Inrad Optics, Inc. - Annual Report: 2016 (Form 10-K)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

Inrad Optics, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code 201-767-1910

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to section 12(g) of the Act:

Common stock, par value $.01 Per Share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o.      No ý.

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o.      No ý.

Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated file, or a smaller reporting company. See definition of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $2,750,322. (For purposes of determining this amount, only directors, executive officers and shareholders with voting power of 10% or more of our stock have been deemed affiliates.)

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

Common Shares outstanding as of March 30, 2017 – 13,151,994 shares

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive Proxy Statement for the 2017 Annual Meeting of Shareholders, to be filed with the Commission not later than 120 days after the close of the registrant’s fiscal year, have been incorporated by reference, in whole or in part, into Part III Items 10, 11, 12, 13 and 14 of this Annual Report on Form 10-K.

Inrad Optics, Inc.

INDEX

PART 1

Caution Regarding Forward Looking Statements

This Annual Report contains forward-looking statements as that term is defined in the federal securities laws. The Company wishes to insure that any forward-looking statements are accompanied by meaningful cautionary statements in order to comply with the terms of the safe harbor provided by the Private Securities Litigation Reform Act of 1995. The events described in the forward-looking statements contained in this Annual Report may not occur. Generally, these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of the Company’s plans or strategies, or projections involving anticipated revenues, earnings, or other aspects of the Company’s operating results. The words “may”, “will”, “expect”, “believe”, “anticipate”, “project”, “plan”, “intend”, “estimate”, and “continue”, and their opposites and similar expressions are intended to identify forward-looking statements. The Company cautions you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks, and other influences, many of which are beyond the Company’s control, that may influence the accuracy of the statements and the projections upon which the statements are based. Factors that may cause or contribute to such differences include, but are not limited to, those discussed in more detail in Item 1 (Business) and Item 1A (Risk Factors) of Part I and Item 7 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) of Part II of this Annual Report on Form 10-K. Any one or more of these uncertainties, risks, and other influences could materially affect the Company’s results of operations and whether forward-looking statements made by the Company ultimately prove to be accurate. Readers are further cautioned that the Company’s financial results can vary from quarter to quarter, and the financial results for any period may not necessarily be indicative of future results. The foregoing is not intended to be an exhaustive list of all factors that could cause actual results to differ materially from those expressed in forward-looking statements made by the Company. The Company’s actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. The Company undertakes no obligation to publicly update or revise any forward looking statements, whether from new information, future events, or otherwise, except as otherwise required by law.

Inrad Optics, Inc. (the “Company”, “Inrad”, or “we”), was incorporated in New Jersey in 1973. The Company develops, manufactures and markets products and services for use in photonics industry sectors via three distinct but complementary product areas - “Crystals and Devices”, “Custom Optics” and “Metal Optics.”

The Company is a vertically integrated manufacturer specializing in crystal-based optical components and devices, custom optical components from both glass and metal, and precision optical and opto-mechanical assemblies. Manufacturing capabilities include solution and high temperature crystal growth, extensive optical fabrication capabilities including precision diamond turning and the ability to handle large substrates, optical coatings, as well as in-process metrology.

Inrad Optics’ customers include leading corporations in the defense, aerospace, laser systems, process control and metrology sectors of the photonics industry, as well as the U.S. Government, National Laboratories and universities worldwide.

Administrative, engineering and manufacturing operations are in a 42,000 square foot building located in Northvale, New Jersey.

The products produced by Inrad Optics, Inc. fall into two main categories: Optical Components and Laser System Devices/Instrumentation.

The Optical Components category is heavily focused on custom optics manufacturing. The Company specializes in high-end precision components. It develops, manufactures and delivers precision custom optics and thin film optical coating services through its Custom and Metal Optics operations. Glass, metal, and crystal substrates are processed using modern manufacturing equipment, complex processes and techniques to manufacture components, deposit optical thin films, and assemble sub-components used in advanced photonic systems. The majority of custom optical components and optical coating services supplied are used in inspection, process control systems, defense and aerospace electro-optical systems, laser system applications, industrial scanners, and medical system applications.

The Laser Devices/Instrumentation category includes the growth and fabrication of crystalline materials with electro-optic (EO) and non-linear optical properties for use in both standard and custom products. This category also includes crystal based devices and associated instrumentation. The majority of crystals, crystal components and laser devices are used in laser systems, defense and security EO systems, medical lasers and R&D applications by engineers within corporations, universities and national laboratories.

The following table summarizes the Company’s net sales by product categories during the past two years. Laser System Devices/Instrumentation includes all non-linear and electro-optical crystal components.

Products Manufactured by the Company

Optical Components

Manufacturing of high-performance custom optics is a major product area for Inrad Optics and is addressed in the marketplace by the Company’s Custom and Metal Optics product lines.

The Custom Optics product line focuses on products manufactured to specific customer requirements. It specializes in the manufacture of optical components, optical coatings (ultra-violet wavelengths through infra-red wavelengths) and subassemblies for the military, aerospace, industrial and medical marketplace. Planar, prismatic and spherical components are fabricated from glass and synthetic crystals, including fused silica, quartz, germanium, zinc selenide, zinc sulfide, magnesium fluoride and silicon. Components consist of mirrors, lenses, prisms, wave plates, polarizing optics, x-ray monochromators, x-ray mirrors, and cavity optics for lasers.

Most optical components and sub-assemblies require thin film coatings on their surfaces. Depending on the design, optical coatings can refract, reflect and transmit specific wavelengths. The Custom Optics optical coating specialties include high laser damage resistance, polarizing, highly reflective, anti-reflective, infra-red, and coating to complex multi-wavelength requirements on a wide range of substrate materials. Coating deposition process technologies employed included electron beam, thermal, ion and plasma assisted deposition systems.

The Metal Optics product line is a fully integrated precision metal optics and optical assembly operation which employs high precision diamond machining, polishing, and plating of aluminum, AlBeMet™, beryllium and stainless steel. The Metal Optics product line offers opto-mechanical design and assembly services as part of its manufactured deliverables and can support prototyping through production of large and small metal mirrors, thermally stable optical mirrors, low RMS surface finish polished mirrors, diamond machined precision aspheric and planar mirrors, reflective porro prisms, and arc-second accuracy polygons and motor assemblies. Plating specialties include void-free gold and electroless nickel.

This product line consists of crystals and crystal devices including UV filter materials of both patented and proprietary materials with unique transmission and absorption characteristics. These materials are used in critical applications in defense systems such as missile warning sensors. Such materials include nickel sulfate and other proprietary materials.

Laser Devices/Instrumentation

This product line consists of crystal-based products that are used in, or alongside, laser systems. Developing growth processes for high quality synthetic crystals is a core competency of the Crystals and Devices manufacturing team. These crystals are embedded in our value added devices and instrumentation products manufactured in our Northvale facility and include crystals for wavelength conversion, modulation and polarization, Pockels’ cells, and wavelength conversion instruments. In addition to the filter materials used in the UV Filter Optical components described above, current materials produced include beta barium borate (BBO), lithium niobate, zinc germanium diphosphide, potassium dihydrogen phosphate, potassium dideuterium phosphate and stilbene. Applications for these materials include defense, homeland security, surgical lasers, and industrial processing lasers. The Crystals and Devices team is also engaged in ongoing R & D efforts to develop new materials for evolving applications. Some of the major products produced for the photonics marketplace include:

The Company grows and fabricates electro-optic and nonlinear crystal devices for altering the intensity, polarization or wavelength of a laser beam. Other crystal components, produced as part of the Crystals and Devices product line, are used in laser research,in commercial laser systems and in detection of fast neutrons.

A line of Pockels’ cells and associated electronics is manufactured for sale in multiple market sectors. Pockels’ cells are devices that include one or more crystal components and are used in applications that require fast switching of the polarization direction of a beam of light. These uses include Q-switching of laser cavities to generate pulsed laser light, coupling light into and out from regenerative amplifiers, and light intensity modulation. These devices are sold to medical and industrial laser original equipment manufacturers, research institutes and laser system design engineers.

Sales by Market

The photonics industry serves a very broad, fragmented and expanding set of markets. As technologies are discovered, developed and commercialized, the applications for photonic systems and devices, and the components embedded within those devices, grow across traditional market boundaries. While a significant part of the Company’s business remains firmly in the defense and aerospace markets, other markets served include the OEM medical and industrial laser market, and the OEM metrology and process control market, university research institutes and national labs worldwide. Scanning, detection and imaging technologies for homeland security and health care markets are beginning to provide opportunities for the Company and these new sectors are expected to continue to account for potential future growth and demand for our products and capabilities.

In 2016 and 2015 the Company’s product sales were made to customers in the following market areas:

Defense and Aerospace

This market consists of sales to OEM defense electro-optical systems and subsystems manufacturers, manufacturers of non-military satellite-based electro-optical systems and subsystems, and direct sales to governments where the products have the same end-use.

End-use applications for the Company’s products in the defense and aerospace sector include military laser systems, military electro-optical systems, satellite-based systems, and missile warning sensors and systems that protect aircraft. The dollar volume of shipments of product within this sector depends in large measure on the U.S. Defense Department budget and its priorities, that of foreign governments, the timing of their release of contracts to their prime equipment and systems contractors, and the timing of competitive awards from this customer community to the Company.

Defense/Aerospace sales represented approximately 37.2% and 33.8% of sales in 2016 and 2015, respectively. Sales increased by approximately $90,000 or 2.5% from 2015. The increase in 2016 is primarily due to increased shipments under one long-term government defense contract as compared to the previous year.

The Company believes that the defense and aerospace sector will continue to represent a significant market for the Company’s products and offers an ongoing opportunity for growth given the Company’s capabilities in specialty crystal, glass and metal precision optics.

Process Control and Metrology

This market consists of capital equipment manufacturers whose products are used in the areas of manufacturing process and control, optics-based metrology, quality assurance, and inventory and product control. Examples of applications for such equipment include semiconductor fabrication and testing and inventory management and distribution systems control.

Sales in the Process Control and Metrology market decreased in 2016 as a percentage of total sales from 38.3% to 35.2%.Sales decreased $575,000 or approximately 14.3% compared to 2015. The decrease in 2016 is mainly attributable to reduced sales to one large OEM customer serving the semi-conductor industry.

Despite a decrease in this market’s sales in 2016, the Company believes that the optical and x-ray inspection segment of the semiconductor industry offers growth opportunities which match its capabilities in precision optics, crystal products, and monochromators.

Laser Systems

This market consists principally of customers who are OEM manufacturers of industrial, medical, and R&D lasers which the Company serves as an OEM supplier of standard and custom optical components and laser accessories, as well as a number of smaller customers in other markets that are not currently large enough to list individually.

Sales in this market were lower in 2016 as a percentage of sales, compared to 2015, from 19.2% to 16.1%, or a decrease of $445,000. This was mainly attributable to lower sales to one large health sciences customer and another large customer in the telecom industry.

Universities and National Laboratories

These sales consist of product sales directly to researchers at various educational and research institutions and through distributors into that market. Sales to customers within the University and National Laboratories market consist primarily of the Company’s legacy systems, Pockels’ cells and related repairs. Sales in 2016 increased by $205,000, or 22.4%and as a percentage of total sales to 11.5% compared to 8.7% in 2015. This was primarily attributable to increased business in 2016 from one National Lab that received government funding for a program which utilized our products and an increase in order volume from a second National Lab customer.

Major Customers

The Company’s sales have historically been concentrated within a small number of customers, although the top customers have varied from year to year.

In 2016, the Company’s sales to its top three customers accounted for 25.7% of sales. This included sales to a division of a major U.S. defense industry corporation that manufactures electro-optical systems for U.S. and foreign governments. These sales accounted for 10.5% of 2016 sales to this customer that were comparable to the prior year sales volume. Two other customers were foreign-based manufacturers of process control and metrology equipment whose sales represented 8.8% and 6.4% of sales, respectively.

The same three customers represented 10.3%, 8.3% and 6.7 %, of sales in 2015, respectively.

Sales to the Company’s top five customers represented approximately 37.8% and 42.6% of sales, in 2016 and 2015, respectively. All these customers are OEM manufacturers either within the defense, process control and metrology or laser systems sector.

Export Sales

The Company’s export sales are primarily to customers in Europe, Israel, Asia and Japan and amounted to approximately 23.1%, and 25.2% of product sales in 2016 and 2015, respectively.

Long-Term Contracts

Certain of the Company’s agreements with customers provide for periodic deliveries at fixed prices over a long period of time. In such cases, the Company negotiates to obtain firm price commitments, as well as cash advances from its customers for the purchase of the materials necessary to fulfill the order.

Marketing and Business Development

The Company markets its products domestically, through the coordinated efforts of the sales, marketing and customer service teams.

The Company has moved towards a strategy of utilizing these combined sales and marketing resources for cross-selling all products across all business lines. This strategy is well suited to the diverse and fragmented markets that utilize photonic technologies.

Independent sales agents are used in countries in major non-U.S. markets, including Canada, the United Kingdom, the European Union, Israel, and Japan.

Sales and marketing efforts to promote our product lines and our participation in trade shows, internet-based marketing, media and non-media advertising and promotion, and management of international sales representatives and distributor relationships are coordinated at the corporate level under the auspices of the Vice President, Sales and Marketing.

Backlog

The Company’s order backlog at December 31, 2016 was $6,255,000. The Company’s order backlog as of December 31, 2015 was $5,195,000.

We anticipate shipping a majority of the present backlog during fiscal year 2017. However, our backlog at any given date may consist of orders with delivery schedules that extend beyond twelve months into the future.

Competition

Within each product category in which the Company’s business units are active, there is competition.

Changes in the photonics industry have had an effect on suppliers of custom optics. As end users have introduced products requiring large volumes of optical components, suppliers have responded either by staying small and carving out niche product areas, or by ramping up manufacturing capacity and modernizing their manufacturing methods to meet higher volume production rates. Additionally, the availability of an increasingly large variety of inventoried inexpensive catalog optics has led some OEM manufacturers to “design in” these low-cost solutions rather than utilizing custom designed and manufactured products.

Competition for the Company’s crystal devices and instrumentation is more limited and the Company’s laser devices are considered to be high quality and generally offer a combination of features not available elsewhere. As a result of the Company’s in-house crystal growth capability, this area of the business is highly vertically integrated, providing a competitive advantage over other suppliers.

For crystal products, the market is highly competitive. Many of the Company’s competitors who supply non-linear optical crystals are located overseas, and can offer significantly reduced pricing for some crystal materials. On many occasions, the quality of the crystal component drives the ultimate performance of the component or instrument into which it is installed. Quality and technical support are considered to be valuable attributes for a crystal supplier by some, but not all, OEM customers.

Our metal optics product line has several key competitors who are larger and better equipped to compete on high volume work. There are also several large and small competitors who compete with our products on large form factor optics. The Company has made recent inroads within this competitive landscape, and is building brand awareness in the marketplace.

Although price is a principal factor in many product categories, competition is also based on product design, performance, customer confidence, quality, delivery, and customer service. Based on its performance to date, the Company believes that it can continue to compete successfully, although no assurances can be given in this regard.

Employees

As of the close of business on March 23, 2017, the Company had 63 employees.

Patents and Licenses

The Company mainly relies on its manufacturing and technological expertise, know-how and trade secrets in addition to its patents, to maintain its competitive position in the industry. The Company takes precautionary and protective measures to safeguard its technical design and manufacturing processes. The Company executes nondisclosure agreements with its employees and, where appropriate, with its customers, suppliers and other associates.

Regulation

Foreign sales of certain of the Company’s products to certain countries may require export licenses from the United States Department of Commerce. Such licenses are obtained when required. All requested export licenses of Inrad Optics products have been granted or deemed not-required.

International Traffic in Arms Regulations (“ITAR”) governs much of the Company’s domestic defense sector business, and the Company is capable of handling its customers’ technical information under these regulations. Inrad Optics, Inc. is registered with the Directorate of Defense Trade Controls, and utilizes a supplier base of similarly registered companies.

There are no other federal regulations or any unusual state regulations that directly affect the sale of the Company’s products other than those environmental compliance regulations that generally affect companies engaged in manufacturing operations in New Jersey.

Availability of Reports

Our principal executive offices are located at 181 Legrand Avenue, Northvale, N.J. 07647 which also houses our manufacturing operations. Our telephone number is 201-767-1910 and our corporate website address is www.inradoptics.com. We include our website address in this annual report on Form 10-K only as an inactive textual reference and do not intend it to be an active link to our website. The information on our website is not incorporated by reference in this annual report on Form 10-K.

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to such reports, as well as other documents we file with the Securities and Exchange Commission, are available free of charge on our web site at www.inradoptics.com as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”) (www.sec.gov). We will also provide electronic or paper copies of such reports free of charge, upon request made to our Corporate Secretary.

The Company cautions investors that its performance (and, therefore, any forward looking statement) is subject to risks and uncertainties. The risks described below are not the only ones we face, but those we currently consider to be material. There may be other risks which we now consider immaterial, or which are unknown or unpredictable, with respect to our business, the markets in which we operate, our competition, the regulatory environment or otherwise that could have a material adverse effect on our business, financial condition and results of operation.

The Company has historically incurred substantial net losses. We had a net loss of $0.6 million and $0.5 million for the fiscal years ended December 31, 2016 and 2015, respectively. These losses have had, and will continue to have, an adverse effect on our working capital, total assets and stockholders’ equity. We are unable to predict, with certainty, when we will become profitable and our inability to achieve and sustain profitability will negatively affect our business, financial condition, results of operations and cash flows.

We may need to raise additional financing to repay our outstanding indebtedness of approximately $3.2 million, as well as, to fund our current level of operations. Additional financing, which is not in place at this time, may be from the sale of equity or convertible or other debt securities in a public or private offering, or from an additional credit facility. We may be unable to raise sufficient additional capital on favorable terms, if at all, to supply the working capital needs of our existing operations or to expand our business.

Sales to customers in the defense industry represent a significant part of our business. These customers in turn generally contract with government agencies. Most governmental programs are subject to funding approval through congressional appropriations which can be modified or terminated without warning upon the determination of a legislative or administrative body. Appropriations can also be affected by legislation that addresses larger budgetary issues of the U.S. Government which could reduce available funding for most federal agencies, including the Department of Defense. It is difficult to assess how this may impact our defense industry customers and the business we do with them in the future. The loss or failure to obtain certain contracts or a loss of a major government customer could have a material adverse effect on our business, results of operations or financial condition.

For the year ended December 31, 2016, five customer accounts represented approximately 37.8% of total revenues and one of these customers accounted for more than 10% of revenues. We are a supplier of custom manufactured components to OEM customers, and have a number of large customers in both the commercial and defense markets, but the relative size and identity of our largest customers change year to year. In the short term, the loss of any of these large customer accounts or a decline in demand in the markets which they represent could have a material adverse effect on our business, results of operations, and financial condition.

To meet the Company’s strategic objectives, the Company needs to continue to develop new processes, improve existing processes, and manufacture and market new products. As a result, the Company may continue to make investments in process development and additions to its product portfolio. There can be no assurance that the Company will be able to develop and introduce new products or enhancements to its existing products and processes in a way that achieves market acceptance or other pertinent targeted results. The Company also cannot be sure that it will have the human or financial resources to pursue or succeed in such activities.

The Company’s stock is thinly traded. Many factors, including, but not limited to, future announcements concerning the Company, its competitors or customers, as well as quarterly variations in operating results, announcements of technological innovations, seasonal or other variations in anticipated or actual results of operations, changes in earnings estimates by analysts or reports regarding the Company’s industries in the financial press or investment advisory publications, could cause the market price of the Company’s stock to fluctuate substantially. In addition, the Company’s stock price may fluctuate widely for reasons which may be unrelated to operating results. These fluctuations, as well as general economic, political and market conditions such as recessions, military conflicts, or market or related declines, may materially and adversely affect the market price of the Company’s common stock. In addition, any information concerning the Company, including projections of future operating results, appearing in investment advisory publications or on-line bulletin boards or otherwise emanating from a source other than the Company could in the future contribute to volatility in the market price of the Company’s common stock.

The Company depends on the expertise, experience, and continuing services of certain scientists, engineers, production and management personnel, and on the Company’s ability to recruit additional personnel. There is competition for the services of these personnel, and there is no assurance that the Company will be able to retain or attract the personnel necessary for its success, despite the Company’s efforts to do so. The loss of the services of the Company’s key personnel could have a material adverse effect on its business, results of operations, or financial condition.

The Company’s business is significantly dependent on the demand its customers experience for their products. Many of their end users are in industries that historically have experienced a cyclical demand for their products. The industries include, but are not limited to, the defense electro-optics industry and the manufacturers of process control capital equipment for the semiconductor tools industry. As a result, demand for the Company’s products are subject to cyclical fluctuations, and this could have a material adverse effect on our business, results of operations, or financial condition.

The Company utilizes many relatively uncommon materials and compounds to manufacture its products. Examples include optical grade quartz, specialty optical glasses, scarce natural and manmade crystals, beryllium and its alloys, and high purity chemical compounds. The Company’s suppliers could fail to deliver sufficient quantities of these necessary materials on a timely basis, or deliver contaminated or inferior quality materials, or markedly increase their prices. Any such actions could have an adverse effect on the Company’s business, despite the Company’s efforts to secure long term commitments from its suppliers. Adverse results might include reducing the Company’s ability to meet commitments to its customers, compromising the Company’s relationship with its customers, adversely affecting the Company’s ability to meet expanding demand for its products, or causing the Company’s financial results to deteriorate.

The Company encounters substantial competition from other companies positioned to serve the same market sectors. Some competitors may have financial, technical, capacity, marketing or other resources more extensive than ours, or may be able to respond more quickly than the Company to new or emerging technologies and other competitive pressures. Some competitors have manufacturing operations in low-cost labor regions such as the Far East and Eastern Europe and can offer products at lower prices than the Company. The Company may not be successful in winning orders against the Company’s present or future competitors, and competition may have a material adverse effect on our business, results of operations or financial condition.

The Company currently holds one patent for a material applicable to an important product, but does not in general rely on patents to protect its products or manufacturing processes. The Company generally relies on a combination of trade secrets and employee non-compete and nondisclosure agreements to protect its intellectual property rights. There can be no assurance that the steps the Company takes will be adequate to prevent misappropriation of the Company’s technology. In addition, there can be no assurance that, in the future, third parties will not assert infringement claims against the Company. Asserting the Company’s rights or defending against third-party claims could involve substantial expense, thus materially and adversely affecting the Company’s business, results of operations or financial condition.

None

Administrative, engineering and manufacturing operations are housed in a 41,935 square foot building located in Northvale, New Jersey. The lease for the Northvale facility was renewed for a term of two years from June 1, 2015 to May 31, 2017, at substantially the same terms. The Company has an option to renew the Northvale lease for two additional one year terms running through May 31, 2019, at substantially the same terms. The Company intends to exercise the first option to renew the lease for a one-year term prior to the end of the current lease term.

We believe that our existing facility is adequate to meet current and future projected production needs.

We are not party to any legal proceedings as of the date hereof.

Not Applicable

PART II

The Company’s Common Stock, with a par value of $0.01 per share, is traded on the OTC Bulletin Board under the symbol INRD.

The following table sets forth the range of high and low closing prices for the Company’s Common Stock in each fiscal quarter from the quarter ended March 31, 2015 through the quarter ended December 31, 2016, as reported by the OTC Bulletin Board. Such over-the-counter quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

As of March 21, 2017 the Company’s closing stock price was $0.69 per share.

As of March 17, 2017, there were approximately 119 shareholders of record of our Common Stock based upon the Shareholders’ Listing provided by the Company’s Transfer Agent. As of the same date, the Company estimates that there are an additional 239 beneficial shareholders.

The Company has not historically paid cash dividends. Payment of cash dividends is at the discretion of the Company’s Board of Directors and depends, among other factors, upon the earnings, capital requirements, operations and financial condition of the Company. The Company does not anticipate paying cash dividends in the foreseeable future.

There have been no sales of unregistered securities during the past year.

Equity Compensation Plan Information

The following table provides information about the Company’s common stock that may be issued upon the exercise of options under the Company’s 2000 Equity Compensation Program and the Company’s 2010 Equity Compensation Program, as of December 31, 2016. These plans were the Company’s only equity compensation plans in existence as of December 31, 2016. The 2010 Equity Compensation Program is the successor to the 2000 Equity Compensation Program, and no additional awards will be granted under the 2000 Equity Compensation Program. No warrants or rights may be granted, or are outstanding, under the 2000 or the 2010 Equity Compensation Programs.

The following data is qualified in its entirety by the financial statements presented elsewhere in this Annual Report on Form 10-K.

The following discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and the notes thereto presented elsewhere herein. The discussion of results should not be construed to imply any conclusion that such results will necessarily continue in the future.

Critical Accounting Policies

The Company’s significant accounting policies are described in Note 1 of the Consolidated Financial Statements that were prepared in accordance with accounting principles generally accepted in the United States of America. In preparing the Company’s financial statements, the Company made estimates and judgments that affect the results of its operations and the value of assets and liabilities the Company reports. The Company’s actual results may differ from these estimates.

The Company believes that the following summarizes critical accounting policies that require significant judgments and estimates in the preparation of the Company’s consolidated financial statements.

Revenue Recognition

The Company records revenue from the sale of its products and services when all four of the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the sales price is fixed or determinable; and collectability is reasonably assured. Losses on contracts are recorded when identified.

Inventory

Inventories are stated at the lower of cost (first-in, first-out method) or market. Cost of manufactured goods includes material, labor and overhead.

The Company records a reserve for slow moving inventory as a charge against earnings for all products identified as surplus, slow moving or discontinued. Excess work-in-process costs are charged against earnings whenever estimated costs-of-completion exceed unbilled revenues.

Stock-based compensation

Stock based compensation expense is estimated at the grant date based on the fair value of the award. The Company estimates the fair value of stock options granted using the Black-Scholes option pricing model. The fair value of restricted stock units granted is estimated based on the closing market price of the Company’s common stock on the date of the grant. The fair value of these awards, adjusted for estimated forfeitures, is amortized over the requisite service period of the award, which is generally the vesting period.

Income Taxes

Deferred income taxes are provided on the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the amounts of assets and liabilities recorded for income tax and financial reporting purposes. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

The Company recognizes the financial statement benefit of an uncertain tax position only after determining that the relevant tax authority would more likely than not sustain the position. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.

The Company classifies interest and penalties related to income taxes as income tax expense in its Consolidated Financial Statements.

Results of Operations

The following table sets forth, for the past two years, the percentage relationship of statement of operations categories to total revenues.

Revenues

Sales were $9,767,000 in 2016, a decrease of 6.9%, or $726,000 compared to $10,492,000 in 2015.

Sales to the defense and aerospace market increased 2.5% to $3,639,000 from $3,549,000 in 2015 representing 37.2% and 33.8% of total sales, respectively. This increase primarily reflects increased sales to an existing customer in this market.

Sales in the process control and metrology market decreased to $3,436,000 in 2016 from $4,011,000 in 2015, a decrease of $575,000 or 14.4%. These sales represented 35.2% and 38.3%, of total sales, respectively. The decrease in 2016 is mainly the result of lower demand from one large OEM customer in the semi-conductor business.

The Company serves as an OEM supplier of standard and custom optical components and laser accessories within the non-military laser industry. Sales to this and related markets were $1,573,000 in 2016 and $2,018,000 in 2015. Overall, sales of laser devices and related products represented 16.1% of total sales in 2016, a decrease from 19.2% in 2015. Sales to one large customer decreased by approximately $409,000 as a result of lower demand during the year.

Sales to customers within the university and national laboratories market increased in 2016 to $1,119,000 from $914,000 in 2015, up 22.4%, mainly due to an increase in orders from one national laboratory customer who received government funding for a program that utilized our products. As a percentage of total sales, this market represented 11.5% and 8.7% of total sales in 2016 and 2015, respectively.

Bookings

The Company booked new orders totaling approximately $10.8 million in 2016, an increase of $1.3 million or 13.7% from $9.5 million in 2015, as the result of an increase in orders for the Company’s custom optics and metal optics product lines offset by a decrease in orders for the Company’s crystals and devices product line.

The Company’s backlog as of December 31, 2016 was $6.3 million compared to $5.2 million as of December 31, 2015.

Cost of Goods Sold and Gross Profit Margin

Cost of goods sold as a percentage of sales was 80.0% and 78.7% for the years ended December 31, 2016 and 2015, respectively. In 2016, cost of goods sold was $7,812,000 compared to cost of goods sold of $8,258,000 in 2015.

The decrease in cost of goods sold in 2016 was attributable to several factors. Material costs decreased by approximately 13.5% compared to a sales decrease of 6.9%. In addition, wage and salary expenses and variable overhead costs decreased primarily due to lower sales. However, the overall decrease in the cost of goods sold was not proportional to the sales decrease, which resulted in an increase in the cost of goods sold as a percentage of sales in 2016 from 2015.

Selling, General and Administrative Expenses

Selling, general and administrative expenses (“SG&A”) were $2,451,000 in 2016 compared to $2,543,000 in 2015, a decrease of $92,000 or 3.6%. The decrease partially reflects reductions in SG&A salaries, wages and associated benefits of approximately $140,000 due to a decrease in the number of employees from 2015 to 2016. This was partially offset by increased expenses for outside services which were related to certain administrative functions which the Company decided to outsource in 2016.

As a percentage of sales, SG&A was 25.1% of sales in 2016 compared to 24.2% in 2015, primarily due to lower sales in 2016.

Operating (Loss)

The Company had an operating loss of $496,000 in 2016, compared to $308,000 in 2015.

Other Income and Expenses

Net interest expense of $168,000 in 2016 decreased from $176,000 in 2015 as the Company continues to make payments to reduce its long-term notes payable.

The Company recorded a gain of $59,000 in 2016 as part of a transaction which included the sale of precious metals. In 2015, the Company sold surplus equipment and recorded a gain of $5,500.

Income Taxes

In 2016 and 2015, the Company did not record a current provision for either state tax or federal alternative minimum tax due to the losses incurred for both income tax and financial reporting purposes.

Net (Loss)

In 2016, the Company recorded a net loss of $605,000 compared to a net loss of $479,000 in 2015. The increase in the net loss was mainly the result of the lower sales levels which resulted in lower margins related to fixed manufacturing costs. Lower sales and margins were partially offset by lower selling, general and administrative expenses compared to 2015.

Liquidity and Capital Resources

The Company’s primary source of liquidity is cash and cash equivalents and on-going collection of our accounts receivable. The Company’s major uses of cash in the past three years have been for operating expenses, capital expenditures and for repayment and servicing of outstanding debt and accrued interest.

As of December 31, 2016 and December 31, 2015, cash and cash equivalents were $973,000 and $674,000, respectively.

On June 9, 2016 the maturity dates of a $1,500,000 Subordinated Convertible Promissory Note to Clarex Limited (“Clarex”) and a $1,000,000 Subordinated Convertible Promissory Note to an affiliate of Clarex were each extended to April 1, 2019 from April 1, 2017. The notes bear interest at 6%. Interest accrues yearly and is payable on maturity. Unpaid interest, along with principal, may be converted into securities of the Company as follows: the notes are convertible in the aggregate into 1,500,000 units and 1,000,000 units, respectively, with each unit consisting of one share of common stock and one warrant. Each warrant allows the holder to acquire 0.75 shares of common stock at a price of $1.35 per share. As part of the agreement to extend the maturity date of the notes, the expiration dates of the warrants were extended from April 1, 2020 to April 1, 2022.

The Company paid $75,000 and $150,000 for interest on the notes in 2016 and 2015, respectively. Accrued interest of $75,000 and $37,500 is included in Accounts payable and accrued liabilities as of December 31, 2016 and 2015, respectively.

The Company paid $132,000 of interest in 2016 and $177,000 of interest in 2015 on its outstanding debt.

In 2016, the Company had capital expenditures of $114,000. In 2015, capital expenditures were $30,000.

For the year ended December 31, 2016, net cash provided by operating activities was $615,000 compared to net cash used by operating activities of $141,000 for 2015, with the result that cash increased by $300,000 in 2016 compared to a decrease of $330,000 in 2015.

Cash flows pertaining to our source and use of cash are presented below (in thousands):

Overview of Financial Condition

The Company recorded a net loss of $605,000 compared to a net loss of $479,000 in 2015. The Company’s cash and cash equivalents increased to $973,000 at December 31, 2016 compared to $674,000 at December 31, 2015 as operating activities provided $615,000 in cash during the year.

The Company’s management expects that future cash flows from operations and its existing cash reserves will provide adequate liquidity for the Company’s operations and working capital requirements through at least March 31, 2018.

Contractual Obligations

The following table describes our contractual obligations as of December 31, 2016 (in thousands).

Off-Balance Sheet Arrangements

The Company did not have any off-balance sheet arrangements at December 31, 2016 and 2015.

N/A

The financial statements and supplementary financial information required to be filed under this Item are presented commencing on page 22 of the Annual Report on Form 10-K, and are incorporated herein by reference.

None

a) Evaluation of Disclosure Controls and Procedures

The Company’s management, including the Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Annual Report on Form 10-K. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures as of December 31, 2016 are effective to ensure that information required to be disclosed in the reports the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to the Company's management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding disclosure.

b) Management’s Annual Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining an adequate system of internal control over financial reporting. Our internal control over financial reporting includes those policies and procedures that:

Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Because of the inherent limitations of internal control, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

Our management assessed the effectiveness of our system of internal control over financial reporting as of December 31, 2016. In making this assessment, management used the framework in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our assessment and the criteria set forth by COSO, management has concluded that the Company maintained effective internal control over financial reporting as of December 31, 2016.

c) Changes in Internal Control over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting identified in connection with the evaluation that occurred during the Company’s last fiscal quarter that have materially affected, or that are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

None

PART III

The information required under this item is incorporated by reference to the Company’s Proxy Statement for the 2017 Annual Meeting of Stockholders which we anticipate will be filed within 120 days after our fiscal year ended December 31, 2016.

The information required under this item is incorporated by reference to the Company’s Proxy Statement for the 2017 Annual Meeting of Stockholders which we anticipate will be filed within 120 days after our fiscal year ended December 31, 2016.

The information required under this item is incorporated by reference to the Company’s Proxy Statement for the 2017 Annual Meeting of Stockholders which we anticipate will be filed within 120 days after our fiscal year ended December 31, 2016.

The information required under this item is incorporated by reference to the Company’s Proxy Statement for the 2017 Annual Meeting of Stockholders which we anticipate will be filed within 120 days after our fiscal year ended December 31, 2016.

The information required under this item is incorporated by reference to the Company’s Proxy Statement for the 2017 Annual Meeting of Stockholders which we anticipate will be filed within 120 days after our fiscal year ended December 31, 2016.

PART IV

Reference is made to the Index to Financial Statements and Financial Statement Schedule commencing on Page 20

Reference is made to the Index to Financial Statements and Financial Statement Schedule on Page 20. All other schedules have been omitted because the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the Financial Statements or Notes thereto.

Not Applicable

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

INRAD OPTICS, INC. AND SUBSIDIARIES

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015

CONTENTS

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders, Audit Committee and Board of Directors

Inrad Optics, Inc. and Subsidiaries

Northvale, New Jersey

We have audited the accompanying consolidated balance sheets of Inrad Optics, Inc. and Subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations, shareholders’ equity and cash flows for the years then ended. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of its internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall consolidated 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 Inrad Optics, Inc. and Subsidiaries as of December 31, 2016 and 2015 and the results of their operations and cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

/s/ Baker Tilly Virchow Krause, LLP

New York, New York

March 31, 2017

INRAD OPTICS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See notes to consolidated financial statements

INRAD OPTICS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

See notes to consolidated financial statements

INRAD OPTICS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

See notes to consolidated financial statements

INRAD OPTICS, INC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to consolidated financial statements

INRAD OPTICS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

TWO YEARS ENDED DECEMBER 31, 2016

Inrad Optics, Inc. and Subsidiaries (the “Company”), formerly known as Photonic Products Group, Inc., was incorporated in the state of New Jersey and is a manufacturer of crystals, crystal devices, electro-optic and optical components, and sophisticated laser devices and instruments. The Company has administrative offices and manufacturing operations in Northvale, New Jersey.

The Company’s principal customers include commercial instrumentation companies and OEM laser systems manufacturers, research laboratories, government agencies, and defense contractors. The Company’s products are sold domestically using its own sales staff, and in major overseas markets, principally Europe, Israel, Japan, and Asia, using independent sales agents.

As of December 31, 2016, the Company had working capital of $3,280,263 and cash and cash equivalents of $973,333. Management believes based on the Company’s operations and its existing working capital resources together with existing cash flows, the Company has sufficient cash flows to fund operations through at least March 31, 2018.

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Upon consolidation, all inter-company accounts and transactions are eliminated.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates.

The Company considers cash-on-hand and highly liquid investments with original maturity dates of three months or less at the date of purchase to be cash and cash equivalents.

Accounts receivable are carried at net realizable value, net of write-offs and allowances. The Company establishes an allowance for doubtful accounts based on estimates as to the collectability of accounts receivable. Management specifically analyzes past-due accounts receivable balances and, additionally, considers bad debt history, customer credit-worthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. Uncollectible accounts receivable are written-off when it is determined that the balance will not be collected.

Inventories are stated at the lower of cost (first-in, first-out method) or market. Cost of manufactured goods includes material, labor and overhead.

The Company records a reserve for slow moving inventory as a charge against earnings for all products identified as surplus, slow moving or discontinued. Excess work-in-process costs are charged against earnings whenever estimated costs-of-completion exceed unbilled revenues.

Plant and equipment are depreciated using the straight-line method over the estimated useful lives of the related assets which range between five and seven years. Amortization of leasehold improvements is computed using the straight-line method over the lesser of 10 years or the remaining term of the lease including optional renewal periods, as appropriate, when failure to renew the lease imposes an economic penalty on the Company in such an amount that renewal appears to be probable. In determining the amount of the economic penalty, management considers such factors as (i) the costs associated with the physical relocation of the offices, manufacturing facility and equipment, (ii) the economic risks associated with business interruption and potential customer loss during relocation and transition to new premises, (iii) the significant costs of leasehold improvements required at any new location to custom fit our specific manufacturing requirements, and (iv) the economic loss associated with abandonment of existing leasehold improvements or other assets whose value would be impaired by vacating the facility.

Maintenance and repairs of property and equipment are charged to operations and major improvements are capitalized. Upon retirement, sale or other disposition of property and equipment, the cost and accumulated depreciation are eliminated from the accounts and a gain or loss is recorded.

Deferred taxes are provided on the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the amounts of assets and liabilities recorded for income tax and financial reporting purposes. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

The Company recognizes the financial statement benefit of an uncertain tax position only after determining that the relevant tax authority would more likely than not sustain the position. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority.

The Company classifies interest and penalties related to income taxes as income tax expense in its Consolidated Financial Statements.

The Company had no unrecognized tax benefits or liabilities, and no adjustment to its financial position, results of operations, or cash flows relating to uncertain tax positions taken on all open tax years. The Company is no longer subject to federal income tax examinations by tax authorities for the years before 2013 and state or local income tax examinations by tax authorities for the years before 2012.

Long-lived assets, such as plant and equipment and purchased intangibles with finite lives, which are subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the assets. Long-lived assets held for sale would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell and would no longer be depreciated. 

Stock based compensation expense is estimated at the grant date based on the fair value of the award. The Company estimates the fair value of stock options granted using the Black-Scholes option pricing model. The fair value of restricted stock units granted is estimated based on the closing market price of the Company’s common stock on the date of the grant. The fair value of these awards, adjusted for estimated forfeitures, is amortized over the requisite service period of the award, which is generally the vesting period.

The Company records revenue from the sale of products and services used in the photonics industry when all four of the following criteria are met:

Losses on contracts in progress are recorded when identified.

Internal research and development costs are charged to expense as incurred.

Precious metals are stated at the lower of cost or market and consist of various fixtures used in the high temperature crystal growth manufacturing process. From time to time the quoted market values of these precious metals may be below cost. Management evaluates these market adjustments on a recurring basis and if it is determined that they are other than temporary the carrying value would be adjusted.

Advertising costs included in selling, general and administrative expenses were $7,000 and $6,400 for the years ended December 31, 2016 and 2015, respectively. Advertising costs are charged to expense when the related services are incurred or related events take place.

The concentration of credit risk in the Company’s accounts receivable is mitigated by the Company’s credit evaluation process, familiarity with its small base of recurring customers and reasonably short collection terms and the geographical dispersion of revenue. The Company generally does not require collateral but, in some cases, the Company negotiates cash advances prior to the undertaking of the work. These cash advances are recorded as current liabilities on the balance sheet until corresponding revenues are realized.

The Company utilizes many relatively uncommon materials and compounds to manufacture its products and relies on outside vendors for certain manufacturing services. Therefore, any failure by its suppliers to deliver materials of an adequate quality and quantity could have an adverse effect on the Company’s ability to meet the commitments of its customers.

For the year ended December 31, 2016, the Company had one customer who had sales representing 10.5% of total revenues. In 2015, the Company had two customers who had sales representing 10.4% and 10.3% of total revenues, respectively. Since the Company is a supplier of custom manufactured components to OEM customers, the relative size and identity of the largest customer accounts changes somewhat from year to year. In the short term, the loss of any one of these large customer accounts could have a material adverse effect on business, results of operations, and financial condition.

The Company follows U.S. GAAP accounting guidance which establishes a framework for measuring fair value and expanded related disclosures. The framework requires fair value to be determined based on the exchange price that would be received for an asset, or paid to transfer a liability (an exit price), in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants.

The valuation techniques required are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The accounting guidance requires the following fair value hierarchy:

Long-lived assets, including goodwill and other intangible assets, may be measured at fair value if such assets are held for sale or if there is a determination that the asset is impaired. Managements’ determination of fair value, although highly subjective, is based on the best information available, including internal projections of future earnings and cash flows discounted at an appropriate interest rate, quoted market prices when available, market prices for similar assets, broker quotes and independent appraisals, as appropriate.

In August 2016, the FASB issued ASU 2016-15, Statement of cash flows (Topic 230) which provides guidance on the classification of certain cash receipts and payments in the statement of cash flows intended to reduce diversity in practice. The guidance is effective for interim and annual periods beginning in 2018. Early adoption is permitted. The guidance is to be applied retrospectively to all periods presented but may be applied prospectively if retrospective application would be impracticable. The Company is currently evaluating the effect of the standard on its Consolidated Statement of Cash Flows.

In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments" (“ASU 2016-13” which amended guidance on the accounting for credit losses on financial instruments within its scope. The guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The new guidance is effective for interim and annual periods beginning in 2020, with earlier application permitted in 2019. The Company is currently evaluating the impact of adoption on its consolidated financial statements.

In May 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-12 “Revenue from Contracts with Customers (Topic 606), Narrow-Scope Improvements and Practical Expedients” (“ASU 2016-12”), which amends the guidance on transition, collectability, noncash consideration and the presentation of sales and other similar taxes. ASU 2016-12 clarifies that, for a contract to be considered completed at transition, all (or substantially all) of the revenue must have been recognized under legacy GAAP. In addition, ASU 2016-12 clarifies how an entity should evaluate the collectability threshold and when an entity can recognize nonrefundable consideration received as revenue if an arrangement does not meet the standard’s contract criteria. The Company is currently evaluating the impact the adoption of ASU 2016-12 will have on its consolidated financial statements

In April 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing.” The amendments clarify two aspects of Topic 606: (a) identifying performance obligations; and (b) the licensing implementation guidance. The update is effective for annual periods beginning after December 15, 2017 including interim reporting periods therein. The Company is currently evaluating the impact the adoption of ASU 2016-10 will have on its consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which simplifies several aspects of the accounting for employee share-based payments, including income tax consequences, application of award forfeitures to expense, classification on the statement of cash flows, and classification of awards as either equity or liabilities. This guidance is effective for annual reporting periods beginning after December 15, 2016, and interim periods within those annual periods. The Company is currently evaluating the effect that this guidance will have on its financial statements and related footnote disclosures.

In February 2016, the FASB created Topic 842 and issued ASU 2016-02, Leases. The guidance in this update supersedes Topic 840, Leases. This ASU requires lessees to recognize a right-of-use assets and a lease liability, initially measured at the present value of the lease payments on the balance sheet. For public companies, the amendments will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Earlier application is permitted. The Company is currently evaluating the impact of the adoption of ASU 2016-02 on its financial statements and disclosure.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities”, which changes how entities measure certain equity investments and how entities present changes in the fair value of financial liabilities measured under the fair value option that are attributable to instrument-specific credit risk. We are currently assessing the impact the adoption of ASU 2016-01 will have on our consolidated financial statements. ASU 2016-01 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those fiscal years.

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Subtopic 740-10). The amendments in this update require deferred tax liabilities and assets be classified as noncurrent regardless of the classification of the underlying assets and liabilities. For public companies, the amendments will be effective for financial statements issued for annual periods beginning after December 15, 2016. Earlier application is permitted. We expect the adoption of this guidance will not have a material impact on our financial statements.

Inventories are comprised of the following and are shown net of inventory reserves of approximately $2,249,000 for 2016 and $2,010,000 for 2015:

Plant and equipment are comprised of the following:

Depreciation expense recorded by the Company totaled approximately $366,000 and $470,000 for 2016 and 2015, respectively. Plant and equipment with a net book value of $0 was disposed of in 2015. No plant or equipment was disposed of in 2016.

The Company evaluates its property and equipment for impairment when events or circumstances indicate and impairment may exist. Based on this evaluation, the Company concluded that, at December 31, 2016, its long-lived assets were not impaired.

Intangible assets include acquired intangible assets with finite lives, consisting principally of non-contractual customer relationships, completed technology, trademark and licensed patents. Intangible assets with finite lives are amortized on a straight-line basis over the assets’ estimated useful life up to 14 years.

Based on management’s judgement, there were no events or circumstances that would lead us to conclude that a possible impairment of intangible assets exists as of December 31, 2016.

Amortization expense was approximately $80,000 and $79,000 for the years ended December 31, 2016 and 2015, respectively. Aggregate amortization for the five succeeding years from January1, 2017 through December 31, 2021 is expected to be approximately $134,000, accumulating at the rate of $81,000, $45,000 for the years ended December 31, 2017 and 2018 and $2,000 for each year, thereafter.

The weighted average remaining life of the Company’s intangible assets is approximately 4 years.

The following schedule details the Company’s intangible asset balance by major asset class.

On June 9, 2016 the maturity dates of a $1,500,000 Subordinated Convertible Promissory Note to Clarex Limited (“Clarex”) and a $1,000,000 Subordinated Convertible Promissory Note to an affiliate of Clarex were each extended to April 1, 2019 from April 1, 2017. The notes bear interest at 6%. Interest accrues yearly and is payable on maturity. Unpaid interest, along with principal, may be converted into securities of the Company as follows: the notes are convertible in the aggregate into 1,500,000 units and 1,000,000 units, respectively, with each unit consisting of one share of common stock and one warrant. Each warrant allows the holder to acquire 0.75 shares of common stock at a price of $1.35 per share. As part of the agreement, the expiration dates of the warrants were extended from April 1, 2020 to April 1, 2022.

The Company paid $75,000 and $150,000 for interest on the notes in 2016 and 2015, respectively. Accrued interest of $75,000 and $37,500 is included in Accounts payable and accrued liabilities as of December 31, 2016 and 2015, respectively.

The Company has a term loan agreement with Valley National Bank, Wayne, NJ. The loan is payable in equal monthly installments through July 2017 and bears an interest rate of 4.35% annually. The loan is secured with a security interest in equipment.

The Company also has a note payable to the U.S. Small Business Administration which bears interest at the rate of 4.0% and is due in 2032.

Other Long-Term Notes consist of the following:

Other Long-Term Notes mature as follows:

Accounts payable and accrued expenses are comprised of the following:

The Company’s income tax provision consists of the following:

A reconciliation of the income tax provision computed at the statutory Federal income tax rate to our effective income tax rate follows (in percent):

At December 31, 2016 and 2015, the Company had estimated Federal net operating loss carry forwards of approximately $9,194,000 and $9,192,000, respectively and State net operating loss carry forwards of approximately $4,969,000 and $4,745,000. These tax loss carry forwards expire at various dates through 2036.

Internal Revenue Code Section 382 places a limitation on the utilization of Federal net operating loss and other credit carry forwards when an ownership change, as defined by the tax law, occurs. Generally, this occurs when a greater than 50 percentage point change in ownership occurs. Accordingly, the actual utilization of the net operating loss and carryforwards for tax purposes may be limited annually to a percentage (based on the risk free interest rate) of the fair market value of the Company at the time of any such ownership change. The Company has not prepared an analysis of ownership changes but does not believe that a greater than 50% change of ownership has occurred and such limitations would not apply to the Company.

Deferred tax assets (liabilities) are comprised of the following:

In evaluating the Company’s ability to recover deferred tax assets in future periods, management considers the available positive and negative factors, including the Company’s recent operating results, the existence of cumulative losses and near term forecasts of future taxable income that is consistent with the plans and estimates management is using to manage the underlying business. A significant piece of objective negative evidence evaluated was the cumulative loss incurred by the Company over the three-year period ended December 31, 2016. Such objective evidence limits the ability to consider other subjective evidence such as our projections for future growth.

On the basis of this evaluation, as of December 31, 2016 and 2015, the Company concluded it was more likely than not that it would not be able to realize any portion of the benefit on the deferred tax assets and the valuation allowance was increased by $151,000 and $185,000, respectively, to provide a full valuation against the deferred tax assets.

The Company files income tax returns in the United States, which typically provides for a three-year statute of limitations on assessments. The Company is no longer subject to federal income tax examinations by tax authorities for the years before 2013 and state or local income tax examinations by tax authorities for the years before 2012.

The guidance for accounting for uncertainties in income taxes requires that we recognize the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. There were no unrecognized tax benefits that impacted our effective tax rate and accordingly, there was no material effect to our financial position, results of operations or cash flows.

Our policy is to recognize interest and penalties related to the underpayment of income taxes as a component of income tax expense. To date, there have been no interest or penalties charged to us in relation to the underpayment of income taxes.

We do not anticipate that our unrecognized tax benefits will significantly increase in the next 12 months.

The Company’s 2010 Equity Compensation Program provides for grants of options, stock appreciation rights and restricted stock awards to employees, officers, directors, and others who render services to the Company. The Program is comprised of four parts including: (i) the Incentive Stock Option Plan which provides for grants of “incentive stock options”, (ii) the Supplemental Stock Option Plan which provides for grants of stock options that shall not be “incentive stock options”, (iii) the Stock Appreciation Rights Plan which allows the granting of stock appreciation rights and, (iv) the Restricted Stock Award Plan which provides for the granting of restrictive shares of Common Stock and restricted stock units. The plan is administered by the Compensation Committee of the Board of Directors. Under this plan, an aggregate of up to 4,000,000 shares of common stock may be granted.

The Company’s 2000 Equity Compensation Program expired on June 2, 2010. All outstanding grants of options, stock appreciation rights and performance shares issued under the Program will remain outstanding and shall expire on the date determined by the terms of the original grant. The latest date of expiration for outstanding grants under the plan is March 28, 2020.

The Company's results for the years ended December 31, 2016 and 2015 include stock-based compensation expense for stock option grants totaling $30,000 and $26,000, respectively. Such amounts have been included in the Consolidated Statements of Operations within cost of goods sold ($7,000 for 2016 and $5,000 for 2015), and selling, general and administrative expenses ($23,000 for 2016 and $21,000 for 2015).

As of December 31, 2016 and 2015, there were $49,000 and $26,000 of unrecognized compensation costs, net of estimated forfeitures, related to non-vested stock options, which are expected to be recognized over a weighted average period of approximately 1.5 years and 0.9 years, respectively.

The weighted average estimated fair value of stock options granted in the two years ended December 31, 2016 and 2015 was $0.34 and $0.19, respectively. The Company uses the Black-Scholes option pricing model to calculate the grant-date fair value of an option award. The Company assumes a dividend yield of zero, as the Company has not paid dividends in the past and does not expect to in the foreseeable future. The expected volatility is based upon the historical volatility of our common stock which the Company believes results in the best estimate of the grant-date fair value of employee stock options because it reflects the market’s current expectations of future volatility. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of the grant with maturity dates approximately equal to the expected life at the grant date. The expected life is based upon the period of expected benefit based on the Company’s evaluation of historical and expected future employee exercise behavior.

The following range of weighted-average assumptions were used for to determine the fair value of stock option grants during the years ended December 31, 2016 and 2015:

A summary of the Company’s outstanding stock options as of and for the years ended December 31, 2016 and 2015 is presented below:

(a) Intrinsic value for purposes of this table represents the amount by which the fair value of the underlying stock, based on the respective market prices as of December 31, 2015 exceeds the exercise prices of the respective options. All of the options used in the calculation of the aggregate intrinsic value for outstanding options are exercisable as of December 31, 2015.

(b) Based on the Company’s historical forfeiture rate, the number of options expected to vest is the same as the total outstanding at December 31, 2016.

The following table represents non-vested stock options granted, vested, and forfeited for the year ended December 31, 2016.

The total weighted average grant date fair value of options vested during the years ended December 31, 2016 and 2015, was $21,000 and $17,000, respectively.

The following table summarizes information about stock options outstanding at December 31, 2016:

Basic income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares and common stock equivalents outstanding, calculated on the treasury stock method for options, stock grants and warrants using the average market prices during the period, including potential common shares issuable upon conversion of outstanding convertible notes, except if the effect on the per share amounts is anti-dilutive.

For the year ended December 31, 2016, a total of 2,500,000 anti-dilutive common shares issuable upon conversion of outstanding convertible notes and 1,875,000 warrants issuable upon conversion of outstanding related party convertible notes have been excluded from the diluted computation because their effect is anti-dilutive. In addition, 760,214 common stock equivalents related to outstanding options have been excluded from the diluted computation because their effect is anti-dilutive.

For the year ended December 31, 2015, all common equivalent shares outstanding have been excluded from the diluted computation because their effect is anti-dilutive. This included 699,604 common stock equivalents related to outstanding options and grants, in addition to 2,500,000 common shares and 1,875,000 warrants issuable upon conversion of outstanding related party convertible notes which were anti-dilutive.

The Company occupies approximately 42,000 square feet of space located at 181 Legrand Avenue, Northvale, New Jersey pursuant to a net lease. Under the terms of the lease, the Company is obligated for all real estate taxes, maintenance and operating costs of the facility. The lease has a two year term from June 1, 2015 to May 31, 2017 with options to renew the Northvale lease for two additional one year terms running through May 31, 2019, at substantially the same terms. The Company is currently negotiating to exercise these options prior to the end of the current lease term.

The Company’s total rent payments for the year ended December 31, 2016 and 2015 were $284,000 and $279,000, respectively.

Future minimum annual rentals which cover the remaining lease terms, excluding uncommitted option renewal periods at December 31, 2016 are as follows:

The Company also paid real estate taxes and insurance premiums under the terms of the lease that totaled approximately $89,000 in 2016 and $89,000 in 2015.

The Company maintains a 401(k) savings plan (the “Plan”) for all eligible employees (as defined in the plan). The 401(k) plan allows employees to contribute up to 70% of their compensation on a salary reduction, pre-tax basis up to the statutory limitation. The 401(k) plan also provides that the Company, at the discretion of the Board of Directors, may match employee contributions based on a pre-determined formula.

In 2016, the Company’s 401(k) matching contribution for employees was $124,289. This will be funded by way of a contribution of 356,323 shares of the Company’s common stock, which will be issued to the Plan in April, 2017. In 2015, the Company’s 401(k) matching contribution for employees was $135,196. This was funded by way of a contribution of 466,181 shares of the Company’s common stock, which were issued to the Plan in April 2016. The Company records the distribution of the common shares in the Consolidated Statement of Shareholders’ Equity as of the date of distribution to the 401(k) plan administrator.

The Company’s export sales, which are primarily to customers in countries within Europe, Asia and Japan, amounted to approximately 23.1% and 25.2% of product sales in 2016 and 2015, respectively.

The Company had sales to three major customers which accounted for approximately 25.7% of sales in 2016. One customer, a division of a major U.S. defense industry corporation that manufactures electro-optical systems for U.S. and foreign governments accounted for 10.5% of 2016 sales. The two other customers were foreign- based manufacturers of process control and metrology equipment whose sales represented 8.8% and 6.4% of sales, respectively. The same three customers represented 10.3%, 8.3% and 6.7%, of sales in 2015, respectively.

During the past two years, sales to the Company’s top five customers represented approximately 37.8%, and 42.64% of sales, respectively. Given the concentration of sales within a small number of customers, the loss of any of these customers would have a significant negative impact on the Company and its business units.

The Company had no outstanding warrants as of December 31, 2016 and 2015.

The methods and assumptions used to estimate the fair value of the following classes of financial instruments were:

Current Assets and Current Liabilities: The carrying amount of cash, current receivables and payables and certain other short-term financial instruments approximate their fair value as of December 31, 2016 due to their short-term maturities.

Long-Term Debt: The fair value of the Company’s long-term debt, including the current portion, for notes payable and subordinated convertible debentures, was estimated using a discounted cash flow analysis, based on the Company’s assumed incremental borrowing rates for similar types of borrowing arrangements. The carrying amount of debt at December 31, 2016 in the amount of $2,879,000 approximates fair value.