The LGL Group, Inc. (together with its subsidiaries, the(the "Company"), incorporated in 1928 under the laws of the State of Indiana and reincorporated under the laws of the State of Delaware in 2007, is a holding company with subsidiaries engaged in the designdesigning, manufacturing and manufacturemarketing of highly-engineered electronic components used to control the frequency or timing of signals in electronic circuits and in the design of high reliability, frequencyperformance Frequency and spectrum control products.Time reference standards that form the basis for timing and synchronization in various applications.

As of JuneSeptember 30, 2016, the subsidiaries of the Company are as follows:

The Company operates through its two principal subsidiary,subsidiaries, M-tron Industries, Inc., which includes the operations of Piezo Technology, Inc. ("PTI") and M-tron Asia, LLC ("Mtron")., together ("MtronPTI"), and Precise Time and Frequency, LLC ("PTF"), a newly formed subsidiary, to hold the assets of Precise Time and Frequency, Inc., as discussed in Note B below. The combined operations of Mtron and PTI and their subsidiaries are referred to herein as "MtronPTI."  MtronPTICompany has operations in Orlando, Florida, Yankton, South Dakota, Wakefield, Massachusetts and Noida, India.  MtronPTI also has sales offices in Sacramento, California and Hong Kong.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP")GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and sixnine months ended JuneSeptember 30, 2016, are not necessarily indicative of the results that may be expected for the full year ending December 31, 2016.

This interim information should be read in conjunction with the consolidated financial statements and related notes thereto set forth in the Company's Annual Report on Form 10-K for the year ended December 31, 2015, filed with the Securities and Exchange Commission (the "SEC") on March 29, 2016. The accompanying unaudited condensed consolidated financial statements should also be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in this Quarterly Report on Form 10-Q.

Inventories are valued at the lower of cost or market value using the FIFO (first-in, first-out) method. The Company reduces the value of its inventories to market value when the market value is believed to be less than the cost of the item.  The inventory reserve for obsolescence as of JuneSeptember 30, 2016 and December 31, 2015 was $3,129,000$2,873,000 and $3,016,000, respectively.

Inventories are comprised of the following (in thousands):

Intangible assets are recorded at cost less accumulated amortization.amortization and included in engineering, selling and administrative expenses in the accompanying condensed consolidated statements of operations. Amortization is computed for financial reporting purposes using the straight-line method over the estimated useful lives of the assets, which range up to 10 years and is recorded as part of engineering, selling and administrative expenses in the accompanying Condensed Consolidated Statements of Operations.years. The intangible assets consist of intellectual property and goodwill. As a result of the PTF Acquisition, the gross carrying amount of intangible assets increased from $538,000 at December 31, 2015 to $752,000 at September 30, 2016. The net carrying value of the amortizable intangible assets was $408,000$607,000 and $435,000 as of JuneSeptember 30, 2016 and December 31, 2015, respectively. Goodwill, which is not amortizable, was $40,000 as of JuneSeptember 30, 2016 and December 31, 2015.

The estimated aggregate amortization expense for the remaining portion of 2016 and each of the four succeeding years and thereafter is as follows (in thousands):

The Company measures the cost of employee services in exchange for an award of equity instruments based on the grant-date fair value of the award and recognizes the cost over the requisite service period, typically the vesting period.

Restricted stock awards are made at a value equal to the market price of the Company's common stock on the date of the grant.

There were noOn September 2, 2016, the Company's board of directors (the "Board") granted a total of 28,000 options to purchase shares of the Company's common stock option awards or restrictedto members of executive management pursuant to the Company's Amended and Restated 2011 Incentive Plan. These stock awards granted duringoptions have an exercise price equal to the threegrant date fair value of the Company's common stock of $3.90, a three-year life expiring on September 2, 2021, and six months ended June 30, 2016.vest as follows: 25% on the grant date; 25% on the first anniversary of the grant date; an additional 25% on the second anniversary of the grant date; and the remaining 25% on the third anniversary of the grant date. These stock options have a grant date fair value of $0.89 per option.

Compensation expense related to share-based compensation is recognized over the applicable vesting periods. As of JuneSeptember 30, 2016, there was approximately $28,000$38,000 of total unrecognized compensation expense related to unvested share-based compensation arrangements.arrangements that will be recognized over a weighted average period of 2.2 years..

The Company computes net income (loss) per share in accordance with Accounting Standards Codification ("ASC") 260, Earnings Per Share ("ASC 260").  Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share adjusts basic income (loss) per share for the effects of stock options, non-participating restricted common stock, and other potentially dilutive financial instruments, only in the periods in which the effects are dilutive. Shares of restricted stock granted to members of the Board of Directors (the "Board") as a portion of their director fees are deemed to be participating as defined by ASC 260 and therefore are included in the computation of basic income (loss) per share.

For the three and sixnine months ended  JuneSeptember 30, 2016 and 2015, there were options to purchase 117,226130,554 shares and 189,023139,902 shares, respectively, of the Company's common stock and warrants to purchase 519,241 shares of common stock that were excluded from the diluted income (loss) per share computation because the impact of the assumed exercise of such stock options would have been anti-dilutive during the respective periods.

On August 29, 2011, the Board authorized the Company to repurchase up to 100,000 shares of its common stock in accordance with applicable securities laws. This authorization increased the total number of shares authorized and available for repurchase under the Company's existing share repurchase program to 540,000 shares, at such times, amounts and prices as the Company shall deem appropriate. As of JuneSeptember 30, 2016, the Company had repurchased a total of 79,66480,534 shares of common stock at a cost of $572,000,$576,000, which shares are currently held in treasury.

The warrants are "European style warrants" and will only become exercisable on the earlier of (i) their expiration date, August 6, 2018, and (ii) such date that the 30-day volume weighted average price per share, or VWAP, of the Company's common stock is greater than or equal to $15.00 (subject to adjustment). Once the warrants become exercisable, they may be exercised in accordance with the terms of the warrant agreement between the Company and the warrant agent until their expiration at 5:00 p.m., Eastern Time, on the expiration date.

The Company measures financial and non-financial assets and liabilities at fair value in accordance with ASC 820, Fair Value Measurements and Disclosures.  These measurements involve various valuation techniques and assume that the transactions would occur between market participants in the most advantageous market for the Company. 

GAAP defines fair value, establishes a framework for measuring fair value, and requires disclosures about fair value measurements. GAAP emphasizes that fair value is intended to be a market-based measurement, as opposed to a transaction-specific measurement.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions.  Depending on the nature of the asset or liability, various techniques and assumptions can be used to estimate the fair value. Assets and liabilities are measured using inputs from three levels of the fair value hierarchy, as follows:

The following is a summary of valuation techniques utilized by the Company for its significant financial and non-financial assets and liabilities as of September 30, 2016 and December 31, 2015:

To estimate the fair value of its equity and U.S. Treasury securities (Level 1), the Company obtains current market pricing from quoted market sources or uses pricing for identical securities. Assets measured at fair value on a recurring basis are summarized below (in thousands).

There were no transfers from level 2 to level 3 during the period. There were no level 2 or 3 assets  as of JuneSeptember 30, 2016 or December 31, 2015.

The Company also has assets that may be subject to measurement at fair value on a non-recurring basis, including goodwill and intangible assets, and other long-lived assets. The Company reviews the carrying value of these assets whenever events and circumstances indicate that the carrying amounts of the assets may not be recoverable. If it is determined that the assets are impaired, the carrying value would be reduced to estimated fair value.

For the three and sixnine months ended JuneSeptember 30, 2016 and 2015, significant foreign revenues from operations (10% or more of foreign sales) were as follows (in thousands):

In the normal course of business, the Company and its subsidiaries may become defendants in certain product liability, patent infringement, worker claims and other litigation.  The Company records a liability when it is probable that a loss has been incurred and the amount is reasonably estimable. The Company is not involved in any legal proceedings other than routine litigation arising in the normal course of business, none of which the Company believes will have a material adverse effect on the Company's business, financial condition or results of operations.

At JuneSeptember 30, 2016 and December 31, 2015, approximately $4,093,000$3,695,000 and $4,089,000, respectively, was invested in United States Treasury money market funds managed by a related entity (the "Fund Manager") which is related through a common director. One of the Company's directors, who is also a 10% stockholder, currently serves as a director and executive officer of the Fund Manager. The fund transactions during the sixnine months ended JuneSeptember 30, 2016 and for the year ended December 31, 2015, were directed solely at the discretion of Company management. There are no management fees associated with fund transactions.

The following discussion and analysis of the Company's financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements, the notes thereto and the other unaudited financial data included in this Quarterly Report on Form 10-Q. The following discussion should also be read in conjunction with the audited consolidated financial statements and the notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Company's Annual Report on Form 10-K for the year ended December 31, 2015.

Certain statements contained in this Quarterly Report on Form 10-Q of the Company and the Company's other communications and statements, other than historical facts, may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act.Act of 1934, as amended (the "Exchange Act"). The Company intends for all such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Exchange Act, as applicable by law. Such statements include, in particular, statements about the Company's beliefs, plans, objectives, goals, expectations, estimates, projections and intentions. These statements are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond the Company's control. The words "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan," "target," "goal," and similar expressions are intended to identify forward-looking statements. All forward-looking statements, by their nature, are subject to risks and uncertainties. Therefore, such statements are not intended to be a guarantee of the Company's performance in future periods. The Company's actual future results may differ materially from those set forth in the Company's forward-looking statements. For information concerning these factors and related matters, see "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, filed with the Securities and Exchange Commission (the "SEC")the SEC on March 29, 2016, this Report and our other filings with the SEC. However, other factors besides those referenced could adversely affect the Company's results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties. Any forward-looking statements made by the Company herein speak as of the date of this Report. The Company does not undertake to update any forward-looking statement, except as required by law. As a result, you should not place undue reliance on these forward-looking statements.

Total revenues for the three months ended JuneSeptember 30, 2016 were $5,231,000, a decrease$5,128,000, an increase of 4.4%6.9% from revenues of $5,471,000$4,796,000 for the same prior year period.  Price compression from offshore manufacturers has reducedThe increase is being driven by the number of economically feasible opportunities in the Internet Communications Technology ("ICT") market segment. The Company has movedCompany's strategy to move away from such low margin commodities business and is focusedfocus on achieving revenue growth through the development of more complex, higher margin products, particularly in the Aerospace and Defense ("Aero/Defense") market segment.

Consolidated gross margin, which is consolidated revenues less manufacturing cost of sales, as a percentage of revenues increased to 33.9%34.6% from 32.7%33.1% for the three months ended JuneSeptember 30, 2016, compared to the same prior year period.

At JuneAs of September 30, 2016, the Company's order backlog was $9,679,000,$11,017,000, which was an increase of 7.4%25.4% compared to the backlog as of March 31, 2016, which was $9,016,000, and an increase of 9.3% compared to the backlog as of JuneSeptember 30, 2015, which was $8,857,000.$8,783,000. The backlog of unfilled orders includes amounts based on signed contracts as well as agreed letters of intent, which MtronPTI has determined are firm orders and likely to proceed.  Although backlog represents only firm orders that are considered likely to be fulfilled within the 12 months following receipt of the order, cancellations or scope adjustments may and do occur.

Order backlog is adjusted quarterly to reflect project cancellations, deferrals, revised project scope and cost, and sales of subsidiaries, if any.  The Company expects to fill its entire backlog within the next 12 months, but cannot provide assurances as to what portion of the order backlog will be fulfilled in a given year.

Operating incomeloss was $26,000($28,000) for the three months ended JuneSeptember 30, 2016, compared to an operating loss of ($333,000)154,000) for the three months ended JuneSeptember 30, 2015.  The improvement is due to a reduction6.9% increase in engineering, selling and administrative costs which were 33.4% of revenue for the three months ended June 30, 2016, compared to 38.8% of revenue for the comparable prior year period, and a 1.21.5 percentage point increase in gross margin offset by a 4.4% decrease in revenue.approximately $38,000 of one-time period costs related to the PTF Acquisition.

For the three months ended JuneSeptember 30, 2016, stock-based compensation expense was $3,000,$8,000, compared to $174,000$14,000 for the three months ended JuneSeptember 30, 2015. Compensation expense related to stock-based compensation is recognized over the applicable vesting periods. As of JuneSeptember 30, 2016, there was approximately $28,000$38,000 of total unrecognized compensation expense related to unvested share-based compensation arrangements.

The Company recorded a tax benefit (provision) of $1,000$0 and ($11,000)2,000) for the three months ended JuneSeptember 30, 2016 and 2015, respectively.

The Company maintains a full valuation allowance against its deferred tax assets under the provisions of ASC 740, Income Taxes, ("ASC 740"), based on the Company's assessment of the uncertainty surrounding the realization of the favorable U.S. tax benefits in future tax returns. When assessing the need for valuation allowances, the Company considers future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the ability to realize deferred tax assets in future years, the Company will adjust related valuation allowances in the period that the change in circumstances occurs, along with a corresponding increase or charge to income.

For the three months ended JuneSeptember 30, 2016, the Company reported net income of $16,000,$32,000, compared to a net loss of ($201,000)195,000) for the comparable period in 2015. Basic and diluted net income (loss) per share for the three month periods ended JuneSeptember 30, 2016 and 2015, was $0.01 and ($0.08)0.07), respectively.

Total revenues for the sixnine months ended JuneSeptember 30, 2016 were $9,987,000,$15,115,000, a decrease of 8.2%3.5% from revenues of $10,875,000$15,671,000 for the same prior year period.  Price compression from offshore manufacturers has reduced the number of economically feasible opportunities in the ICTInternet Communications Technology market segment. The Company has moved away from such low margin commodities business and is focused on achieving revenue growth through the development of more complex, higher margin products, particularly in the Aero/Defense market segment.

Consolidated gross margin, which is consolidated revenues less manufacturing cost of sales, as a percentage of revenues was 32.8%33.4% for the sixnine months ended JuneSeptember 30, 2016, compared to 33.0% for the sixnine months ended JuneSeptember 30, 2015. The slight decline in margin from the prior year period was primarily due to the affect of lower overall revenues on the fixed portion of manufacturing costs.

At JuneAs of September 30, 2016, the Company's order backlog was $9,679,000,$11,017,000, which was an increase of 10.0%25.2% compared to the backlog as of December 31, 2015, which was $8,799,000.

Operating loss of ($136,000)164,000) for the sixnine months ended JuneSeptember 30, 2016 improved by $358,000$484,000 compared to an operating loss of ($494,000)648,000) for the comparable period in 2015.  The improvement is due to a reduction in engineering, selling and administrative costsexpenses which were 34.1%34.5% of revenue for the sixnine months ended JuneSeptember 30, 2016, compared to 37.5%37.2% of revenue for the comparable prior year period, partially offset by the 8.2%a 3.5% decrease in revenue.

For the sixnine months ended JuneSeptember 30, 2016, stock-based compensation expense was ($13,000)4,000) due to the effect of actual forfeitures. For the sixnine  months ended JuneSeptember 30, 2015, stock-based compensation expense was $187,000.$201,000. Compensation expense related to stock-based compensation is recognized over the applicable vesting periods. As of JuneSeptember 30, 2016, there was approximately $28,000$38,000 of total unrecognized compensation expense related to unvested share-based compensation arrangements.

The Company recorded a tax benefit (provision) of $1,000 and ($11,000)13,000) for the three months ended JuneSeptember 30, 2016 and 2015, respectively.

The Company maintains a full valuation allowance against its deferred tax assets under the provisions of ASC 740, based on the Company's assessment of the uncertainty surrounding the realization of the favorable U.S. tax benefits in future tax returns.  When assessing the need for valuation allowances, the Company considers future taxable income and ongoing prudent and feasible tax planning strategies.  Should a change in circumstances lead to a change in judgment about the ability to realize deferred tax assets in future years, the Company will adjust related valuation allowances in the period that the change in circumstances occurs, along with a corresponding increase or charge to income.

Net loss for the sixnine months ended JuneSeptember 30, 2016 improved to ($110,000)78,000), compared to a net loss of ($379,000)574,000) for the comparable period in 2015. Basic and diluted net loss per share for the sixnine month periods ended JuneSeptember 30, 2016 and 2015 was ($0.04)0.03) and ($0.14)0.22), respectively.

Cash and cash equivalents increaseddecreased by $10,000,$100,000, to $5,563,000 at June$5,453,000 as of September 30, 2016 from $5,553,000 at December 31, 2015.

Cash provided by operating activities was $43,000$268,000 and $414,000$1,025,000 for the sixnine months ended JuneSeptember 30, 2016 and 2015, respectively.  The $371,000$757,000 decrease was primarily due to thea decrease in non-cash adjustments for depreciation, stock-based compensation, gain on disposal of assets and bargain purchase gain totaling ($366,000), and net changes in working capital accounts of ($887,000), offset by an improvement in net loss.loss of $496,000.

Cash used in investing activities for the sixnine months ended JuneSeptember 30, 2016 and 2015 was ($33,000)364,000) and ($175,000)276,000), respectively. The decrease was dueFor the nine months ended September 30, 2016 the Company used ($295,000) to a reductioninvestment in the PTF Acquisition and ($112,000) to invest in capital expenditures. These investments were offset by insurance proceeds of $43,000. For the nine months ended September 30, 2015 the Company invested ($370,000) in capital expenditures. These investments were offset by insurance proceeds of $94,000.

As of September 30, 2016, the Company's consolidated working capital was $10,079,000,$9,974,000, compared to $9,876,000 at December 31, 2015.  At JuneAs of September 30, 2016, the Company had current assets of $12,404,000,$12,579,000, current liabilities of $2,325,000$2,605,000 and a ratio of current assets to current liabilities of 5.344.83 to 1.00.  AtAs of December 31, 2015, the Company had current assets of $11,952,000, current liabilities of $2,076,000 and a ratio of current assets to current liabilities of 5.76 to 1.00.  Management continues to focus on efficiently managing working capital requirements to match operating activity levels.

On September 30, 2014,2016, MtronPTI entered into arenewed its Loan Agreement (the "CNB Loan Agreement"), with City National Bank of Florida ("City National"). The CNB Loan Agreement provides for a revolving line of credit in the amount of $3.0 million (the "CNB Revolver"), which bears interest at a variable rate equal to 30-day LIBOR plus 200 basis points to be set on the first day of each month, and expires on September 30, 2016.2018. The CNB Loan Agreement also provides that MtronPTI will pay City National a fee equal to 0.75% per year on the daily unused amount. The Company's obligations under the CNB Loan Agreement are secured only by cash collateral and do not require any other liens.

In connection with the CNB Loan Agreement, MtronPTI also entered into a Cash Collateral Agreement with City National (the "CNB Cash Collateral Agreement") and delivered a Revolving Promissory Note in the principal amount of $3.0 million to City National (the "CNB Revolving Promissory Note").

The CNB Cash Collateral Agreement provides that MtronPTI will hold cash collateral equal to any amounts outstanding under the CNB Revolver in a non-interest bearing deposit account with City National. Provided that MtronPTI is not in default of any of its obligations under the CNB Loan Agreement, the CNB Revolving Promissory Note or the CNB Cash Collateral Agreement, the funds collateralizing the CNB Revolver are restricted only to the extent of the outstanding principal amount under the CNB Revolver. At JuneSeptember 30, 2016 and December 31, 2015, there was no balance outstanding under the CNB Revolver and no associated restricted cash.

The Company believes that existing cash and cash equivalents and cash generated from operations will be sufficient to meet its ongoing working capital and capital expenditure requirements for the next 12 months.  However, the Company has entered into discussions with City National to renew the CNB Loan Agreement, and may seek additional capital to fund future growth in its business, to provide flexibility to respond to dynamic market conditions, or to fund its strategic growth objectives.  

The Board has adhered to a practice of not paying cash dividends.  This policy takes into account our long-term growth objectives, including our anticipated investments for organic growth, potential technology acquisitions or other strategic ventures, and stockholders' desire for capital appreciation of their holdings.  No cash dividends have been paid to the Company's stockholders since January 30, 1989, and none are expected to be paid for the foreseeable future.

The Company's accounting policies and condensed consolidated financial statements have been established to conform with GAAP. The preparation of financial statements in conformity with GAAP requires the Company to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Management believes that the Company has made these estimates and assumptions in an appropriate manner and in a way that accurately reflects the Company's financial condition. The Company continually tests and evaluates these estimates and assumptions using its historical knowledge of the business, as well as other factors, to ensure that they are reasonable for reporting purposes. However, actual results may differ from these estimates and assumptions. If the Company's judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of the Company's results of operations to those of companies in similar businesses. The Company believes the following critical accounting policies govern the significant judgments and estimates used in the preparation of the financial statements, which should be read in conjunction with the more complete discussion of accounting policies and procedures included in Note A – Accounting and Reporting Policies to the consolidated financial statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2015.

 

The Company's most critical accounting policies include revenue recognition, accounts receivable allowance, valuation of inventories, accounting for warranty obligations, accounting for income taxes, and accounting for stock-based compensation.

The Company recognizes revenue from the sale of its productsproduct in accordance with the criteria in ASC 605, Revenue Recognition, which are:

The Company meets these conditions upon shipment because title and risk of loss passes to the customer at that time.  However, the Company offers a limited right of return and/or authorized price protection provisions in its agreements with certain electronic component distributors who resell the Company's products to original equipment manufacturers or electronic manufacturing services companies.  As a result, the Company estimates and records a reserve for future returns and other charges against revenue at the time of shipment consistent with the terms of sale. The reserve is estimated based on historical experience with each respective distributor.  The amount of the reserve at JuneSeptember 30, 2016 and December 31, 2015 is not material to the financial statements.

The Company recognizes revenue related to transactions with a right of return and/or authorized price protection provisions when the following conditions are met:

Accounts receivable on a consolidated basis consists principally of amounts due from both domestic and foreign customers.  Credit is extended based on an evaluation of the customer's financial condition and collateral is not generally required.  In relation to export sales, the Company generally requires letters of credit supporting a significant portion of the sales price prior to production to limit exposure to credit risk.  Certain credit sales are made to industries that are subject to cyclical economic changes.

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments.  Estimates are based on historical collection experience, current trends, credit policy and relationship between accounts receivable and revenues.  In determining these estimates, the Company examines historical write-offs of its receivables and reviews each client's account to identify any specific customer collection issues.  If the financial condition of its customers were to deteriorate, resulting in an impairment of their ability to make payment, additional allowances might be required.  The Company's failure to estimate the losses for doubtful accounts accurately and ensure that payments are received on a timely basis could have a material adverse effect on its business, financial condition and results of operations.

Inventories are stated at the lower of cost using the FIFO (first-in, first-out) method and market value.

The Company maintains a reserve for inventory based on estimated losses that result from inventory that becomes obsolete as of period end. In determining these estimates, the Company performs an analysis on demand and usage for each inventory item over historical time periods.  Based on that analysis, the Company reserves a percentage of the inventory amount within each time period based on historical demand and usage patterns of specific items in inventory.

 

The Company offers a standard one-year warranty. The Company tests its products prior to shipment in order to ensure that they meet each customer's requirements based upon specifications received from each customer at the time its order is received and accepted. The Company's customers may request to return products for various reasons, including but not limited to the customers' belief that the products are not performing to specification. The Company's return policy states that it will accept product returns only with prior authorization and if the product does not meet customer specifications, in which case the product would be replaced or repaired. To accommodate the Company's customers, each request for return is reviewed, and if and when it is approved, a return materials authorization ("RMA") is issued to the customer. Each month the Company records a specific warranty reserve for approved RMAs covering products that have not yet been returned. The Company does not maintain a general warranty reserve because, historically, valid warranty returns resulting from a product not meeting specifications or being non-functional have been immaterial.

Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. The future recoverability of the Company's net deferred tax assets is dependent upon the generation of future taxable income prior to the expiration of the loss carry forwards. The Company maintains a full valuation allowance against the Company's net deferred tax assets.  The valuation allowance was calculated in accordance with the provisions of ASC 740, which requires an assessment of both positive and negative evidence when measuring the need for a valuation allowance.  The Company intends to maintain a valuation allowance until sufficient positive evidence exists to support its reversal.

The Company measures the cost of employee services in exchange for an award of equity instruments based on the grant-date fair value of the award and recognizes the cost over the requisite service period, typically the vesting period.

The Company estimates the fair value of stock options on the grant date using the Black-Scholes-Merton option-pricing model. The Black-Scholes-Merton option-pricing model requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. There is no expected dividend rate. Historical Company information was the basis for the expected volatility assumption as the Company believes that the historical volatility over the life of the option is indicative of expected volatility in the future. The risk-free interest rate is based on the U.S. Treasury zero-coupon rates with a remaining term equal to the expected term of the option. The Company also estimates forfeitures at the time of grant and revises, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Based upon past history of actual performance, forfeiture rates ranging from zero percent to tentwenty-five percent have been assumed for options granted.

Stock awards are made at a value equal to the market price of the Company's common stock on the date of the grant.

The Company maintains disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in the Company's reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to the Company, including the Company's principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, the Company recognizes that no controls and procedures, no matter how well designed and operated, can provide absolute assurance of achieving the desired control objectives.

As required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, an evaluation as of JuneSeptember 30, 2016 was conducted under the supervision and with the participation of the Company's management, including the Company's principal executive officer and principal financial officer, of the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, the Company's principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures, as of JuneSeptember 30, 2016, were effective at a reasonable assurance level.

DuringExcept as set forth below, during the fiscal quarter ended JuneSeptember 30, 2016, there were no changes in the Company's internal controls over financial reporting, or in other factors that could significantly affect these controls, that materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.