2 0 0 1 A N N U A L R E P O R T C O R P O R A T E P R O F I L E Giga-tronics provides instruments, systems, subsystems and components for inclusion in, and for the maintenance of, a wide range of communications equipment and facilities. We serve a broad market spanning commercial, military and industry users. Instrument Division supplies RF and microwave frequency synthesizers and power measurement instruments in bench top, rack mount and VXIbus configurations for use in cellular, PCS, radar, electronic warfare, satellite and telecommunications systems test applications. Microsource is a vertically integrated designer and manufacturer of leading-edge microwave circuits, components, and sub-systems. It’s product line includes a broad range of YIG based signal sources and peripheral devices such as oscillators, filters, multipliers, band reject and band pass filters, and broad band signal synthesizers. ASCOR designs and manufactures ATE instrumentation and switching equipment in the VXI and PXI formats for terrestrial and satellite related communications, commercial aircraft, military flight systems and automatic test systems. DYMATIX designs and manufactures automation and test equipment for the semiconductor and memory media industries. Key products include, automatic die sorting systems, automatic tape and reel equipment, robotic wafer/disk handling and inspection equipment, and wafer test probers. F I N A N C I A L H I G H L I G H T S (In thousands except per share data and ratio) March 31, 2001 March 25, 2000 March 27, 1999 New orders $ 57,830 $ 64,013 $ 36,786 Net sales 54,159 47,577 37,636 Operating income 3,024 1,495 (3,759) Pre-tax earnings Net earnings 3, 461 1, 901 1,633 1,139 (3,006) (1,858) Backlog 39,964 34,128 17,692 Earnings per share - basic 0.42 0.26 (.43) Earnings per share - diluted 0.40 0.24 (.43) Current ratio Working capital Shareholders’ equity Total assets Equity per share 4.06 22,924 28,475 37,318 6.27 3.17 21,066 26, 149 3.32 18,021 24,710 37,526 33,259 5.90 5.66 1 T O O U R S H A R E H O L D E R S Performance for the fiscal year ended March 31, 2001 showed substantial improvement over the prior year. Sales of $54,159,000 were up 14% while earnings of $1,901,000 were up 67%. Earnings of $.40 per fully diluted share compared with $.24 per fully diluted share a year ago. Backlog of approximately $40,000,000 (about $32,700,000 shippable in 12 months) was up 17% from the $34,100,000 ($23,900,000 shippable within 12 months) of a year earlier. Manufacturing margins increased 21% to $19,056,000 compared to $15,810,000 for the prior year. Giga-tronics financial condition continued strong with no debt, $3,469,000 in cash and liquid investments and a back-up unused $7,000,000 line of credit. Current ratio was 4.06 up from 3.17 a year earlier. Shareholders equity increased to $28,475,000 or 6.27 per share from $26,149,000 or 5.90 per share last year. Tangible book value was 6.18 per share up from 5.75 a share a year ago. 2 In November 2000, we established a research and develop- ment facility in England. This was done because of the availability of power measurement engineers in the United Kingdom at a time when that kind of technical talent was virtually unavailable in California. This is currently a very small facility, but has thus far well served our original purpose. R & D expenses for FY 2001 were $5,087,000 or 9.4% of sales, up from $4,180,000 or 8.8% of sales for the prior year. There were several significant management changes shortly after year end and in the early months of FY 2002. Claudio Mariotta became President and General Manager of the Instrument Division as of April 1st replacing Jim Koehn who retired at year end. Mr. Mariotta had been with the organization for 3 years as Vice President Engineering and Vice President Operations. He has had more than 30 years of technology based business experi- ence with such companies as SSE Telecom and the Farinon Division of Harris Corporation. 3 On April 16, 2001, William Wilson became President and General Manager of Microsource Division replacing Robert Smith who retired at that time. Bill had been and continues as a Director of Giga-tronics Inc. He brings many years of very applicable experience to this challenging job having served as CEO of Microwave Technology, Inc., President of Amplica, Inc., Business Director of Hybrid Microcircuits at Rockwell/Collins Radio and on Technical Staff at Sandia Laboratories. On June 4, John Regazzi joined Giga-tronics Instrument Division as VP for Engineering. Mr. Regazzi comes to us from Hewlett Packard/Agilent where he spent 24 years in senior technical management and product planning positions. On July 1, 2001, Carlos Blanco was named National Sales and Marketing Manager of the Instrument Division. He had previously served as International Manager for Europe, South America, and Mexico. Prior to joining Giga-tronics in November 1999, Mr. Blanco was Director of Latin American Sales for IFR Systems Inc. and Marconi Instruments Inc. On June 25, Scott Weiss joined Microsource Division as VP of Sales and Marketing. Mr. Weiss has served in sales and marketing positions at companies such as TrueTime, Inc. and Internet Commerce. 4 Because we believe it is important to understand the breadth and depth of the market we serve, we have reproduced on the following two pages the spectrum analysis and market outline that appeared in last years annual report. Giga-tronics serves many segments of this broad market with equipment essential to the manufacture, calibration, maintenance and operation of these communications systems. Through the fourth quarter of FY 2001 and the first quarter of FY 2002, this market has softened substantially due in part to the general economic slowdown and in part to an imbalance in the build-out of many of the large wireless communication systems. We will undoubtedly feel the effects of this through the first part of this year. Fortunately, we now have experienced senior managers aggressively addressing this challenge. Sincerely, George H. Bruns, Jr. Chairman and Chief Executive Officer 5 CB Citizens Band EMC Electro-magnetic Compatibility TETRA Trans Euro. Trunked Radio GSM Global Sytem/Mobile Comm. UHF Ultra High Frequency IMTS Improved Mobile Telephone Service ISM Industrial Scientific & Medical Band PCN Public Communications Network GPS Global Positioning System DECT Digital European Cordless Telephone PCS Personal Comm. System WLL Wireless Local Loop MMDS Multi-channel, Multi-point Distribution Service TVRO TV Receive Only LEO Low Earth Orbit LMDS Local Multi-point Distribution Service CDMA Code Division Multiple Access TDMA Time Division Multiple Access LAN Local Area Network WAN Wide Area Network DBS Direct Broadcast Service F R E Q U E N C Y S P E C T R U M FIXED & MOBILE SERVICES MARITIME COMM & NAV BROADCAST, AM TO TVRO AERO COMM & NAV CB PAGING LOW BAND LAND MOBILE CT1 Wireless Local Loop SCA PAGING HIGH BAND LAND MOBILE PAGING TETRA, Wireless Local Loop UHF LAND MOBILE IMTS PAGING UHF TV CELLULAR CELLULAR TRUNKING SMR Wireless Local Loop ISM PCN spread spectrum CT2 Narrowband GPS GPS Wireless Local Loop GPS LEO DECT, Wireless Local Loop PCS Wireless Local Loop PCS ISM Wireless Local Loop PCS, Big LEO sat/mobile downlink Bluetooth Wireless Local Loop TV RELAY AND MMDS-IFTS MMDS Wireless Local Loop MILITARY RADAR, AERO. COMM & NAV MARITIME COMM & NAV Wireless Local Loop AERO. COMM & NAV TVRO Fixed Satellite, Mobile, space to earth Big LEO, forward link Private Land Mobile WLL, unlicensed high speed data, ISM, Govt Big LEO Big LEO, return link Govt, space research, satellite RADAR Mobile Satellite DBS RADAR Fixed - Satellite, earth to space RADAR Fixed - Mobile, Video LMDS LMDS Big LEO Microwave point to point European LMDS ISM Vehicle Radar Air to Air secure communications 6 10 KHZ - 500 10 KHZ - 3000 500 KHZ - 4000 40 KHZ - 3700 27 30 - 50 30 - 50 40 - 50 66 - 88, 132 - 520 90 - 108 150 - 170 150 - 175 380 - 512 450 - 500 450 - 500 500 - 800 800 - 900 800 - 950 800 800 - 1000 900 1000 1GHz 930 - 931 970 - 1210, 1220 - 1400, 1420 - 1540 1500 1550 - 1580, 1590 - 1640, 1650 - 1680 1600 1800 1850 - 1990 1900 2130 - 2150, 2180 - 2200 2200 - 2700 2300 - 2310 2400 - 2500 2400 2400 2.5 GHz 1700 - 2700 2500 - 2700 2700 2700 - 2900 2700 - 3000 2900 - 3000 3500 3600 - 3700 3950 - 4000 4660 - 4685 5 GHz 5000 - 5150 5150 - 5650 5150 - 5350, 5725 - 5825 5925 - 6425 6425 - 7125 8 GHz 7075 - 8500 9000 - 10500 11.7 - 12.2 GHz 12.2 - 12.7 13.4 - 14 GHz 14 - 15.7 GHz 15 - 17.7 GHz 20 GHz 21.4 - 22.5 GHz 27.5 - 28.35 GHz 29.1 - 29.25 GHz 29 .75 - 30 GHz 38 GHz 40 GHz 41 - 42 GHz 61 GHz 77 GHz 94 GHz 110 GHz B R E A D T H O F M A R K E T S The allocation of frequency spectrum on the preceding page, ranging from 10 kilohertz to 110 gigahertz, indicates the real breadth of the wireless communications market and the wide range of specific applications of this technology. We tend to think of wireless communication principally in terms of voice and data transmission. Certainly this is a large and growing segment of this market and includes such sub-segments as cellular, internet, point to point, point to multipoint, LMDS, back-haul, fixed and mobile services, satellite up and down links, GPS, LAN, WAN and others. At the same time, however, the civilian aviation and the commercial aviation segments of this market use wireless communication not only in voice and data trans- mission, but in the application of radar to the very vital function of air traffic control. Commercial aircraft in flight use storm warning radar to detect and avoid storm cells for reasons of both safety and passenger comfort. Forward looking radar provides ter- rain warning in mountainous country. Ground control radar is used to direct and con- trol aircraft traffic on runways and taxiways of very large airports where visual surveil- lance is difficult. There are potential applications for in-flight close proximity warning. The military uses radar in a wide range of navigation, missile identification and weapons control applications. Ground forces are now equipped with very sophisticated wireless communications and wireless weapons control systems. With the current emphasis by the armed services on COTS (commercial off-the-shelf ) procurement there is little difference between commercial and military procurement. Then there is the "every-day" private user market including Global Positioning Systems, the home use walk around telephone, CB (citizen band) users, ham radio, even the remote control door locks on your car. All of the foregoing segments of this very large and diverse market utilize the same fundamental technologies and have very similar needs for instruments and test systems that calibrate and maintain the various elements of these communications systems. Therefore, they are all extremely important markets to Giga-tronics. 7 U S E R S O F G I G A - T R O N I C S P R O D U C T S ShinEtsu Hughes Raytheon Northrop Grumman Harris Aerospace Nokia Rohde & Schwarz BAE Systems U.S. Navy U.S. Army Marine Corps US Air Force Ericsson Siemens Kyocera Teradyne Delphi Nortel French Navy Australian Military St. Judes Hospital Unisys Spectrian MEMC Tektronix PEI Electronic Amkor Spectrian Loral Denso Agilent Management Technologies RCAF (Canadian Airforce) Boeing Qualcomm Phillips BEI Sanders Motorola Lockheed Martin Alcatel Grumman Conexant Korean Army Canadian Military Mitsubishi Lucent Seoul University Dallas Semiconductor 8 I N S T R U M E N T S 4650 Norris Canyon Road San Ramon, CA 94583-1320 (925)-328-4650 (925)-328-4700 (FAX) e-mail: info@gigatronics.com www.gigatronics.com Microwave Signal Generators, RF Signal Generators, Peak Power Meters, Universal Power Meters, VXI Signal Generators and VXI Universal Power Meters. Claudio Mariotta is the President and General Manager of this Division, having previously served as Vice President of Operations and as Vice President of Engineering. Before coming to Giga-tronics he had served as Executive Vice President of SSE Telecom and as Vice President of Engineering at the Microwave Division of Harris Corporation. Claudio S. Mariotta President, Giga-tronics Instrument Division M I C R O S O U R C E 1269 Corporate Center Parkway Santa Rosa, CA 95407-5412 (707)-527-7010 (707)-527-7176 (FAX) www.microsource-inc.com YIG Oscillators, YIG based microwave and millimeter wave products, free running and phase locked oscillators in narrow and wide band configurations, band pass and band reject filters, narrow and wide band frequency synthesizers and highly integrated front-end modules for applications in test & measurement, wireless communications and defense electronics. Bill Wilson is the President and General Manager of Microsource. He is also a Director of Giga-tronics Incorporated. His prior experience includes Chairman and CEO of Microwave Technology, Inc., President of Amplica Inc./COMSAT, Business Director Hybrid Microcircuits of Rockwell International/Collins Radio and on technical staff of Sandia Laboratories and Rome Air Development Center. William E. Wilson President, Microsource, Inc. A S C O R 4384 Enterprise Place Fremont, CA 94539-6365 (510)-490-2300 (510)-490-8493 (FAX) e-mail: info@ascor-inc.com www.ascor-inc.com Counters, Volt meters, A to D Converters, D to A Converters, Electronic and Optical Switches, GPIB, VXI, PXI and USB Platforms. Jeffrey T. Lum is the President and founder of ASCOR. Previously he was the Vice President and founder of Autek Systems. He holds several patents derived from this technology. Jeffrey T. Lum President, ASCOR, Inc. D Y M A T I X 3380 Montgomery Drive Santa Clara, CA 95054-2907 (408)-980-0666 (408)-980-0670 (FAX) www.dymatix.com Die sorting systems, Wafer/Disk handling systems and Wafer probers. Dan Markowitz is the President of DYMATiX. He has extensive prior experience as General Manager of MAR Engineering, as a Director of Material, Relocation Project Manager and Group Contracts Manager while with various Allied Signal divisions, as well as a Plant Manager, Director of Contracts, Program Manager, Cost Control/Estimating Manager and Purchasing Manager with Bendix Electrodynamics Division. Daniel S. Markowitz President, DYMATiX F I N A N C I A L R E P O R T “Giga-tronics continues to maintain a strong financial position with a current ratio of over 4 and almost $23 million in working capital.” Mark H. Cosmez, II Vice President, Finance Chief Financial Officer & Secretary 13 F I N A N C I A L R E P O R T 15 MANAGEMENT’S DISCUSSION AND ANALYSIS 17 CONSOLIDATED BALANCE SHEETS 18 CONSOLIDATED STATEMENTS OF OPERATIONS 19 CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY 20 CONSOLIDATED STATEMENTS OF CASH FLOWS 21 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 29 INDEPENDENT AUDITOR’S REPORT 30 SELECTED FINANCIAL DATA 32 CORPORATE INFORMATION 14 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S R e s u l t s o f O p e r a t i o n s f o r F i s c a l 2 0 0 1 a s C o m p a r e d t o 2 0 0 0 During the fourth quarter of fiscal 2001, the Company adopted SAB 101, Revenue Recognition in Financial Statements. The Company recorded a net cumulative effect adjustment related to this change in accounting of $520,000, effective March 26, 2000. The adoption of SAB 101 resulted in the deferral of $2,165,000 in sales as of the beginning of the 2001 fiscal year, and subsequent recognition of the deferred sales during the year. New orders received in 2001 were $57,830,000, a decrease of 10% from $64,013,000 in 2000. This decrease was attribut- able primarily to the non recurrence of a three year contract for about $14,100,000 recorded at the end of fiscal 2000. At year end 2001, the Company’s backlog of unfilled orders was $39,964,000, compared to $34,128,000 at the end of 2000. As of year end 2001, there were approximately $7,245,000 unfilled orders that were scheduled for shipment beyond a year and as of year end 2000 there were $10,201,000 unfilled orders scheduled for shipment beyond a year. Primarily, the increase in backlog is attributable to strong order levels at Microsource and at the Giga-tronics Instruments division. Net sales for 2001 were $54,159,000, a 14% increase from $47,577,000 in 2000. Sales for the fiscal year 2001, without the SAB 101 adjustment, would have been $51,994,000, or over a 9% increase in revenue as compared to the $47,577,000 of the prior year. In fiscal 2001, Microsource decreased revenues 12% or $1,861,000, while Giga-tronics Instruments increased 35% or $6,485,000, in sales and ASCOR improved 12% or $798,000, in sales. DYMATIX (formerly the Semiconductor Equipment Group) improved 16% or $1,160,000. DYMATIX sales for the fiscal year 2001, without the SAB 101 adjustment, would have declined over 14% or $1,005,000. Cost of sales increased 11% in 2001 to $35,103,000 from $31,767,000 in 2000. Cost of sales for the fiscal year 2001, without the SAB 101 adjustment, would have been $33,681,000, or over a 6% increase in cost of sales as compared to the prior year. The increase in fiscal 2001 is attributable to increased shipments of products during the fiscal year coupled with higher costs for labor and material for the products shipped. Operating expenses increased 12% in 2001 over 2000. Product development costs increased $907,000 in fiscal 2001 to $5,087,000. This was principally due to increased development of new products at the Instruments division and at Microsource. Selling, general and administrative expenses increased $1,058,000 to $10,713,000 in 2001 due to higher commissions on higher revenues coupled with higher personnel and promotional expenses at the Instruments division. Amortization of intangibles decreased $248,000 to $232,000 principally, as a result of reduced amortization of patents and licenses. Other income increased in fiscal 2001 primarily due to increased sublease rent from the facilities leased in Santa Rosa. Net interest income in 2001 increased from 2000 due to higher average cash available for investment. The average cash improvement resulted principally from higher cash levels in the middle of the year. The provision for income taxes in 2001 was $1,040,000, or 30%, of the pre-tax earnings. Giga-tronics recorded net earnings before cumulative effect of accounting change of $2,421,000, or $0.51 per diluted share, in 2001 versus $1,139,000, or $0.24 per diluted share, in 2000. The improvement in 2001 earnings was due to the Company’s higher sales levels in 2001 as compared to 2000. The Company recorded $520,000 for the cumulative effect of accounting change as a result of the implementation of SAB 101. As a result, Giga-tronics recorded net earnings of $1,901,000, or $0.40 per diluted share, in 2001 versus $1,139,000, or $0.24 per diluted share, in 2000. R e s u l t s o f O p e r a t i o n s f o r F i s c a l 2 0 0 0 a s c o m p a r e d t o 1 9 9 9 New orders received in 2000 were $64,013,000, an increase of 74% from $36,786,000 in 1999. At year end 2000, the Company’s backlog of unfilled orders was $34,128,000, compared to $17,692,000 at the end of 1999. As of year end 2000, there were approximately $10,201,000 unfilled orders that were scheduled for shipment beyond a year and as of year end 1999 there were no unfilled orders scheduled for shipment beyond a year. Primarily, the increase in backlog is attributable to strong order levels at Microsource and at the Giga-tronics Instruments division. Net sales for 2000 were $47,577,000, a 26% increase from $37,636,000 in 1999. Every segment of the business improved revenue during the fiscal year. In fiscal 2000, Microsource increased revenues 68% or $6,085,000, DYMATIX (formerly the Semiconductor Equipment Group) improved 43% or $2,180,000, in revenue, while Giga-tronics Instruments increased 8% or $1,455,000, in sales and ASCOR improved 3% or $221,000, in sales. Cost of sales increased 22% in 2000 to $31,767,000 from $26,102,000 in 1999. The increase in fiscal 2000 is attributable to increased shipments of products during the fiscal year coupled with higher costs for labor and material for the products shipped. Operating expenses declined 6% in 2000 over 1999. Product development costs declined $1,133,000 in fiscal 2000 to $4,180,000 as the development of new products returned to previous levels. Selling, general and administrative expenses increased $237,000 to $9,655,000 in 2000 due to higher commissions on higher revenues. Amortization of intangibles decreased $82,000 to $480,000 as a result of reduced amortization of patents and licenses. Other income decreased in fiscal 2000 primarily due to the fiscal 1999 gain from the sale of a surplus building following facilities consolidation at DYMATIX for which there was no corresponding sale in fiscal 2000. Net interest income in 2000 decreased 51% from 1999 due to lower average cash available for investment. The average cash decline resulted principally from low cash level at the beginning of the year. The provision for income taxes in 2000 was $494,000, or 30%, of the pre-tax earnings. Giga-tronics recorded net earnings of $1,139,000, or $0.24 per diluted share, in 2000 versus a loss of $1,858,000, or $0.43 per diluted share, in 1999. The improvement in 2000 earnings was due to the Company’s higher sales levels in 2000 as compared to 1999. 15 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S F i n a n c i a l C o n d i t i o n a n d L i q u i d i t y As of March 31, 2001, Giga-tronics had $3,469,000 in cash and cash equivalents, compared to $3,455,000 as of March 25, 2000 and $2,286,000 as of March 27, 1999. Cash provided by operations amounted to $1,951,000 in 2001 and $2,644,000 in 2000, compared to cash used by operations of $2,365,000 in 1999. Cash provided by operations in 2001 is attributed to operating income in the year primarily offset by cash paid for income taxes of $988,000 and the net change in operating assets and liabilities. Cash provided by operations in 2000 is attributed to operating income in the year. In 1999, losses by operations were the significant rea- son for the increase in use of cash by operations. Giga-tronics continues to maintain a strong financial position, with working capital at year end of $22,924,000 compared to $21,066,000 in 2000 and $18,021,000 in 1999. The Company’s current ratio of 4.1 increased from the 2000 and 1999 current ratio of 3.2 and 3.3, respectively. The increase in working capital is primarily a result of the increased operations of the Company. Additions to property and equipment were $1,800,000 in 2001, compared to $1,361,000 in 2000 and $953,000 in 1999. Fiscal 2001 spending reflects continuing investments to support new product development, increased productivity, and improved product quality. Other cash inflows in 2001 consists of $367,000 of common stock in connection with the exercise of stock options. Other cash inflows in 2000 were $174,000 of common stock in connection with the exercise of stock options. Management believes that the Company has adequate resources to meet its operating and capital expenditure needs for the foreseeable future. The Company has a seven million dollar unsecured line of credit, none of which has been used. The Company may continue to increase product development expenditures in the near term for the purpose of broadening its product base. It is the Company’s intention to broaden its product lines and expand its market, both by internal development of new products and through the acquisition of other business entities. F a c t o r s T h a t M a y A f f e c t F u t u r e R e s u l t s O f O p e r a t i o n s BUSINESS CLIMATE MAY BECOME VOLATILE Giga-tronics’ has a significant number of defense-related orders. If the defense market should decline, shipments in the current year could be less than anticipated and cause a decrease 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 the contract. If this occurs, then shipments in the current year could fall short of plan resulting in a decline in earnings. GIGA-TRONICS ACQUISITIONS MAY NOT BE EFFECTIVELY INTEGRATED AND THEIR INTEGRATION MAY BE COSTLY As part of its business strategy, Giga-tronics intends to 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. 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. FORWARD LOOKING STATEMENTS Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Annual Report to Shareholders contain forward-looking statements that involve risks and uncertainties. The actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed herein and in the Company’s 2001 Report 10-K under “Item 1. Business” and “Certain Factors Which May Affect Future Operation Or An Investment In Giga-tronics” as filed with the Securities and Exchange Commission. 16 C O N S O L I D A T E D B A L A N C E S H E E T S (In thousands except share data) Assets Current assets Cash and cash equivalents Trade accounts receivable, net of allowance of $262 and $254 respectively Inventories, net Prepaid expenses Deferred income taxes Total current assets Property and equipment Leasehold improvements Machinery and equipment Office furniture and fixtures Property and equipment, gross cost Less accumulated depreciation and amortization Property and equipment, net Patents and licenses Goodwill, net Other assets Total assets Liabilities and shareholders’ equity Current liabilities Accounts payable Accrued commissions Accrued payroll and benefits Accrued warranty Customer advances Obligation under capital lease Other current liabilities Total current liabilities Obligations under capital lease, net of current portion Deferred income taxes Deferred rent Total liabilities Shareholders’ equity Preferred stock of no par value Authorized 1,000,000 shares; no shares outstanding at March 31, 2001 and March 25, 2000 Common stock of no par value; Authorized 40,000,000 shares; 4,542,694 shares at March 31, 2001 and 4,431,008 shares at March 25, 2000 issued and outstanding Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity See Accompanying Notes to Consolidated Financial Statements March 31, 2001 March 25, 2000 $ 3,469 7,767 $ 3,455 9,194 15,185 424 3,560 30,405 398 16,123 1,142 17,663 12,357 5,306 36 339 1,232 $ 37,318 $ 3,347 435 1,687 732 690 167 423 7,481 115 796 451 8,843 14,113 444 3,570 30,776 382 14,673 1,023 16,078 10,678 5,400 112 564 674 $ 37,526 $ 4,065 625 1,638 553 1,536 118 1,175 9,710 127 1,011 529 11,377 — — 12,346 16,129 28,475 $ 37,318 11,921 14,228 26,149 $ 37,526 17 C O N S O L I D AT E D S TAT E M E N TS O F O PE R AT I O N S Years ended (In thousands except per share data) March 31, 2001 March 25, 2000 March 27, 1999 Net sales Cost of sales Gross profit Product development Selling, general and administrative Amortization of intangibles Operating expenses Operating income (loss) Other income (expense) Interest income, net Earnings (loss) before provision (benefit) for income taxes and cumulative effect of accounting change Provision (benefit) for income taxes Earnings (loss) before cumulative effect of accounting change Cumulative effect of accounting change Net earnings (loss) $ 54,159 35,103 19,056 5,087 10,713 232 16,032 3,024 232 205 3,461 1,040 2,421 520 $ 1,901 $ 47,577 31,767 15,810 4,180 9,655 480 14,315 1,495 79 59 1,633 494 1,139 — $ 1,139 $ 37,636 26,102 11,534 5,313 9,418 562 15,293 (3,759 ) 632 121 (3,006) (1,148) (1,858) — $ (1,858) Basic earnings (loss) per share: Before cumulative effect of accounting change $ 0.54 $ 0.26 $ (0.43) Cumulative effect of accounting change (0.12) — — Basic earnings (loss) per share $ 0.42 $ 0.26 $ (0.43) Diluted earnings (loss) per share: Before cumulative effect of accounting change $ 0.51 $ 0.24 $ (0.43) Cumulative effect of accounting change (0.11) — — Diluted earnings (loss) per share $ 0.40 $ 0.24 $ (0.43) Weighted average basic common shares outstanding Weighted average diluted common shares outstanding Pro forma amounts assuming accounting change is applied retroactively: (Unaudited) 4,474 4,803 4,379 4,693 4,338 4,338 Net income (loss) Net income (loss) per share – Basic Net income (loss) per share – Diluted See Accompanying Notes to Consolidated Financial Statements 18 $ 2,421 0.54 $ 0.51 $ $ $ $ 623 0.14 0.13 $ (1,404) $ (0.32) $ (0.32) C O N S O L I D AT E D S TAT E M E N TS O F S H A R E H O L D E R S ’ E QU I T Y (In thousands except share data) Balance at March 28, 1998 Comprehensive Income Net loss Unrealized gain on investments, net of income tax benefit of $10 Comprehensive loss Stock issuance under stock option plans Balance at March 27, 1999 Comprehensive Income – net Net earnings Stock issuance under stock Option plans Tax benefit associated with exercise of stock options Balance at March 25, 2000 Comprehensive Income – net Net earnings Stock issuance under stock option plans Tax benefit associated with exercise of stock options — — — Common Stock Shares Amount Comprehensive Income (Loss) Other Comprehensive Income (Loss) Retained Earnings Total 4,326,299 $ 11,532 $ — $ (18) $ 14,947 $ 26,461 — (1,858) — (1,858) (1,858) 18 — — (1,840) 18 — — — — — 18 — 89 35,603 89 — 4,361,902 $ 11,621 $ — $ — $ 13,089 $ 24,710 — — 1,139 69,106 — 174 126 — — — — — 1,139 1,139 — — 174 126 4,431,008 $ 11,921 $ — $ — $ 14,228 $ 26,149 — — 1,901 111,686 — 367 58 — — — — — 1,901 1,901 — — 367 58 Balance at March 31, 2001 4,542,694 $ 12,346 $ — $ — $ 16,129 $ 28,475 See Accompanying Notes to Consolidated Financial Statements 19 C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S Years ended (In thousands) March 31, 2001 March 25, 2000 March 27, 1999 Cash flows provided from operations: Net earnings (loss) Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operations: Provision for bad debt Depreciation and amortization Tax benefit from employee stock options Tax benefit of pre acquisition NOL utilization Gain on sales of fixed assets Deferred income taxes Changes in operating assets and liabilities: Trade accounts receivable Inventories Prepaid expenses Accounts payable Accrued commissions Accrued payroll and benefits Accrued warranty Accrued other expenses Customer advances Income taxes receivable/payable Net cash provided by (used in) operations Cash flows from investing activities: Purchases of investments Maturities of investments Proceeds from sale of property and equipment Additions to property and equipment Payment for purchase of Microsource, including transaction costs Advances to Microsource Other assets Net cash provided by (used in) investing activities Cash flows from financing activities: Issuance of common stock Payment on line of credit Payment on notes payable and other long term liabilities Payments on capital lease and other long term obligations Net cash provided by (used in) financing activities Increase (decrease) in cash and cash equivalents Beginning cash and cash equivalents Ending cash and cash equivalents Supplementary disclosure of cash flow information: Cash paid for income taxes Cash paid for interest Non-cash investing and financing activities: Purchases under capital lease obligations See Accompanying Notes to Consolidated Financial Statements 20 $ 1,901 $ 1,139 $(1,858) 8 2,120 58 — (20) (205) 1,419 (1,072) 20 (718) (190) 49 179 (613) (846) (139) 1,951 — — 26 (1,645) — — (489) (2,108) 367 — (78) (118) 171 14 3,455 3,469 (182) 2,111 126 394 (20) (81) (2,578) (864) (61) 1,043 256 292 86 535 (112) 560 2,644 — — 7 (1,311) (8) — (565) (1,877) 174 — (45) (127) 2 769 2,686 3,455 142 2,208 — — (521) (443) 1,738 (1,710) 74 (622) (180) 67 (269) (209) (968) 186 (2,365) (2,268) 8,010 1,291 (953) (605) (940) (17) 4,518 89 (1,500) (2,497) (170) (4,078) (1,925) 4,611 2,686 $ 988 — 155 $ 86 — 50 $ 7 — — N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S 1 Business Combinations On May 18, 1998, Giga-tronics Incorporated acquired Microsource, Inc. (Microsource) of Santa Rosa, California. Microsource develops and manufactures a broad line of YIG (Yttrium, Iron, Garnet) tuned oscillators, filters, and microwave synthesizers. The acquisition was accounted for using the purchase method of accounting, and accordingly, the results of operations of Microsource have been included in the Company’s consolidated financial statements from May 18, 1998. The purchase price consisted of $1,500,000 plus contingent payments based upon future net income of Microsource during the two fiscal years after the effective time of the merger. The purchase price was subsequently adjusted to give effect to the contingent payment of $8,000, net paid to Microsource shareholders based on the subsidiary’s fiscal year 2000 operating results. In addition, the purchase price allocation was adjusted to give effect in fiscal year 2000 to the recognition of deferred tax assets of $394,000 for which no value was assigned at the date of the acquisition. 2 Summary of Significant Accounting Policies The accompanying consolidated financial statements include the accounts of Giga-tronics and its wholly owned subsidiaries. The Company Giga-tronics and its subsidiary companies design, manufacture and market 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. The Company also manufactures and markets a line of test, measurement, and handling equipment used in the manufacturing of semiconductor devices. The Company’s products are sold worldwide to customers in the test and measurement and semiconductor industries. The Company has a United Kingdom (UK) research & development facility for the Instruments division. Otherwise the Company has no other foreign-based operations or material amounts of identifiable assets in foreign countries. Its gross margins on foreign and domestic sales are similar, and all non-U.S. sales are made in U.S. dollars. Principles of Consolidation significant intercompany balances and transactions have been eliminated in consolidation. The consolidated financial statements include the accounts of Giga-tronics and its wholly-owned subsidiaries. All The preparation of financial statements in conformity with accounting principles generally accepted in the United States of Use of Estimates America requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Fiscal Year March. Fiscal year 2001 contained 53 weeks while fiscal years 2000 and 1999 each contained 52 weeks. The Company’s financial reporting year consists of either a 52 week or 53 week period ending on the last Saturday of the month of Reclassifications conform to the current year presentation. Certain reclassifications, none of which affected net income (loss), have been made to prior year balances in order to Revenues are recognized when there is evidence of an arrangement, delivery has occurred, the price is fixed and Revenue Recognition determinable, and collectibility is reasonably assured. Revenue to customers is recorded when products are shipped and the risk of loss has passed. Upon shipment, the Company also provides for the estimated cost that may be incurred for product warranties. Revenue related to products shipped subject to customers’ evaluation is recognized upon final acceptance. During the fourth quarter of fiscal 2001, the Company adopted Staff Accounting Bulletin (SAB) 101, Revenue Recognition in Financial Statements, effective March 26, 2000. Prior to the adoption of SAB 101, the Company recognized revenue on sales with final customer acceptance upon delivery and provided for the estimated costs of installation obligations at the time the revenue was recognized. The Company recorded a cumulative effect adjustment related to this change in accounting of $520,000, net of income taxes. The adoption of SAB 101 resulted in the deferral of $2,165,000 in sales as of the beginning of the 2001 fiscal year, and subsequent recognition of the deferred sales during the year. Pro forma effect of SAB 101 assuming accounting change is applied retroactively is as follows: Years ended (In thousands except per share data) (Unaudited) Net Sales Cost of Sales Gross Profit Operating Expense Operating Income (loss) Interest and other income Earnings (loss) before taxes Provision (benefit) for income taxes Net income (loss) Net income (loss) per share – Basic Net income (loss) per share – Diluted March 31, 2001 March 25, 2000 March 27, 1999 $ 54,159 35,103 19,056 16,032 3,024 437 3,461 1,040 $ 2,421 0.54 $ 0.51 $ $ 45,412 30,345 15,067 14,315 752 138 890 267 623 0.14 0.13 $ $ $ $ 39,120 26,938 12,182 15,293 (3,111) 753 (2,358) (954) $ (1,404) (0.32) $ (0.32) $ 21 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Cash Equivalents of purchase to be cash equivalents. The Company considers all highly liquid debt instruments with remaining maturity dates of 90 days or less from date Inventories Inventories are stated at the lower of cost or market. Cost is determined on a first-in, first-out basis. Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated Property and Equipment useful lives of the respective assets, which range from three to ten years for machinery and equipment and office fixtures. Leasehold improvements and assets acquired under capital leases are amortized using the straight-line method over the shorter of the estimated useful lives of the respective assets or the lease term. Recoverability of property and equipment is measured by comparison of its carrying amount, including the unamortized portion of goodwill allocated to property and equipment, to future cash flows the property and equipment are expected to generate. The Company assesses the recoverability of enterprise level goodwill by determining whether the unamortized goodwill balance can be recovered through undiscounted future cash flows of the acquired operation. To date, the Company has made no adjustments to the carrying value of its property and equipment or goodwill due to asset impairment. Deferred Rent Rent expense is recognized in an amount equal to the minimum guaranteed base rent plus future rental increases amortized on the straight-line basis over the terms of the leases, including free rent periods. Included in other long-term liabilities is the excess of rent expense over required rental payments. Income Taxes Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Patents and Licenses 2001 and March 25, 2000 accumulated amortization on patents and licenses was $2,160,000 and $2,084,000, respectively. Patents and licenses are being amortized using the straight-line method over periods of five to seven years. As of March 31, Goodwill accumulated amortization on goodwill was $1,881,000 and $1,725,000 respectively. Goodwill is being amortized using the straight-line method over a period of five years. As of March 31, 2001 and March 25, 2000 The Company incurs pre-production costs on certain long-term supply arrangements. The costs, which represent Pre-production costs non-recurring engineering and tooling costs owned by the Company, are capitalized as part of other assets and amortized over their useful life when reimbursable by the customer. Otherwise, they are expensed as incurred. Included in other assets as of March 31, 2001 and March 25, 2000 are capitalized design and development costs of $1,133,000 and $579,000, respectively. Product Development Costs Product development costs are charged to operations in the year incurred. Software Development Costs are expensed as incurred until technological feasibility in the form of a working model has been established. To date, completion of software development has been concurrent with the establishment of technological feasibility, and accordingly, no costs have been capitalized. Development costs included in the research and development of new products and enhancements to existing products Stock-based Compensation The Company uses the intrinsic value method to account for employee stock-based compensation. Earnings (Loss) Per Share Basic earnings (loss) per share are computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share incorporate the incremental shares issuable upon the assumed exercise of stock options using the treasury method. Antidilutive options are not included in the computation of diluted earnings per share. Financial Instruments and Concentration of Credit Risk 31, 2001, consist principally of cash, cash equivalents and trade accounts receivable. The Company’s cash equivalents consist principally of money market funds and certificates of deposits. Cash and cash equivalents are held in recognized depository institutions. Concentration of credit risk in trade accounts receivable results primarily from sales to major customers. The Company individually evaluates the creditworthiness of its customers and generally does not require collateral or other security. Financial instruments, which potentially subject the Company to credit risk as of March Fair Market Value of Financial Instruments payable approximates fair market value because of the short maturity of these financial instruments. The carrying amount for the Company’s cash equivalents, trade accounts receivable and accounts Recent Accounting Pronouncements The Financial Accounting Standards Board (FASB) issued SFAS No.133, “Accounting for Derivative Instruments and Hedging Activites.” SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the Balance Sheet and measure those instruments at fair value. For a derivative not designated as a hedging instrument, changes in the fair value of the derivative are recognized in earnings in the period of change. The Company must adopt SFAS No. 133 in the first quarter of fiscal 2002. Management does not believe the adoption of SFAS No. 133 will have a material effect on the financial position or operations of the Company. 22 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S 3 Cash and Cash Equivalents Cash and cash equivalents consisted of the following at March 31, 2001 and March 25, 2000: Cash and Cash Equivalents Amortized Cost $ 3,469 $ 3,469 Fair Value $ 3,469 $ 3,469 Cash and Cash Equivalents Amortized Cost $ 1,067 1,933 455 $ 3,455 Fair Value $ 1,067 1,933 455 $ 3,455 March 31, 2001 (In thousands) Cash Total March 25, 2000 (In thousands) Cash Money market funds Other marketable securities Total 4 Inventories Years ended (In thousands) Raw materials Work-in-progress Finished goods Loaned inventory 5 Selling Expenses March 31, 2001 March 25, 2000 $ 8,432 4,833 1,020 900 $ 15,185 $ 8,095 5,167 294 557 $ 14,113 Selling expenses consist primarily of commissions paid to various marketing agencies. Commission expense totaled $2,579,000, $2,360,000, and $2,051,000 in fiscal 2001, 2000, and 1999, respectively. Advertising costs which are expensed as incurred totaled $579,000, $511,000, and $558,000 for fiscal 2001, 2000, and 1999, respectively. 6 Significant Customers and Industry Segment Information The Company has five reportable segments: Giga-tronics Instruments division, ASCOR, Microsource, DYMATIX, and Corporate. Giga-tronics Instrument division produces 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. ASCOR designs, manufactures, and markets a line of switching devices that link together many specific purpose instruments that comprise automatic test systems. Microsource develops and manufactures a broad line of YIG (Yttrium, Iron, Garnet) tuned oscillators, filters and microwave synthesizers, which are used in a wide variety of microwave instruments or devices. DYMATIX, which includes Viking Semiconductor Equipment, Inc. and Ultracision, Inc., manufactures and markets optical inspection equipment used to test semiconductor devices and automation equipment for the test and inspection of silicon wafers. Corporate handles the financing needs of each segment and lends funds to each segment as required. The accounting policies for the segments are the same as those described in the “Summary of Significant Accounting Policies.” The Company evaluates the performance of its segments and allocates resources to them based on earnings before income taxes (pre-tax income (loss)). Segment net sales includes sales to external customers. Segment pre-tax loss includes an allocation for corporate expenses, amortization of goodwill, and interest expense from borrowings from Corporate. Corporate expenses are allocated to the reportable segments based principally on full time equivalent headcount. Interest expense is charged at prime which is currently 9% for cash required by each segment. Goodwill associated with acquisitions are recorded as assets of the individual segments. Assets include accounts receivable, inventories, equipment, cash, deferred income taxes, prepaid expenses, goodwill and other long-term assets. The Company accounts for inter-segment sales and transfers at terms that allow a reasonable profit to the seller. During the periods reported there were no significant inter-segment sales or transfers. The Company’s reportable operating segments are strategic business units that offer different products and services. They are managed separately because each business utilizes different technology and requires different marketing strategies. All of the businesses except for Giga- tronics Instruments were acquired. The Company’s chief operating decision maker is considered to be the Company’s Chief Executive Officer (“CEO”). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues and pre-tax income by operating segment. The tables below present information for the fiscal years ended in 2001, 2000 and 1999: 23 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S March 31, 2001 (In thousands): Revenue Interest income Interest expense Depreciation and amortization Pre-tax income Assets March 25, 2000 (In thousands): Revenue Interest income Interest expense Depreciation and amortization Pre-tax income Assets March 27, 1999 (In thousands): Revenue Interest income Interest expense Depreciation and amortization Pre-tax income (loss) Assets Giga-tronics Instruments $ 25,001 25 (196) 604 1,193 15,518 Giga-tronics Instruments $ 18,516 — (25) 699 361 13,546 Giga-tronics Instruments $ 17,061 35 — 924 (805) 10,130 ASCOR $ 7,503 93 (4) 148 1,436 4,172 ASCOR $ 6,705 34 (15) 153 53 5,299 ASCOR $ 6,484 10 31 152 546 4,426 Microsource $ 13,208 6 (744) 1,270 (985) 11,937 Microsource $ 15,069 1 (634) 1,164 132 11,874 Microsource $ 8,984 — 455 1,004 (777) 11,495 DYMATIX $ 8,447 3 (354) 98 434 5,236 DYMATIX $ 7,287 — (329) 95 168 5,396 DYMATIX $ 5,107 2 287 128 (2,791) 5,763 Corporate Total $ — $ 54,159 236 (31) 2,120 3,461 37,318 109 1,267 — 1,383 455 Corporate $ — 70 957 — 919 1,411 Corporate $ — 120 (727) — 821 1,445 Total $ 47,577 105 (46) 2,111 1,633 37,526 Total $ 37,636 167 46 2,208 (3,006) 33,259 The Company’s Giga-tronics Instruments, ASCOR, and Microsource segments sell to agencies of the U.S. Government and U.S. defense-related customers. In fiscal 2001, 2000, and 1999 U.S. Government and U.S. defense-related customers accounted for 11%, 16%, and 24%, of sales, respectively. In addition during 2001, a Japanese distributor of the Company, Midoriya, accounted for 10% of the Company’s consolidated sales and 11% of accounts receivable as of year end. Export sales accounted for 41%, 30%, and 20% of the Company’s sales in fiscal 2001, 2000, and 1999, respectively. Export sales by geographical area are shown below: Years ended (In thousands) Americas Europe Asia Rest of world 7 Earnings (loss) per Share March 31, 2001 4,256 6,831 9,512 1,473 22,072 $ $ March 25, 2000 1,989 6,448 4,981 1,050 14,468 $ $ March 27, 1999 445 3,446 3,371 403 7,665 $ $ Shares used in per share computations for the years ended March 31, 2001, March 25, 2000, and March 27, 1999 are as follows: Years ended (In thousands except per share data) March 31, 2001 March 25, 2000 March 27, 1999 Net earnings (loss) Weighted average: Common shares outstanding Common share equivalents Common shares assuming dilution Net earnings per share of common stock Net earnings per share of common stock assuming dilution Stock options not included in computation $ 1,901 $ 1,139 $ (1,858) 4,474 329 4,803 $ 0.42 $ 0.40 57 4,379 314 4,693 $ 0.26 $ 0.24 24 4,338 — 4,338 $ (0.43) $ (0.43) 537 The number of stock options not included in the computation of diluted earnings per share (EPS) for the period ended March 27, 1999 is a result of the Company’s loss from continuing operations and therefore the options are antidilutive. The number of stock options not included in the computation of diluted EPS for the periods ending March 31, 2001 and March 25, 2000 reflects stock options where the exercise prices were greater than the average market price of the common shares and are therefore antidilutive. 24 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S 8 Income Taxes Following are the components of the provision (benefit) for income taxes: Years ended (In thousands) Current: Federal State Deferred: Federal State Charge in lieu of taxes attributable to employer stock option plans Goodwill, for initial recognition of acquired tax benefits that previously were included in the valuation reserve March 31, 2001 March 25, 2000 March 27, 1999 $ $ 1,063 66 1,129 58 (263) (205) 58 58 46 7 53 (180) 100 (80) 127 394 494 $ (720) 4 (716) (205) (227) (432) — — $ (1,148) Provision (benefit) for income taxes $ 1,040 $ The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are as follows: Years ended (In thousands) Current tax assets, net Noncurrent tax asset (liabilities), net Net deferred taxes Future state tax effect Allowance for doubtful accounts Fixed asset depreciation Inventory reserves and additional costs capitalized Deferred revenue Accrued vacation Accrued warranty Other accrued liabilities Net operating loss carryforward Income tax credits Valuation allowances March 31, 2001 March 25, 2000 $ 3,560 (796) $ 2,764 (182) 112 (855) 2,529 — 284 314 212 6,056 786 (6,492) $ 2,764 $ 3,570 (1,011) $ 2,559 (188) 196 (1,116) 2,747 19 268 237 330 6,452 501 (6,887) $ 2,559 Years ended (In thousands except percentages) Statutory federal income tax (benefit) Beginning of year change in deferred Tax asset valuation allowance State income tax, net of federal benefit Nontax deductible expenses Tax credits Goodwill and patent amortization Interest income exempt from federal tax Other Effective income tax (benefit) March 31, 2001 March 25, 2000 March 27, 1999 $ 1,176 34.0% $ 555 34.0% $(1,022) 34.0% — 200 6 (297) 60 (58) (47) $ 1,040 — 5.8 0.2 (8.6 ) 1.7 (1.7 ) (1.4 ) 30.0% (55) 57 6 (98) 88 (51) (8) $ 494 (3.4) 3.5 0.4 (6.0) 5.4 (3.1) (.5) 30.3% — — 4.9 (146) (0.4) 14 1.9 (58) (2.8) 84 (19) .6 (1) — $(1,148) 38.2% 25 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S The change in valuation allowance from March 25, 2000 to March 31, 2001 was $395,000. The change in valuation allowance from March 27, 1999 to March 25, 2000 was $860,000. The change in valuation allowance from March 28, 1998 to March 27, 1999 was $7,648,000. The Company has recorded a valuation allowance to reflect the estimated amount of deferred tax assets, which may not be realized. The ultimate realization of deferred tax assets is dependent upon generation of future taxable income during the periods in which those temporary differences become deductible. Management considers projected future taxable income and tax planning strategies in making this assessment. Based on the historical taxable income and projections for future taxable income over the periods in which the deferred tax assets become deductible, management believes it more likely than not that the Company will realize benefits of these deductible differences, net of valuation allowances as of March 31, 2001. During the year ended March 27, 1999, the Company acquired approximately $7,600,000 of deferred tax assets in the acquisition of Microsource, which was fully offset by a valuation allowance. Subsequent recognition of tax benefits relating to the valuation allowance for deferred tax assets of Microsource will be allocated to goodwill and the remainder to income tax benefit. As of March 31, 2001, goodwill has been reduced by $452,000 for the tax benefits realized from the Microsource deferred tax assets. During the years ended March 31, 2001 and March 25, 2000, disqualifying employee stock option dispositions resulted in an income tax deduction to the Company of approximately $145,000 and $269,000, respectively, and a tax benefit of approximately $58,000 and $127,000, respectively. The tax benefit has been reflected as an increase to the Company’s paid-in capital in the accompanying Statement of Shareholders’ Equity. 9 Stock Options and Employee Benefit Plans The Company established a 1990 Stock Option Plan which provided for the granting of options for up to 700,000 Stock Option Plan shares of common stock. The 1990 Plan expired during the 2001 fiscal year. The Company subsequently established the 2000 Stock Option Plan which provides for the granting of options for up to 700,000 shares of common stock at 100% of fair market value at the date of grant, with each grant requiring approval by the Board of Directors of the Company. Options granted vest in one or more installments as set forth in the relevant option agreement and must be exercised while the grantee is employed by the Company or within a certain period after termination of employment. Options granted to employees shall not have terms in excess of 10 years from the grant date. During December 1998, the Company offered options holders the opportunity to have outstanding options repriced to current fair value, with the related vesting period starting over. The Company cancelled and reissued (repriced) 405,250 options pursuant to the repricing. Holders of options may be granted stock appreciation rights (SAR’s), which entitle them to surrender outstanding options for a cash distribution under certain changes in ownership of the Company, as defined in the stock option plan. As of March 31, 2001, no SAR’s have been granted under the option plan. As of March 31, 2001, the total number of shares of common stock available for issuance is 540,800 under the 2000 stock option plan. All outstanding options have a term of five years. Following is a summary of stock option activity: Outstanding as of March 28, 1998 Exercised Forfeited Granted Outstanding as of March 27, 1999 Exercised Forfeited Granted Outstanding as of March 25, 2000 Exercised Forfeited Granted Per Share Weighted Average Fair Value of Options Granted $ 2.914 $ 2.613 $ 6.407 Options Exercisable 106,682 48,814 131,424 Outstanding as of March 31, 2001 143,988 Shares Weighted Average Exercise Price 390,670 $ 7.268 (1,400) (561,456) 807,750 635,564 (28,204) (168,875) 115,500 553,985 (84,212) (89,737) 214,700 594,736 2.660 6.399 2.818 2.391 2.515 2.118 2.613 2.514 2.247 4.786 6.407 $ 3.610 26 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S In accordance with SFAS No. 123, “Accounting for Stock-Based Compensation”, the Company is required to disclose the effects on net earnings and earnings per share as if it had elected to use the fair value method to account for employee stock-based compensation plans. Had the Company recorded a charge for the fair value of options granted consistent with SFAS No. 123, net earnings (loss) and net earnings (loss) per share would have been changed to the pro-forma (unaudited) amounts shown below: Years ended (In thousands except per share data) Net earnings (loss) As reported Pro-forma Net earnings (loss) per share – basic As reported Pro-forma Net earnings (loss) per share – diluted As reported Pro-forma March 31, 2001 March 25, 2000 March 27, 1999 $ 1,901 1,537 0.42 0.34 0.40 $ 0.32 $ 1,139 872 0.26 0.20 0.24 $ 0.19 $ (1,858) (2,234) (0.43) (0.52) (0.43) $ (0.52) For purposes of computing pro-forma (unaudited) consolidated net earnings (loss), the fair value of each option grant and Employee Stock Purchase Plan purchase right is estimated on the date of grant using the Black Scholes option pricing model. The assumptions used to value the option grants and purchase rights are stated below: Years ended Expected life of options Expected life of purchase rights Volatility Risk-free interest rate Dividend yield March 31, 2001 March 25, 2000 March 27, 1999 4 years 6 mos 60% 4.64 to 6.30 Zero 4 years 6 mos 60% 5.08 to 5.97 Zero 4 years 6 mos 60% 4.53 to 5.66 Zero Options Outstanding and Exercisable as of March 25, 2001, by Price Range Range of Exercise Prices $2.09 From $2.12 to $5.09 From $6.13 to $8.88 From $2.09 to $8.88 Number of Options Outstanding Weighted Average Remaining Contractual Life Weighted Average Exercise Price Number of Options Exercisable Weighted Average Exercise Price 286,536 182,200 126,000 594,736 2.69 3.77 4.54 3.41 $ 2.094 3.658 6.990 $ 3.610 113,238 30,750 — 143,988 $ 2.094 2.895 — $ 2.26 Employee Stock Purchase Plan Under the Company’s Employee Stock Purchase Plan (the Purchase Plan), employees meeting specific employment qualifications are eligible to participate and can purchase shares semi-annually through payroll deductions at the lower of 85% of the fair market value of the stock at the commencement or end of the offering period. The Purchase Plan permits eligible employees to purchase common stock through payroll deductions for up to 10% of qualified compensation. As of March 31, 2001, 18,260 shares remain available for issuance under the Purchase Plan. The weighted average fair value of the purchase rights granted in fiscal 2001 was $6.471. The Company has established 401(k) plans which cover substantially all employees. Participants may make voluntary 401(k) Plan contributions to the plan up to 20% of their defined compensation. The Company is required to match a percentage of the participants’ contributions in accordance with the plan. Participants vest ratably in Company contributions over a four-year period. Company contributions to the plans for fiscal 2001, 2000, and 1999 were approximately $208,000, $151,000, and $153,000, respectively. 27 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S 10 Commitments The Company leases a 47,300 square foot facility located in San Ramon, California, under a twelve-year lease (as amended) that commenced in April 1994. The Company leases a 18,756 square foot facility located in Fremont, California, under a seven-year lease that commenced in July 1999. The Company leases a 20,400 square foot facility located in Santa Clara, California, under a seven-year lease that commenced in July 1995. The Company leases a 49,090 square foot facility located in Santa Rosa, California, under a twenty-year lease that commenced in July 1993. These facilities accommodate all of the Company’s present operations. The Company also has acquired equipment under capital and operating leases. The future minimum lease payments for operating equipment and facility leases are shown below: Fiscal years (In thousands) 2002 2003 2004 2005 2006 Thereafter $ $ 1,717 1,581 1,535 875 886 6,241 12,835 The aggregate rental expense was $1,816,000, $1,812,000, and $1,462,000 in fiscal 2001, 2000, and 1999, respectively. As of March 31, 2001, Property and Equipment includes equipment under capital lease of $283,000 and related accumulated amortization of $162,000. As of March 25, 2000, Property and Equipment includes equipment under capital lease of $313,000 and related accumulated amortization of $99,000. As of March 27, 1999, Property and Equipment includes equipment under capital lease of $502,000 and related accumulated amortization of $111,000. The future minimum lease payments for capital equipment leases are shown below. Fiscal years (In thousands) 2002 2003 2004 Total Less interest costs Present value of minimum lease payments Less current portion Long term portion of capital lease obligations 11 Line of Credit $ 182 70 57 309 27 282 167 $ 115 The Company has an agreement with a bank for an unsecured revolving line of credit loan for $7,000,000 with interest payable at prime rate or at LIBOR plus 11/2 percent. As of March 31, 2001, this credit line has not been utilized by the Company and expires July 31, 2001. 28 I N D E P E N D E N T A U D I T O R S ’ R E P O R T The Board of Directors and Shareholders Giga-tronics Incorporated: We have audited the accompanying consolidated balance sheets of Giga-tronics Incorporated and subsidiaries as of March 31, 2001 and March 25, 2000, and the related consolidated statements of operations, shareholders’ equity and cash flows for years ended March 31, 2001, March 25, 2000, and March 27, 1999. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Giga-tronics Incorporated and subsidiaries as of March 31, 2001 and March 25, 2000, and the results of their operations and their cash flows for the years ended March 31, 2001, March 25, 2000, and March 27, 1999, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 2 to the consolidated financial statements, effective March 26, 2000, the Company changed its method of accounting for certain equipment sales. KPMG LLP Mountain View, California May 4, 2001 29 S E L E C T E D F I N A N C I A L D A T A Summary of Operations: (In thousands except per share data) Net sales Gross profit Operating expenses Interest income, net Earnings (loss) before cumulative effect of accounting change and income taxes Earnings (loss) before cumulative effect of accounting change Net earnings (loss) Net earnings (loss) per share – basic Net earnings (loss) per share – diluted Financial Position: (In thousands except ratio) Current ratio Working capital Total assets Shareholders’ equity Shares of common stock – basic Shares of common stock – diluted Percentage Data: March 31, March 25, March 27, March 28, March 29, 2001 2000 1999 1998 1997 $ 54,159 19,056 16,032 205 $ 47,577 15,810 14,315 59 $ 37,636 11,534 15,293 121 $ 36,813 15,789 15,172 457 $ 38,031 14,627 13,096 533 3,461 1,633 (3,006) 1,096 2,048 2,421 1,901 $ 0.42 $ 0.40 1,139 1,139 $ 0.26 $ 0.24 (1,858) (1,858) $ (0.43) $ (0.43) 767 767 $ 0.18 $ 0.18 1,509 1,509 $ 0.35 $ 0.34 March 31, March 25, March 27, March 28, March 29, 2001 4.06 $ 22,924 37,318 $ 28,475 4,474 4,803 2000 3.17 $ 21,066 37,526 $ 26,149 4,379 4,693 1999 3.32 $ 18,021 33,259 $ 24,710 4,338 4,338 1998 5.06 $ 23,484 32,672 $ 26,461 4,319 4,377 1997 4.32 $ 22,692 33,618 $ 25,654 4,300 4,376 March 31, March 25, March 27, March 28, March 29, 2001 2000 1999 1998 1997 Percent of net sales Gross profit Operating expenses Interest income, net Earnings (loss) before cumulative effect of accounting change and income taxes Net earnings (loss) 35.2 29.6 0.4 6.4 3.5 Common Stock Market Prices 33.2 30.1 0.1 3.4 2.4 30.6 40.6 0.3 (8.0) (4.9) 42.9 41.2 1.2 3.0 2.1 38.5 34.4 1.4 5.4 4.0 Giga-tronics’ common stock is traded over the counter on NASDAQ/NMS National Market System using the symbol “GIGA”. The number of record holders of the Company’s common stock as of March 31, 2001 was close to 1,400. The table below shows the high and low closing bid quotations for the common stock during the indicated fiscal periods. These quotations reflect inter-dealer prices without retail mark-ups, mark-downs, or commission and may not reflect actual transactions. First quarter Second quarter Third quarter Fourth quarter 2001 (3/26-6/24) (6/25-9/30) (10/1-12/30) (12/31-3/31) High 127/8 10 75/16 83/16 Low 63/8 625/32 413/16 47/8 2000 (3/28-6/26) (6/27-9/25) (9/26-12/25) (12/26-3/25) High 3 35/16 71/2 22 Low 13/4 113/16 21/2 61/2 30 S E L E C T E D F I N A N C I A L D A T A Effective March 26, 2000, the Company changed its method of accounting for revenue recognition to conform with the guidance provided by SAB 101 (see Note 2). The Company’s unaudited financial results for the quarters ended June 24, September 30 and December 30, 2000 have been restated to apply SAB 101 retroactively to the beginning of fiscal 2001. The impact in 2001 of adopting SAB 101 was to increase net income before the cumulative effect of the accounting change by $520,000, net of income taxes. Quarterly Financial Information (Unaudited) (In thousands except per share data) First Second 2001 Third Fourth Year Net sales Gross profit Operating expenses Interest income, net Earnings before cumulative effect of accounting change and income taxes Earnings before cumulative effect of accounting change Net earnings Net earnings per share – basic Net earnings per share – diluted Equivalent shares of common stock - basic Equivalent shares of common stock - diluted $ 13,637 4,963 3,775 33 $ 13,642 4,814 4,298 36 $ 11,368 4,068 3,883 96 $ 15,512 5,211 4,076 40 $ 54,159 19,056 16,032 205 1,253 666 322 1,220 3,461 877 357 $ 0.08 $ 0.07 4,437 4,817 465 465 $ 0.10 $ 0.10 4,460 4,796 225 225 $ 0.05 $ 0.05 4,488 4,777 854 854 $ 0.19 $ 0.18 4,511 4,801 2,421 1,901 $ 0.42 $ 0.40 4,474 4,803 The results of operations and statements of financial position as previously reported in the Company’s interim 2001 financial statements filed on Form 10-Q have been revised to retroactively reflect on a pro-forma basis the application of SAB 101 effective March 26, 2000. Net sales Gross profit Operating expenses Interest income, net Earnings before cumulative effect of accounting change and income taxes Earnings before cumulative effect of accounting change Net earnings For the three months ended June 24, 2000 September 30, 2000 December 30, 2000 As Reported Revised As Reported Revised As Reported Revised $ 12,161 $ 13,637 4,963 3,775 33 4,436 3,775 33 $ 14,058 $ 13,642 4,814 4,298 36 4,946 4,298 36 $ 11,810 $ 11,368 4,068 3,883 96 4,266 3,883 96 726 1,253 508 508 877 357 798 557 557 666 465 465 520 363 363 322 224 224 Quarterly Financial Information (Unaudited) (In thousands except per share data) First Second Net sales Gross profit Operating expenses Interest income, net Earnings before income taxes Net earnings Net earnings per share – basic Net earnings per share – diluted Equivalent shares of common stock - basic Equivalent shares of common stock - diluted $ 11,505 3,451 3,315 (1) 162 112 $ 0.03 $ 0.03 4,362 4,372 $ 11,834 3,948 3,638 3 324 227 $ 0.05 $ 0.05 4,368 4,483 2000 Third $ 11,314 3,990 3,568 22 460 322 $ 0.07 $ 0.07 4,383 4,611 Fourth Year $ 12,924 4,421 3,794 35 687 478 $ 0.11 $ 0.10 4,402 4,846 $ 47,577 15,810 14,315 59 1,633 1,139 $ 0.26 $ 0.24 4,379 4,693 31 C O R P O R A T E I N F O R M A T I O N D I R E C T O R S H E A D Q U A R T E R S Giga-tronics Incorporated George H. Bruns, Jr. Chairman and Chief Executive Officer 4650 Norris Canyon Road San Ramon, CA 94583 (925) 328-4650 (925) 328-4700 (FAX) www.gigatronics.com S U B S I D I A R I E S ASCOR, Inc. 4384 Enterprise Place Fremont, CA 94539 (510) 490-2300 (510) 490-8493 (FAX) www.ascor-inc.com Microsource, Inc. 1269 Corporate Center Parkway Santa Rosa, CA 95407 (707) 527-7010 (707) 527-7176 (FAX) www.microsource-inc.com DYMATIX (Ultracision, Inc. and Viking Semiconductor Equipment. Inc.) 3380 Montgomery Drive Santa Clara, CA 95054 (408) 980-0666 (408) 980-0670 (FAX) www.dymatix.com George H. Bruns, Jr. Chairman and Chief Executive Officer James A. Cole 1,2 General Partner, Windward Ventures General Partner, Spectra Enterprises Robert C. Wilson 1,2 Chairman Wilson & Chambers William E. Wilson 1,2 President Microsource, Inc. 1 2 Member, Compensation Committee Member, Audit Committee E X E C U T I V E O F F I C E R S George H. Bruns, Jr. Chairman and Chief Executive Officer Mark H. Cosmez II Vice President, Finance/ Chief Financial Officer & Secretary Claudio S. Mariotta President, Giga-tronics Instrument Division Jeffrey T. Lum President, ASCOR, Inc. Daniel S. Markowitz President, DYMATIX (Ultracision, Inc. and Viking Semiconductor Equipment, Inc.) William E. Wilson President, Microsource, Inc. 32 C O R P O R A T E I N F O R M A T I O N L E G A L C O U N S E L McCutchen, Doyle, Brown & Enerson, LLP Three Embarcadero Center 18th Floor San Francisco, CA 94111 www.mccutchen.com T R A N S F E R A G E N T Mellon Shareholder Services LLC 253 Montgomery Street, 23rd Floor San Francisco, CA 94104 www.melloninvestor.com I N D E P E N D E N T A U D I T O R S KPMG LLP 500 East Middlefield Road Mountain View, CA 94043 www.kpmg.com A N N U A L M E E T I N G The Company’s Annual Meeting of Shareholders will be held at 9:30 a.m. on August 30, 2001 at Giga-tronics’ offices located at 4650 Norris Canyon Road, San Ramon, CA 94583. F O R M 1 0 - K A copy of the Company’s Annual Report on Form 10-K for 2001, filed with the Securities and Exchange Commission, may be obtained by shareholders without charge by a written request to: Company Secretary 4650 Norris Canyon Road San Ramon, CA 94583 Giga-tronics Incorporated 4650 Norris Canyon Road San Ramon, CA 94583 (925) 328-4650 (925) 328-4700 (FAX) www.gigatronics.com