MEAD Meade Instruments Corp. (MM)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Meade Instruments Corp. (the “Company”) is engaged in the design, manufacture, marketing and sale of consumer products, primarily telescopes, telescope accessories and binoculars. The Company designs its products in-house or with the assistance of external consultants. Most of the entry level products are manufactured overseas by contract manufacturers in Asia, while the high-end telescopes are manufactured and assembled at the Company’s Mexico facility. Sales of the Company’s products are driven by an in-house sales force as well as a network of sales representatives throughout the U.S. and through distributors internationally. The Company currently operates out of two primary locations: Irvine, California and Tijuana, Mexico. The California facility serves as the Company’s corporate headquarters, research and development facility; the Mexico facility contains the Company’s manufacturing, assembly, repair, packaging, distribution and other general and administrative functions.

In the opinion of the management of the Company, the information and amounts furnished in this report reflect all adjustments (consisting of normal recurring adjustments) considered necessary for the fair statement of the financial position and results of operations for the interim periods presented. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended February 29, 2012.

The Company has experienced, and expects to continue to experience, substantial fluctuations in its sales, gross margins and results from operations from quarter to quarter. Factors that influence these fluctuations include the volume and timing of orders received, changes in the mix of products sold, market acceptance of the Company’s products, competitive pricing pressures, the Company’s ability to meet fluctuating demand and delivery schedules, the timing and extent of research and development expenses, the timing and extent of product development costs and the timing and extent of advertising expenditures.

The Company’s financial statements have been prepared under the assumption that the Company will continue as a going concern. However, Management believes that substantial doubt exists about the Company’s ability to continue as a going concern due to the Company’s recurring losses and its weakened financial position and reduced liquidity, and management is considering various measures as described in Note B. below.

The Company has incurred significant recurring losses and negative cash flows from operations which have resulted in reduced liquidity and a weakened financial position as of November 30, 2012. The Company also has endured working capital problems caused by product development delays during the past twelve months. In addition, in January 2013, the Company’s largest customer, and one additional customer, notified the Company that they had unilaterally, and without prior notice, decided to indefinitely hold payment of approximately $0.6 million in accounts receivable, which will further reduce the Company’s already limited liquidity. Due to these issues, the Company’s management now believes substantial doubt exists about the Company’s ability to continue as a going concern and that it must modify the Company’s business model and operations to reduce spending to a sustainable level. Such actions could cause the Company to be unable to execute its business plan, take advantage of future opportunities, respond to competitive pressures or customer requirements. It may also cause the Company to delay, scale back or eliminate some or all of its research and development programs, seek opportunities in a strategic relationship or business combination, or to reduce or cease operations.

At November 30, 2012, the Company had cash of $0.3 million, compared to $3.9 million at February 29, 2012 and $1.2 million at November 30, 2011.

Net cash used in operating activities was approximately $4.2 million during the nine months ended November 30, 2012 and $3.8 million during the nine months ended November 30, 2011, an increase in net cash used of approximately $0.4 million compared to the prior year. This increase in net cash used in operating activities was attributed to the increase in the Company’s net loss of approximately $2.0 million from a loss of approximately $0.7 million during the nine months ended November 30, 2011 compared to a loss of approximately $2.7 million during the nine months ended November 30, 2012, offset by favorable net fluctuations in working capital. Approximately $1.1 million or 65% of the net increase in inventories of approximately $1.7 million during the nine months ended November 30, 2012 was due to an increase in inventories relating to the Company’s new LX800 and LX600 products which have taken longer to develop than expected and are not yet ready to be shipped.

The Company typically experiences increases in accounts receivable and inventories and a corresponding decrease in cash beginning with the end of its first fiscal quarter and culminating with the end of its third fiscal quarter. Receivables and inventories then typically decrease, and cash increases, at the end of the Company’s fiscal year. The Company began making advances on its credit facility in September 2012 in order to meet its working capital requirements and continued to do so through the filing of this Form 10-Q. In addition, the Company has incurred substantial operating losses during the nine months ended November 30, 2012.

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MEADE INSTRUMENTS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

At November 30, 2012, the Company had in place a secured credit facility with FCC, LLC d/b/a First Capital Western Region, LLC (“First Capital”) and owed approximately $0.7 million as of November 30, 2012 on that facility. Availability of funds under that credit facility was based on a percentage of eligible accounts receivable and inventory and amounted to approximately $0.3 million as of November 30, 2012, in addition to the $0.7 million owed, and was based solely on accounts receivable as substantially all the Company’s inventory was deemed ineligible due to most of it being located in Mexico.

In December 2012, the Company repaid the balance owed to First Capital, then amended and terminated its credit facility with First Capital and subsequently replaced it with a new financing agreement (“the Agreement”) with Rosenthal & Rosenthal, Inc. (“Rosenthal”). At the time the First Capital credit facility was replaced, both the Rosenthal and First Capital credit facilities allowed for a maximum of $3 million and were based solely upon advances on accounts receivable. As of the closing date of the financing arrangement, December 28, 2012, availability under the new credit facility was approximately $1.6 million. Rosenthal advanced to the Company the $1.6 million maximum available under the new credit facility subsequent to the closing of the Agreement.

While the Company’s agreement with Rosenthal does not contain explicit financial covenants, the Agreement allows the Company’s lender significant latitude to restrict, reduce or eliminate the Company’s access to credit or require the Company to repay any and all amounts outstanding under the Agreement. If its lender restricts, reduces or eliminates the Company’s access to credit, or requires immediate repayment of the amounts outstanding under the agreement, the Company would be required to pursue additional or alternative sources of liquidity such as equity financings, a new debt agreement with other creditors, seek strategic alternatives or liquidate assets. However, the Company cannot assure that any such additional sources of liquidity would be available on reasonable terms, if at all.

The initial term of the credit facility with Rosenthal is through November 30, 2015 and can be renewed thereafter. The credit facility can be terminated by the Company or Rosenthal with at least 60 days, but not more than 120 days, notice except in case of a default, in which case the Company’s lender can terminate the Agreement at any time.

The Company accounts for stock-based compensation in accordance with the provisions of Accounting Standards Codification No. ASC 718-10, Share-Based Payment (“ASC 718-10”), which establishes accounting for equity instruments exchanged for employee services. Under the provisions of ASC 718-10, share-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employee’s requisite service period (generally the vesting period of the equity grant). Share-based compensation expenses, included in general and administrative expenses in the Company’s consolidated statement of operations for the nine months ended November 30, 2012 and 2011, were approximately $52 thousand and $89 thousand, respectively. Due to deferred tax valuation allowances provided, no net benefit was recorded against the share-based compensation charged.

The Company estimates the fair value of restricted stock awards using the closing price on the grant date. The Company estimates the fair value of stock options using the Black-Scholes valuation model. Key input assumptions used to estimate the fair value of stock options include the expected option term, forfeiture rate, the expected volatility of the Company’s stock over the option’s expected term, the risk-free interest rate over the option’s expected term, and the Company’s expected annual dividend yield. The Company believes that the valuation technique and the approach utilized to develop underlying assumptions are appropriate in calculating the fair values of the Company’s stock options. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards.

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MEADE INSTRUMENTS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The fair value of the Company’s stock options granted in the nine months ended November 30, 2012 and 2011, respectively, was estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions:

On June 29, 2011, each of the Company’s executive officers, Steven Murdock and John Elwood, (the “Executive Officers”) was granted a restricted stock award (an “Award”) pursuant to the Company’s form of Restricted Stock Agreement under the Company’s 2008 Stock Incentive Plan. The Awards to Mr. Murdock and Mr. Elwood were in the amounts of 37,500 shares of Common Stock and 25,000 shares of Common Stock, respectively. Each Award vests in ten equal installments with the first installment vesting on June 29, 2012 and the remainder vesting on each of the next nine consecutive anniversaries; provided, however, if the Company subsequently achieves net income for any fiscal year of the Company (but excluding the Company’s fiscal years 2019, 2020 and 2021), as shown on the Company’s audited consolidated financial statements for such fiscal year, the vesting of the Award shall accelerate such that the number of shares of the Award which are unvested at the end of such fiscal year shall vest in three substantially equal installments over the then next three consecutive anniversaries of the date of the Award.

On August 10, 2012, each of the Company’s U.S. employees, including the Executive Officers, were granted restricted stock awards (the “Awards”) pursuant to the Company’s form of Restricted Stock Agreement under the Company’s 2008 Stock Incentive Plan. The Awards were in the aggregate amount of 76,250 shares of Common Stock. Each award vests in three equal installments with the first installment vesting on August 10, 2013 and the remainder vesting on each of the two succeeding anniversaries.

Substantially all of the credit risk associated with the assigned invoices remained with the Company as of November 30, 2012. Accounts receivable, other includes reserves for subsequent sales return and allowances for bad debt—including reserves associated with certain invoices assigned to the factor. Approximately $0.7 million was outstanding on the Company’s credit facility, and therefore owed to the Company’s factor, as of November 30, 2012; no amount was owed at February 29, 2012.

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Intangible assets were a result of an acquisition of substantially all of the assets and assumption of substantially all of the liabilities of Coronado Technology Group, LLC that occurred on December 1, 2004 and are as follows:

The changes in the carrying amount of acquisition-related intangible assets for the three months ended November 30, 2012, are as follows:

Amortization of acquisition-related intangible assets over the next five fiscal years is estimated as follows:

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Since certain of the Company’s machinery and equipment is old and fully depreciated, it is possible that certain of the Company’s machinery and equipment could require replacement in the near future. Given the Company’s weakened financial position and limited liquidity, the Company may not be able to pay for or finance a replacement for such equipment and therefore may be forced to reduce or cease operations until it is able to replace any necessary equipment.

The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of such litigation will not have a material adverse effect on the financial position, results of operations or cash flows of the Company.

Basic loss per share amounts excludes the dilutive effect of potential shares of common stock. Basic loss per share is based upon the weighted-average number of shares of common stock outstanding. Diluted loss per share is based upon the weighted-average number of shares of common stock and dilutive potential shares of common stock outstanding for each period presented. Potential shares of common stock include outstanding stock options and restricted stock, which may be included in the weighted average number of shares of common stock under the treasury stock method.

The total number of options and restricted shares outstanding were as follows:

These amounts were excluded from the weighted-average number of shares of common stock outstanding, as including these items would be anti-dilutive due to the Company’s net loss.

The Company provides reserves for the estimated cost of product warranty-related claims at the time of sale, and periodically adjusts the provision to reflect actual experience related to its standard product warranty programs and its extended warranty programs. The amount of warranty liability accrued reflects management’s best estimate of the expected future cost of honoring Company obligations under its warranty plans. Additionally, from time to time, specific warranty accruals may be made if unforeseen technical problems arise. Meade ^® brand products, principally telescopes and binoculars, are generally covered by a one-year limited warranty. Most of the Coronado ^® products have limited five-year warranties.

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MEADE INSTRUMENTS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Included in the warranty accrual as of February 29, 2012, is $0.5 million related to the Company’s former sport optics brands that were sold in 2008 and for which the Company agreed to retain certain warranty liabilities. In June 2012, the Company entered into an agreement with the owner of one of the Company’s former sport optics brands which eliminated the Company’s remaining liability of approximately $0.3 million for any future product warranty claims associated with that brand. The Company reduced its warranty accrual as of May 31, 2012 by $0.3 million accordingly.

Changes in the warranty liability, which is included as a component of accrued liabilities on the accompanying Consolidated Balance Sheets, were as follows:

In accordance with ASC 740, Accounting for Income Taxes , the Company has determined that there was sufficient uncertainty surrounding the future realization of its deferred tax assets to warrant the recording of a full valuation allowance. The valuation allowance was recorded based upon the Company’s determination that there was insufficient objective evidence, at this time, to recognize those assets for financial reporting purposes. For the period ended November 30, 2012, the Company has not changed its assessment regarding the recoverability of its deferred tax assets. Ultimate realization of the benefit of the deferred tax assets is dependent upon the Company generating sufficient taxable income in future periods, including periods prior to the expiration of certain underlying tax credits.

No provision for income taxes was recorded in the current or prior period presented due to the significance of the Company’s net loss.

The tax years 2008 through 2011 remain open to examination by the major taxing jurisdictions to which the Company is subject. However, the amount of a net operating loss carryforward can be adjusted for federal tax purposes for the three years (four years for the major state jurisdictions in which the Company operates) after the net operating loss is utilized.

Unrecognized Tax Benefits

The Company is subject to income taxes in the United States and Mexico. Significant judgment is required in evaluating the Company’s tax positions and determining its provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. The Company establishes reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. These reserves are established when the Company believes that certain positions might be challenged despite a belief that its tax return positions are fully supportable. The Company adjusts these reserves in light of changing facts and circumstances, such as the outcome of income tax audits. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate. Accruals for unrecognized tax benefits are provided for in accordance with the requirements of the prescribed authoritative guidance. At November 30, 2012 and February 29, 2012, there were no unrecognized tax benefits. Management does not anticipate that there will be a material change in the balance of unrecognized tax benefits within the next 12 months.

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MEADE INSTRUMENTS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The Company recognizes accrued interest and penalties related to uncertain tax positions in income tax expense. At November 30, 2012 and February 29, 2012, there were no accrued interest and penalties related to uncertain tax positions.

On December 28, 2012 (the “Closing Date”), the Company terminated its Amended and Restated Factoring and Security Agreement (the “First Capital Agreement”) with FCC, LLC d/b/a First Capital Western Region, LLC (“First Capital”), and entered into a Financing Agreement (the “Rosenthal Agreement” or “Agreement”) with Rosenthal and Rosenthal, Inc. (“Rosenthal”).

Similar to the First Capital Agreement, the Rosenthal Agreement provides for a maximum credit facility of $3 million (the “Maximum Credit Facility”).

The Agreement provides for advances of up to (i) seventy percent (70.0%) of the Net Amount of Eligible Receivables arising from sales made to customers located in the United States of America and Canada and (ii) 50% of the Net Amount of Eligible Receivables arising from sales made to customers outside the United States of America and Canada, provided that sales described in clause (ii) are subject to a credit insurance policy. In addition, any advances are reduced by reserves as Rosenthal may deem, in its sole discretion, to be necessary from time to time.

Advances under the Agreement incur interest at the greater of (i) the prime rate publicly announced in New York City by JPMorgan Chase Bank plus four percent and (ii) eight percent. A minimum of $3,000 per month in interest will be paid according to the Agreement.

A facility fee in the amount of 1% of the Maximum Credit Facility was paid to Rosenthal on the Closing Date and will be paid on each anniversary thereof. An administration fee of $1,000 per month is also payable during the Agreement.

The Agreement continues through November 30, 2015 and from year to year thereafter unless terminated by either party. The Company or Rosenthal can terminate the Agreement with at least 60 days, and not more than 120 days, written notice except in cases of a Default, at which time Rosenthal can terminate the Agreement at any time and the Company will pay to Rosenthal an amount equal to (a) three percent of the Maximum Credit Facility then in effect, if such termination occurs prior to the first anniversary of the Closing Date; (b) two percent of the Maximum Credit Facility then in effect, if such termination occurs on or after the first anniversary of the Closing Date but prior to the second anniversary of the Closing Date; and (c) one percent of the Maximum Credit Facility then in effect if such termination occurs on or after the second anniversary of the Closing Date.

No amount was owed to First Capital when the First Capital Agreement was terminated, and no termination fees were incurred as a result of the termination of the First Capital Agreement. Rosenthal advanced approximately $1.6 million to the Company subsequent to entering into the Agreement, which constituted the full amount of availability under the Agreement at that time.

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