opposed to evaluatewhen units are delivered. This change has generally resulted in earlier revenue recognition in the contracts across the business segments. ASU 2014-09 also requires expanded disclosures regarding the nature, timing, and uncertainty of revenue, cash flow and customer contract balances, including how and when performance obligations are satisfied and the relationship between revenue recognized and changes in contract balances during a reporting period.

Underperiod as compared to the legacy GAAP,method for those contracts, giving rise to a decrease to the Company records revenue when there is persuasive evidence of an arrangement, delivery has occurred, the price is fixed and determinable, and collectability is reasonably assured. This occurs when products are shipped or the customer accepts title transfer. If the arrangement involves acceptance terms, the Company defers revenue until product acceptance is received. On certain large development contracts, revenue is recognized upon achievementCompany’s opening balance of substantive milestones.  Advanced payments are recordedaccumulated deficit as deferred revenue until the revenue recognition criteria described above has been met.of April 1, 2018.

Based upon an assessmentAdopting ASC 606, Revenue from Contracts with Customers, involves significant new estimates and judgments such as estimating stand-alone selling prices, variable consideration, and total costs to complete the contract. All of material active contracts, the Company expects thatestimates are subject to change during the performance of the contract which may cause more variability due to significant estimates involved in the new accounting.

The cumulative effect of the changes made to the Company’s consolidated April 1, 2018 balance sheet for contracts where revenue is currently recognizedthe adoption of Topic 606 were as units are delivered, in most cases the accounting for those contracts will change under ASU 2014-09 such that revenue will be recognized as costs are incurred. This change will generally result in an acceleration of revenue as comparedfollows (in thousands):

In accordance with the current revenue recognition methodrequirements of Topic 606, the disclosure of the impact of adoption on our condensed consolidated income statement and balance sheet for those contracts.the first quarter ended June 30, 2018 was as follows (in thousands except for net loss per share):

(2)(2)          Going Concern and Management’s Plan

The Company incurred net losses of $313,000 for$287,000 in the thirdfirst quarter and $2.7 million for the firstnine months of fiscal 2018, respectively.2019 and $3.1 million in fiscal year 2018. These losses have contributed to an accumulated deficit of $28.2$27.8 million and shareholders’ (deficit) equity of ($586,000) as of DecemberJune 30, 2017. 2018. The Company used cash flow in operations totaling $1.4$945,000 and $1.1 million in the firstnine months quarters of fiscal 2018.

2019 and 2018, respectively. The Company has also experienced delays in the development of features, receipt of orders, and shipments for theour new Advanced Signal Generator (“ASG”) and the Advanced Signal Analyzer (“ASA”).EW test system products. These delays have significantly contributed in part, to a decrease in working capital. The new ASGour continued losses, liquidity concerns and ASAaccumulated deficits.

Our EW test system products have shipped to several customers, but potential delays in the development or refinement of additional features, longer than anticipated sales cycles, or uncertainty as to the Company’s ability to efficiently manufacture the ASG and ASA,our EW test system products, could significantly contribute to additional future losses and decreases in working capital.

To help fund operations, the Company relies on advances under the line of credit with Bridge Bank which expires on May 6, 2019. The agreement includes a subjective acceleration clause, which allows for amounts due under the facility to become immediately due in the event of a material adverse change in the Company’s business condition (financial or otherwise), operations, properties or prospects, or ability to repay the credit based on the lender’s judgement. As of DecemberJune 30, 2017, the Company had borrowed $552,000 under2018, the line of credit.

These matters raise substantial doubt as to the Company’s ability to continue as a going concern.

To address these matters, the Company’s management has taken several actions to providecredit had an outstanding balance of $582,000, and additional liquidity and reduce costs and expenses going forward. These actions are described in the following paragraphs:borrowing capacity of $143,000.

In April 2017, we entered into a $1.5 million loan agreement with Partners For Growth, V L.P. (“PFG”) to provide additional cash to fund our operations. As a result of experiencing continued delays in receiving EW test system product orders in fiscal 2018, we were unable to maintain compliance with certain financial covenants required by the PFG loan and, as a result, were subject to a default interest rate between June 2017 and March 2018. On March 26, 2018, and concurrent with the execution of certain stock purchase agreements for the sale of new Series E Convertible Preferred Stock and conditional upon the sale of at least $1.0 million in gross proceeds thereof, the Company and PFG entered into a modification agreement which provided for the restructuring of certain terms of the PFG loan including resetting of the financial covenants for the remaining loan term (see Note 6, Term Loans, Revolving Line of Credit and Warrants).

In order to raise additional working capital and to restructure the PFG loan, on March 26, 2018, the Company entered into a Securities Purchase Agreement for the sale of 43,800 shares of a newly designated series of 6.0% Series E Senior Convertible Voting Perpetual Preferred Stock (“Series E Shares”) to approximately 15 private investors. The purchase price for each Series E Share was $25.00. Gross proceeds received by the Company were approximately $1.095 million (the “Placement”). Net proceeds to the Company after fees and expenses of the placement agent were approximately $1.0 million. Each Series E Share is initially convertible into common stock at the option of the holder at the conversion price of $0.25 per share, which is equivalent to 100 shares of the Company’s common stock for each Series E Share (see Note 13, Preferred Stock and Warrants – Series E Senior Convertible Voting Perpetual Preferred Stock).

To assist with the upfront purchases of inventory required for future product deliveries, the Company entered into advance payment arrangements with certain customers, whereby the customers reimburse the Company for raw material purchases prior to the shipment of the finished products. The Company will continue to seek similar terms in future agreements with these customers and other customers.

Management will continue to review all aspects of its business including, but not limited to, the contribution of its individual business segments, in an effort to improve cash flow and reduce costs and expenses, while continuing to invest, to the extent possible, in new product development for future revenue streams.

Management will also continue to seekseek additional working capital and liquidity through debt (including debt refinancing), equity financing or possible product line sales or cessation of unprofitable business product lines, however there are no assurances that such financings or product line sales will be available at all, or on terms acceptable to the Company.

The Company’sOur historical operating results and forecasting uncertainties indicate that substantial doubt exists related to the Company’sour ability to continue as a going concern. Management believes that through the actions to date and possible future actions described above, we should have the necessary liquidity to continue operations at least twelve months from the issuance of the financial statements. However, we cannot predict, with certainty, the outcome of our actions to maintain or generate additional liquidity, including the availability of additional financing, or whether such actions would generate the expected liquidity as currently planned. Forecasting uncertainties also exist with respect to the ASG and ASAour EW test system product line due to the potential longer than anticipated sales cycles, as well as with potential delays in the refinement of certain features or requisition of certain components and/or the Company’sour ability to efficiently manufacture it in a timely manner.

The accompanying Consolidated Financial Statementsconsolidated financial statements have been prepared assuming that the Company will continue as a going concern and do not include any adjustments that might result if the Company were unable to do so.

(3)(3)         Revenue Recognition

The Company records revenue when there is persuasive evidence of an arrangement, delivery has occurred,following table presents changes in the price is fixedCompany’s contract assets and determinable, and collectability is reasonably assured. This occurs when products are shipped orliabilities for the customer accepts title transfer. Ifthree months ended June 30, 2018.

During the arrangement involves acceptance terms,three months ended June 30, 2018, the Company defers revenue until product acceptance is received. The Company limitsrecognized the following revenues (in thousands).

As of June 30, 2018, the aggregate amount of revenue recognition for delivered elementsthe transaction price allocated to the amount that is not contingent on the future delivery of products or services, futureremaining performance obligations or subject to customer-specified return or refund privileges. The Company evaluates each deliverable in an arrangement to determine whether they represent separate units of accounting. On certain large development contracts, revenue is recognized upon achievement of substantive milestones. Determining whether a milestone is substantive is a matter of judgment and that assessment is performed only at the inception of the arrangement. The consideration earned from the achievement of a milestone must meet all of the following for the milestone to be considered substantive:

a. It is commensurate with either of the following:

1. The Company’s performance to achieve the milestone.

2. The enhancement of the value of the delivered item or items as a result of a specific outcome resulting from the Company's performance to achieve the milestone.

b. It relates solely to past performance.

c. It is reasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement.

Milestones for revenue recognition are agreed upon with the customer prior to the start of the contract and some milestones will be tied to product shipping while others will be tied to design review.

On certain contracts with several of the Company’s significant customerswas $257,000, which the Company receives payments in advance of manufacturing. Advanced payments are recorded as deferredexpects to recognize into revenue untilwithin the revenue recognition criteria described above have been met.next twelve months.

Accounts receivable are stated at their net realizable value. The Company has estimated an allowance for uncollectable accounts based on analysis of specifically identified accounts, outstanding receivables, consideration of the age of those receivables, the Company’s historical collection experience, and adjustments for other factors management believes are necessary based on perceived credit risk.

The Company provides for estimated costs that may be incurred for product warranties at the time of shipment. The Company’s warranty policy generally provides twelve to eighteen months depending on the customer. 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 such time as sufficient historical data has been collected on the new product. Adjustments are made as new information becomes available.

(4) Inventories

Inventories consisted of thethe following:

(5)         Software Development Costs

On September 3, 2015, the Company entered a software development agreement with a major aerospace and defense company whereby the aerospace company developed and licensed its simulation software to the Company. The simulation software (also called Open Loop Simulator or OLS technology) is currently the aerospace company’s intellectual property. The OLS technology generates threat simulations and enables various hardware to generate signals for performing threat analysis on systems under test. The Company licenses the OLS software as a bundled or integrated solution with its ASG.

The Company paid the aerospace company software development costs and fees for OLS of $1.2 million in the aggregate (this includes an amendment to the software development agreement for additional features and functionality), which was paid in monthly installments as the work was performed by the aerospace company through the third quarter of fiscal 2017. The OLS technology is a perpetual license agreement that may be terminated by the Company at any time as long as the Company provides a notice to the aerospace company and pays for the development costs incurred through the notice termination date. The Company is also obligated to pay royalties to the aerospace company on net sales of its ASG product sold with the OLS software (ASG TEmS) equal to seven percent of net sales price of each ASG system sold and subject to certain minimums. The Company expenses research and development costs as they are incurred. Development costs of computer software to be sold, leased, or otherwise marketed are subject to capitalization beginning when a product’s technological feasibility has been established and ending when a product is available for general release to customers.

As of December 30, 2017, and March 25, 2017, the Company had net capitalized software costs of zero and $733,000, respectively. The Company began amortizing the costs of capitalized software to cost of sales in the third quarter of fiscal 2017 using the straight-line methodology over an estimated three-year amortization period. During the fourth quarter of fiscal 2017, the Company changed its estimated amortization period from three years to two years due to the longer than anticipated procurement cycle associated with the ASG TEmS product line. The Company also amortized capitalized software costs using the estimated percentage of revenue approach (which was greater than straight-line amortization) in the fourth quarter of fiscal 2017.

In the first and second quarters of fiscal 2018, the Company had no revenues associated with its ASG TEmS product line and therefore amortized capitalized software costs on a straight-line basis. During the three-month period ended December 30, 2017, the Company amortized capitalized software using the estimated percentage of revenue. Amortization of capitalized software costs recorded during the three and nine-month periods ended December 30, 2017, was $431,000 and $733,000, respectively. Amortization of capitalized software costs recorded during the three and nine-month periods ended December 24, 2016 was $34,000.

(6))      Accounts Receivable Line of Credit

On June 1, 2015 the Company entered into a $2.5$2.5 million Revolving Accounts Receivable Line of Credit agreement with Bridge Bank. The agreement provides for a maximum borrowing capacity of $2.5$2.5 million of which $2.0$2.0 million is subject to a borrowing base calculation and $500,000$500,000 is non-formula based. On May 23, 2017, the Company renewed this credit line (which expired on May 7, 2017) through May 6, 2019.

The loan agreement is secured by all assets of the Company including intellectual property and general intangibles and provides for a borrowing capacity equal to 80% of eligible accounts receivable. The loan matures on May 6, 2019 and bears an interest rate, equal to 1.5% over the bank’s prime rate of interest (which was 4.50% at December 30, 2017 resulting in an interest rate of 6.0%).interest. Interest is payable monthly with principal due upon maturity. The Company paid an annual commitment fee of $12,500$12,500 in May 2017. The loan agreement contains financial and non-financial covenants that are customary for this type of lending and includes a covenant to maintain an asset coverage ratio of at least 150% (defined as unrestricted cash and cash equivalents maintained with Bridge Bank, plus eligible accounts receivable aged less than 90 days from the invoice date, divided by the total amount of outstanding principal of all obligations under the loan agreement). While the Company maintained the asset coverage ratio,

As of June 30, 2018, the Company was in a cross default at December 30, 2017, because ofcompliance with all the PFG noncompliance described in Note 7 below.

financial covenants under the agreement. The line of credit requires a lockbox arrangement, which provides for receipts to be swept daily to reduce borrowings outstanding at the discretion of Bridge Bank. This arrangement, combined with the existence of the subjective acceleration clause in the line of credit agreement, necessitates the line of credit be classified as a current liability on the balance sheet. The acceleration clause allows for amounts due under the facility to become immediately due in the event of a material adverse change in the Company’sCompany’s business condition (financial or otherwise), operations, properties or prospects, or ability to repay the credit based on the lender's judgment. As of DecemberJune 30, 2017, 2018, the Company had borrowed $552,000outstanding borrowings of $552,000 under the line of credit.

(76)        Term Loans, Revolving Line of Credit and Warrants  

On April 27, 2017, the Company entered into a new$1,500,000 loan agreement with PFG. Under the terms of the agreement,Partners For Growth V, L.P. (“PFG”), which was funded by PFG made a term loan to Giga-tronics in the principal amount of $1,500,000, with funding occurring on April 28, 2017.

2017 (the “2017 Loan”). The loan has a two-year term, with2017 Loan, which matures on April 27, 2019, provides for interest only payments forduring the term of the loan. Theloan with principal amount of the loan plusand any accrued interest will beand fees due upon maturity. The loan2017 Loan bears interest at ana fixed aggregate per annum rate equal to 16% per annum, fixed,of which is comprised of cash interest reflecting a 9.5% per annum rate is payable monthly in cash and deferred interest reflecting a 6.5% per annum rate. The Company will pay the cash interestrate is accrued monthly and will accrue deferred interest on the unpaid principal balance. The deferred interest will be due and payable upon maturity. In addition, the Company agreed to pay PFG a chargecash fee of up to $100,000 due and$100,000 payable upon maturity (the “back-end fee”), $76,000$76,000 of which was earned on April 27, 2017, and $24,000$24,000 of which is earned at the rate of $1,000$1,000 per month on the first day of each month if the loan principal (of(or any amount)amount thereof) is outstanding during any day of the prior month.

Additionally, the 2017 Loan provides for the Company’s issuance of up to 250,000 common shares to PFG, of which 190,000 was eaned by PFG upon signing (April 27, 2017) and 60,000 of which is earned at the rate of 2,500 per month on the first day of each month if the loan principal (or any amount thereof) is outstanding during any day of the prior month. If the Company meets or exceeds certain revenue and net income minimums in fiscal 2018, the amount could be reduced by 25 percent. To stay in compliance with the loan terms, the Company must meetThe 2017 Loan provided for certain financial covenants associated with minimum quarterly revenuesrelated to the revenue achievement and monthly minimum shareholders’ equity. The lendermaintenance of tangible net worth. PFG can accelerate the maturity of the loan in case of a default. Thedefault and the Company can prepay the loan before maturity at any time without feeinterest prepayments or penalty.

In connection with its loan to the Company, PFG will receive up to 250,000 shares of common stock, 190,000 of which was earned on April 27, 2017 and 60,000 of which is earned at the rate of 2,500 per month on the first day of each month if the loan principal (of any amount) is outstanding during any day of the prior month.

The Company has pledged all of its assets as collateral for the loan made by PFG,2017 Loan, including all its accounts, inventory,inventory, equipment, deposit accounts, intellectual property and all other personal property. The PFG loan2017 Loan is subordinate to the Bridge Bank line of credit (see Note 6,5, Accounts Receivable Line of Credit).

The requirement to issue 60,000 shares of the Company’sCompany’s common stock over the term of the loan is an embedded derivative (an embedded equity forward). The Company evaluated the embedded derivative in accordance with ASC 815-15-25.815-15-25. The embedded derivative is not clearly and closely related to the debt host instrument and therefore has beenis being separately measured at fair value, with subsequent changes in fair value being recognized in the Condensed Consolidated Statementsconsolidated statements of Operations.operations.

The proceeds received upon issuing the loan waswere allocated to: i) common stock,stock, for the fair value of the 190,000 shares of common stock initially issued to the lender; ii) the fair value of the embedded derivative; and iii) the loan host instrument. Upon issuance of the loan, the Company recognized $1,576,000$1,576,000 of principal payable to PFG, representing the stated principal balance of $1,500,000$1,500,000 plus the initial back-end fee of $76,000.$76,000. The initial carrying value of the loan was recognized net of debt discount aggregating approximately $326,000,$326,000, which is comprised of the following:

(87)        FairFair Value

Pursuant to the accounting guidance for fair value measurement and its subsequent updates, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. The accounting guidance establishes a hierarchy for inputs used in measuring fair value that minimizes the use of unobservable inputs by requiring the use of observable market data when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on active market data. Unobservable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.  

The fair value hierarchyhierarchy is broken down into the three input levels summarized below:

Fair value measurements discussed herein are based upon certain market assumptions and pertinent information available to management as of and during the three and nine months period ended December 30, 2017. The carrying valuesamounts of the Company’s cash and cash equivalents, trade accounts receivable,cash-equivalents and line of credit term debt and accounts payable approximate their fair values given theirat each balance sheet date due to the short-term nature. Asmaturity of December 30, 2017, these financial instruments, and generally result in inputs categorized as Level 1 within the fair value hierarchy. The carrying value of the outstanding PFG loan approximates the estimated aggregate fair value, since the embedded equity forward is recognized at fair value and classified with the loan host. The fair value estimate of the embedded equity forward is based on the closing price of the Company’s common stock on the measurement date, the risk-free rate, the date of expiration, and any expected cash distributions of the underlying asset before expiration. The estimated fair value of the embedded equity forward represents a Level 2 measurement.

Derivatives TheOn March 26, 2018, the Company does not use derivative instrumentsand PFG agreed to hedge exposures toeliminate the cash flow, market, or foreign currency risks. Theput provision contained in warrants in exchange for the Company evaluates all of its financial instruments, including notes payable, to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. The Company accounts for certain of its warrants as derivatives. Changes in fair values are reported in earnings as gain or loss on adjustment of warrant liability to fair value.

Embedded derivatives must be separately measured from the host contract if all the requirements for bifurcation are met. The assessmentissuing 150,000 shares of the conditions surrounding the bifurcation of embedded derivatives depends on the natureCompany’s common stock. Upon removal of the host contract. Bifurcated embedded derivatives are recognized at fair value, with changes in fair value recognized input, the statement of operations each period. Bifurcated embedded derivatives are classifiedwarrants were re-valued using the Black-Scholes option-pricing model with the related host contract in the Company’s balance sheet.

The Company’s derivative warrant liability is measured at fair value on a recurring basis and is categorized as Level 3 in the fair value hierarchy. The derivative warrant liability is valued using a Monte Carlo simulation model, which used the following assumptions asassumptions: (i) remaining term of December 30, 2017: (i) the remaining expected life of 1.250.96 years, (ii) the Company’s historicalexpected volatility rate of 83.3%85%, (iii) risk-free interest rate of 1.79%2.12%, and (iv) a discount rate of thirty percent.

no expected dividends. The aforementioned derivative warrant liability and equity forward are the Company’s only asset and liability recognized and measured atresulting change in fair value on a recurring or non-recurring basis and are follows:

There were no transfers between Level 1, Level 2, or Level 3 forof the three and nine-month periods ended December 30, 2017 and March 25, 2017.

The table below summarizes changeswarrants, along with the fair value of the common stock issued to PFG, was recognized as an adjustment of warrant liability in gains and losses recorded in earnings for Level 3 assets and liabilities that are still held at December 30, 2017:the consolidated statements of operations.

There were no assets measured at fair value on a recurring basis and there were no assets or liabilities measured on a non-recurring basis at DecemberJune 30, 2017 or 2018 and March 25, 2017.31, 2018.

The following table presents quantitative information about recurring Level3 fair value measurements at December 30, 2017 and March 25, 2017:

The discount rate of thirty percent at December 30, 2017, and twenty four percent at March 25, 2017 is management’s estimate of the current cost of capital given the Company’s credit worthiness. A significant increase in the discount rate would significantly decrease the fair value, but the magnitude of this decrease would be less significant in a scenario where the Company’s stock price is significantly higher than the exercise price since the holder’s option to take a cash payment at maturity represents a smaller component of the total fair value when the Company’s stock price is higher. The Monte Carlo simulation model simulated the Company’s stock price through the maturity date of March 31, 2019. At the end of the simulated period, the value of the warrant was determined based on the greater of (1) the net share settlement value, (2) the net exercise value, or (3) the fixed cash put value.

(9)Sale of Product Lines

On June 20, 2016, the Company entered into an Asset Purchase Agreement for the sale of its Switch product line to Astronics Test Systems Inc. (Astronics). Upon signing the agreement, Astronics paid $850,000 for the intellectual property of the product line. The Company recognized a net gain of $802,000 in the first quarter ended June 25, 2016 after related expenses were subtracted from the sales price. The following table presents the breakdown of the gain recognized related to the asset sale:

In calculating the gain included in the accompanying consolidated financial statements, the Company released $278,000 of deferred warranty obligations related to the Switch asset. Pursuant to the terms of the agreement, Astronics assumed all the warranty obligations for the Switch product line, including the products sold prior to the asset being transferred to Astronics. The deferred warranty obligation was previously included in other current liabilities in the consolidated financial statements. The Company also had an existing agreement with a consultant supporting the Switch product line which included a three percent commission on the sales of the Switch product line for a period of 4 years ending in January 2020. The agreement allowed for a buyout of future commissions associated with the Switch product which the Company exercised in connection with the Astronics transaction in June 2016 resulting in a payment by the Company during June of $170,000. Astronics also purchased approximately $500,000 of related materials inventory from Giga-tronics between July and August of 2016.

The Company had no revenues or gross margin associated with the Switch product line during the three and nine months periods ended December 30, 2017. During the three-month periods ended December 24, 2016, the Switch product line did not account for any product revenue. During the nine-month period ended December 24, 2016, the Switch product line accounted for approximately $2.1 million in product revenue. Gross margins of the Switch product line for the nine-month periods ended December 24, 2016 was $437,000. While the Company is able to distinguish revenue and gross margin information related to the sale of the Switch product line to Astronics, the Company is unable to present meaningful information about results of operation and cash flows from the Switch product line.

On December 15, 2015, the Company entered into an Asset Purchase Agreement with Spanawave Corporation, whereby Spanawave agreed to purchase the Giga-tronics’ Division product lines for its Power Meters, Amplifiers, and Legacy Signal Generators for $1.5 million (the asset purchase agreement was for $1.5 million, the Company never realized this amount as a result of the dispute with Spanawave as discussed below). The agreement provided for the transfer of these product lines to Spanawave sequentially in six phases beginning with certain sensor and amplifier products. The Company had transferred the Power Meters and Amplifiers in phases one through five, but still holds the rights to phase 6 (Legacy Signal Generators). During the second quarter ended September 24, 2016, the Company and Spanawave became engaged in a dispute, including litigation initiated by Spanawave and an arbitration proceeding initiated by Spanawave’s affiliate Liberty Test Equipment, Inc. (“Liberty Test”), as to whether the Company has fulfilled all the requirements to close phases one through five and become entitled to the $375,000 received by the Company during the first quarter of fiscal 2017 (see below).

The complaint sought specific performance of the agreement and damages. Spanawave’s affiliate Liberty Test also filed an arbitration claim for $440,000 under a distribution agreement between the Company and Liberty. The Company filed cross-complaints in both the litigation and arbitration asserting breach of the respective agreements by Spanawave and Liberty. The Company had previously asserted that the distribution agreement did not extend to the products with respect to which the claim has been made. The parties negotiated in an effort to settle the dispute notwithstanding the filings. On October 16, 2017, the Company reached a settlement agreement with Spanawave and Liberty Test whereby all parties exchanged mutual releases and agreed that phases one through five of the Asset Purchase Agreement were concluded and the sale of the remaining phase (Phase 6) to Spanawave (which was in dispute) was abandoned. The abandoned Phase 6 Legacy Signal Generators product line (and related inventory) remains an asset of the Company. The Company, Spanawave and Liberty Test also dismissed all arbitration claims as part of the settlement.

During the fourth quarter of fiscal 2016, the Company received $375,000 from Spanawave. In the first quarter of fiscal 2017, the Company received an additional $375,000 from Spanawave under the agreement, for a combined total of $750,000. Of this amount, the Company returned $375,000 to Spanawave on July 28, 2016 resulting from the dispute regarding the status of phases one through five. The remaining $375,000 was included in deferred liability related to asset sales in the consolidated balance sheet during the dispute. However, as a result of the settlement of the dispute in the third quarter of fiscal 2018, the Company recognized a net gain of $324,000, which is net of approximately $51,000 in expenses associated with the Spanawave asset sale. During the three and nine-month periods ended December 30, 2017, these product lines accounted for approximately $111,000 and $297,000 in revenue, respectively. In addition, in June 2016, the Company received approximately $275,000 in exchange for raw material purchases. The purchase price of the raw materials approximated its carrying value, therefore no gain or loss was recognized. These product lines accounted for approximately $75,000 and $475,000 in revenue during the three and nine-month periods ended December 24, 2016, respectively. While the Company is able to distinguish revenue and gross margin information related to the sale of these product lines, the Company is unable to present meaningful information about results of operations and cash flows from these product lines.

(108)         Loss Per Share

Basic loss per share (EPS) is calculated by dividing net income or loss by the weighted average common shares outstanding during the period. Diluted EPS reflects the net incremental shares that would be issued if unvested restricted shares became vested andand dilutive outstanding stock options were exercised, using the treasury stock method. In the case of a net loss, it is assumed that no incremental shares would be issued because they would be antidilutive. In addition, certain options are considered antidilutive because assumed proceeds from exercise price, related tax benefits and average future compensation was greater than the weighted average number of options outstanding multiplied by the average market price during the period. The shares used in per share computationsShares excluded from the diluted EPS calculation because they would be anti-dilutive are as follows:

Theexclusion of stock options, restricted stock, convertible preferred stockstocks and warrants fromnot included in the computation of diluted earnings per share (EPS) for the three month period ended June 30, 2018 and nine-month periods ended December 30,June 24, 2017 and December 24, 2016 is a result of the Company’s net loss and, therefore, the effect of these instruments would be anti-dilutive.

(119)          ShareStock Based Compensation

The Company has established the 2005 Equity Incentive Plan, which provide for the granting of options and restricted stock for up to 2,850,000 shares of common stock at 100% of fair market value at the date of grant, with eacheach grant requiring approval by the Board of Directors of the Company. The 2005 Plan has been extended to be effective until 2025. Option grants under the 2000 Stock Option Plan are no longer available. Options granted generally vest in one or more installments in a four or five-year year period and must be exercised while the grantee is employed by the Company or within a certain period after termination of employment.employment or service arrangement. Options granted to employees shall not have terms in excess of 10 years from the grant date. Holders of options may be granted stock appreciation rights (SARs), which entitle them to surrender outstanding awards for a cash distribution under certain changes in ownership of the Company, as defined in the stock option plan. As of DecemberJune 30, 2017, 2018, no SAR’s have been granted under the option plan. As of DecemberJune 30, 2017, 2018, the total number of shares of common stock available for issuance was 1,142,177.437,677. All outstanding options have a ten-year year life from the date of grant. The Company records compensation cost associated with share-based compensation equivalent to the estimated fair value of the awards over the requisite service period.

Stock Options

In calculating compensation related to stock option grants, the fair value of each stock option is was estimated on the date of grant using the Black-Scholes-Merton option-pricing model and the following weighted average assumptions: