LGL GROUP INC - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2019

OR

For the transition period from ____________ to ____________

Commission File No. 001-00106

THE LGL GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

(407) 298-2000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

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.

Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

Yes  ☐    No  ☒

As of November 11, 2019, the registrant had 4,913,678 shares of common stock, $0.01 par value per share, outstanding.

THE LGL GROUP, INC.

Quarterly Report on Form 10-Q for the Quarterly Period Ended September 30, 2019

INDEX

PART I

FINANCIAL INFORMATION

The LGL Group, Inc.

Condensed Consolidated Balance Sheets (Unaudited)

(In thousands, except par value and share amounts)

See Accompanying Notes to Condensed Consolidated Financial Statements.

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The LGL Group, Inc.

Condensed Consolidated Statements of Operations (Unaudited)

(In thousands, except share and per share amounts)

See Accompanying Notes to Condensed Consolidated Financial Statements.

2

The LGL Group, Inc.

Condensed Consolidated Statements of Stockholders’ Equity (Unaudited)

(In thousands, except share amounts)

See Accompanying Notes to Condensed Consolidated Financial Statements.

3

The LGL Group, Inc.

Condensed Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

See Accompanying Notes to Condensed Consolidated Financial Statements.

4

The LGL Group, Inc.

Notes to Condensed Consolidated Financial Statements (Unaudited)

The LGL Group, Inc. (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 diversified holding company with subsidiaries engaged in the designing, manufacturing and marketing of highly-engineered, high reliability frequency and spectrum control products used to control the frequency or timing of signals in electronic circuits, and in the design of high performance Frequency and Time Reference Standards that form the basis for timing and synchronization in various applications.

As of September 30, 2019, the subsidiaries of the Company were as follows:

The Company operates through its two principal subsidiaries, M-tron Industries, Inc. (“MtronPTI”), which includes the operations of Piezo Technology, Inc. (“PTI”) and M-tron Asia, LLC (“Mtron”), and Precise Time and Frequency, LLC (“PTF”). The Company operates in two identified segments. The first segment, the electronic components segment, is focused on the design and manufacture of highly-engineered, high reliability frequency and spectrum control products. These electronic components ensure reliability and security in aerospace and defense communications, low noise and base accuracy for laboratory instruments, and synchronous data transfers throughout the wireless and Internet infrastructure. The second segment, the electronic instruments segment, is focused on the design and manufacture of high performance Frequency and Time Reference Standards that form the basis for timing and synchronization in various applications. The Company has operations in Orlando, Florida, Yankton, South Dakota, Wakefield, Massachusetts and Noida, India and sales offices in Austin, Texas and Hong Kong.

The Company recently added three subsidiaries as part of an effort to reorganize the subsidiaries and to plan potential available strategies for acquisitions. These were Mtron Systems Holdings, LLC, LGL Systems Acquisition Holdings Company, LLC (formerly: Mtron Systems Acquisition Holdings Company, LLC), and LGL Systems Acquisition Corp. (formerly: Mtron Systems Acquisition Corp.). LGL Systems Acquisition Holding Company, LLC, is the sponsor (the “Sponsor”) of LGL Systems Acquisition Corp., a special purpose acquisition company, commonly referred to as a “SPAC”, or blank check company, formed for the purpose of effecting a business combination in the aerospace, defense and communications industries (the “SPAC”).

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Rule 8-03 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 nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2019.

This interim information should be read in conjunction with the audited 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, 2018, filed with the Securities and Exchange Commission (the “SEC”) on March 21, 2019. 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.

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Revenue Recognition

The Company recognizes revenue from the sale of its products in accordance with the criteria in Accounting Standards Codification (“ASC”) 606, Revenue From Contracts with Customers, which are:

Step 1: Identify the contract(s) with a customer.

Step 2: Identify the performance obligations in the contract.

Step 3: Determine the transaction price.

Step 4: Allocate the transaction price to the performance obligations in the contract.

Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.

The Company meets these conditions upon the Company’s satisfaction of the performance obligation, usually at the time of shipment to the customer, because control passes to the customer at that time. Our standard terms for customers are net due within 30 days, with a few exceptions, none regularly exceeding 60 days.

The Company provides disaggregated revenue details by segment in Note J – Segment Information, and geographic markets in Note K – Domestic and Foreign Revenues.

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. These reserves and charges are immaterial as the Company does not have a history of significant price protection adjustments or returns. The Company provides a standard assurance warranty that does not create a performance obligation.

Practical Expedients:

Income Taxes

The Company periodically undertakes a review of its valuation allowance and it evaluates all positive and negative factors that may affect whether it is more likely than not that the Company would realize its future tax benefits from its deferred tax balances. Pursuant to ASC 740, Income Taxes, the Company determined in a previous quarter that it is more likely than not that certain deferred tax assets generated from foreign net operating losses would be utilized in the foreseeable future and a valuation allowance for these assets was no longer required. During the current quarter, we also determined that it is more likely than not that substantially all of our U.S. deferred tax assets including net operating loss carryforwards (“NOL’s”) and tax credits can be utilized in the foreseeable future and that a previously recorded valuation allowance should necessarily be reduced to record deferred tax assets at their expected net realizable value.

Other Comprehensive Income

Our comprehensive income for the nine months ended September 30, 2019 and September 30, 2018 consisted entirely of net income. Therefore a consolidated statement of comprehensive income is not presented for the nine months ended September 30, 2019 and September 30, 2018.

Recent Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, “Leases (Topic 842)”, to require lessees to recognize all leases, with limited exceptions, on the balance sheet. The objective of this update is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. Subsequently, the FASB issued ASU 2018-10, “Codification Improvements to Topic 842”, ASU 2018-11, “Targeted Improvements”, ASU 2018-20, “Narrow-Scope Improvements for Lessors”, and ASU 2019-01, “Codification Improvements”, to clarify and amend the guidance in ASU 2016-02. The Company’s adoption of the ASUs effective January 1, 2019 resulted in the recording of lease assets and lease liabilities of $142,000 on the consolidated balance sheet during the first quarter of 2019 and did not have a material impact on the condensed consolidated statements of operations or the condensed consolidated statements of cash flows. During the second quarter, an operating lease was renewed that was material, resulting in changes to the Company’s condensed consolidated balance sheet and requiring the additional lease related disclosures found within Note N.

Certain balances held and invested in various mutual funds managed by g.research, (the "Fund Manager"). Marc Gabelli, our non-executive chairman of the board, who is also a greater than 10% stockholder, currently serves as an executive officer of the Fund Manager. The brokerage and fund transactions in 2019 and 2018 were directed solely at the discretion of the Company’s management.

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As of September 30, 2019, the balance with the Fund Manager totaled $17,816,000, including $8,874,000 which is classified within cash and cash equivalents on the accompanying unaudited consolidated balance sheets, and $8,941,000 which is classified within marketable securities on the accompanying unaudited consolidated balance sheets. Amounts invested generated $346,000 and $182,000 of realized and unrealized investment income during 2019 and 2018, respectively that is included within other income, net on the accompanying unaudited consolidated statements of operations. Fund management fees are anticipated to average less than 0.35% of the asset balances under management on an annual basis.

As of December 31, 2018, the balance with the Fund Manager totaled $16,270,000, including $12,506,000 which is classified within cash and cash equivalents on the accompanying unaudited consolidated balance sheets, and $3,764,000 which is classified as marketable securities on the accompanying unaudited consolidated balance sheets.

Please see Note O for additional disclosures on related parties from a subsequent event.

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. Fair value guidance identifies three primary valuation techniques: the market approach, the income approach and the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts such as cash flows or earnings, to a single present amount. The measurement is based on the value indicated by current market expectations about those future amounts. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset.

The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to observable inputs such as quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The maximization of observable inputs and the minimization of the use of unobservable inputs are required.

Classification within the fair value hierarchy is based upon the objectivity of the inputs that are significant to the valuation of an asset or liability as of the measurement date. The three levels within the fair value hierarchy are characterized as follows:

Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3 - Unobservable inputs for the asset or liability for which there is little, if any, market activity for the asset or liability at the measurement date. Unobservable inputs reflect the Company's own assumptions about what market participants would use to price the asset or liability. These inputs may include internally developed pricing models, discounted cash flow methodologies, as well as instruments for which the fair value determination requires significant management judgment.

Assets

To estimate the market value of its marketable securities, 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).

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There were no transfers from level 2 to level 3 during the periods presented. There were no level 3 assets as of September 30, 2019 or December 31, 2018. 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. There were no liabilities subject to fair value on a non-recurring or recurring basis as of September 30, 2019 or December 31, 2018.

The Company reviews goodwill and the carrying value of long-lived assets at least annually or 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.

E.Inventories

Inventories are valued at the lower of cost or net realizable value using the FIFO (first-in, first-out) method. The Company reduces the value of its inventories to net realizable value when the net realizable value is believed to be less than the cost of the item. The inventory reserve for obsolescence as of September 30, 2019 and December 31, 2018 was $1,484,000 and $1,266,000, respectively.

Inventories are comprised of the following (in thousands):

Intangible assets are recorded at cost less accumulated amortization which is included in engineering, selling and administrative expenses in the accompanying unaudited 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. The intangible assets consist of intellectual property and goodwill. The net carrying value of the amortizable intangible assets was $381,000 and $437,000 as of September 30, 2019 and December 31, 2018, respectively. Goodwill, which is not amortizable, was $40,000 as of both September 30, 2019 and December 31, 2018.

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 is indicative of expected volatility over the life of the option. 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.

Compensation expense related to share-based compensation is recognized over the applicable vesting periods. As of September 30, 2019, there was approximately $14,000 of total unrecognized compensation expense related to unvested share-based compensation arrangements that will be recognized over a weighted average period of 1.0 years.

The Company computes earnings per share in accordance with ASC 260, Earnings Per Share. Basic earnings per share is computed by dividing net earnings by the weighted average number of common shares outstanding during the period. Diluted earnings per share adjusts basic earnings per share for the effects of stock options and other potentially dilutive financial instruments, only in the periods in which the effects are dilutive. The dilutive effect of share-based awards is reflected in earnings per share by application of the treasury stock method, which includes consideration of unamortized share-based compensation expense required under the Compensation – Stock Compensation Topic of the ASC.

For both the three and nine months ended September 30, 2018 there were 9,541 options to purchase shares, and for the nine months ended September 30, 2018, there were warrants to purchase 519,241 shares of common stock that were excluded from the diluted earnings per share computation because the impact of the assumed exercise of such stock options or warrants would have been anti-dilutive during the respective periods.

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The following table reconciles basic weighted average shares outstanding to diluted weighted average shares outstanding for the three and nine months ended September 30, 2019 and 2018:

Share Repurchase Program

On August 29, 2011, the Company’s board of directors (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 September 30, 2019, the Company had repurchased a total of 81,584 shares of common stock at a cost of $580,000, which shares are currently held in treasury.

The Company periodically undertakes a review of its valuation allowance and it evaluates all positive and negative factors that may affect whether it is more likely than not that the Company would realize its future tax benefits from its deferred tax balances. In 2014, the Company introduced a number of changes, most notably the decision to exit the low-margin, high-volume telecommunications market and focus on engineered solutions in the aerospace and defense markets. This turnaround plan was engineered and executed by the Company’s current chief executive officer, with the consent of the Board of Directors and participation by management. Over the following five years, the negative factors that caused the Company to produce continuing losses in the U.S. tax jurisdiction were eliminated, with the result being sustained increases in the Company’s sales, revenues, and backlog. Margins from its new and improved products and services have continually increased and the Company maintains a strong backlog of orders with its customers to support the assertion that it is more likely than not that substantially all of its net deferred tax assets will be utilized and that associated valuation allowances should be eliminated.

The income tax provision for interim periods is generally determined based upon the expected effective income tax rate for the full year and the tax rate applicable to certain discrete transactions in the interim period. To determine the annual effective income tax rate, we must estimate both the total income (loss) before income tax for the full year and the jurisdictions in which that income (loss) is subject to tax. The actual effective income tax rate for the full year may differ from these estimates if income (loss) before income tax is greater than or less than what was estimated or if the allocation of income (loss) to jurisdictions in which it is taxed is different from the estimated allocations.

The estimated annualized effective income tax rate for the nine months ended September 30, 2019 and 2018 was 24.8% and 24.2%, respectively. Other differences between our effective income tax rate and the U.S. federal statutory rate are the impact of state taxes, foreign taxes, non-deductible expenses, and excess tax benefits or expense on share-based compensation.

The net balance of the deferred tax asset was approximately $5.2 million as of December 31, 2018, with a related valuation allowance of $5.1 million. Through the nine months ended September 30, 2019, the Company was able to realize $0.7 million of its deferred tax assets as a result of its profitable operations. At September 30, 2019, the Company wrote off $0.7 million of deferred tax assets and the related valuation allowance for certain deferred tax assets which were no longer realizable, and released $3.3 million from its valuation allowance, representing the net realizable portion of its U.S. deferred tax assets, with the balance of the valuation allowance of $0.4 million covering that portion of the Company’s U.S. deferred tax assets which are not expected to be realized.

Deferred tax assets totaled $3.4 million at September 30, 2019, which includes the tax effect of federal, state, and foreign net operating loss carryforwards and our federal tax credits. We recognize federal, state, and foreign net operating loss carryforwards and our federal tax credits as deferred tax assets, subject to valuation allowances. At each balance sheet date, we estimate the amount of carryforwards that are not expected to be used prior to expiration of the carryforward period. Our federal, state, and foreign net operating loss carryforwards expire beginning in 2026, and extending to 2037. Our tax credit carryforwards expire beginning in 2020, and extending to 2038. The tax effect of the carryforwards that are not expected to be used prior to their expiration is included in the valuation allowance. At September 30, 2019, the balance in the Company’s valuation allowance over its deferred tax assets was $388,000, consisting primarily of tax credits expiring between 2020 and 2023.

As of September 30, 2019, management assessed the balances of its deferred tax assets and liabilities and has determined that it has not taken any aggressive tax positions that may be considered uncertain under ASC 740-10.

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The Company has two reportable business segments from operations: electronic components, which includes all products manufactured and sold by MtronPTI, and electronic instruments, which includes all products manufactured and sold by PTF. The Company's foreign operations in Hong Kong and India are subsidiaries of MtronPTI. The following table sets forth activity broken down by reportable business segment (in thousands):

Operating income is equal to revenues less cost of sales and operating expenses, excluding investment income, interest expense, and income taxes.

Significant foreign revenues from operations (10% or more of foreign sales) were as follows (in thousands):

The Company allocates its foreign revenue based on the customer's ship-to location.

In the ordinary 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 initially committed up to $150,000 to investigate and pursue setting up the SPAC entity and its Sponsor. As of September 30, 2019, $118,000 had been expended, including $116,000 that was set up as prepaid offering costs on the Company’s condensed consolidated balance sheets. At September 30, 2019, at the anticipated size of $125 million for the offering plus potential underwriter overallotments, the Company was contingently liable to investing up to $4.25 million in the SPAC sponsor.

On November 6, 2019, LGL Group contributed $3.35 million to the Sponsor to fund the Sponsor’s purchase of private warrants in a private placement that closed simultaneously with the consummation of the SPAC’s initial public offering.

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We lease certain manufacturing and office space and equipment. We determine if an arrangement is a lease at inception. A contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. Amounts associated with operating leases are included in right-of-use lease assets, and other accrued expense in our consolidated balance sheet. Right-of-use lease assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Right-of-use lease assets and liabilities are recognized at the lease commencement date based on the estimated present value of lease payments over the lease term. We use our incremental borrowing rate based on the information available at the lease commencement date in determining the present value of lease payments. The incremental borrowing rate for operating leases that commenced in the period is determined by using the prior quarter end’s incremental borrowing rates. Leases with an initial term of 12 months or less are not recorded on the balance sheet, and we recognize lease expense for these leases on a straight-line basis over the lease term.

Certain leases include one or more options to renew, with renewal terms that can extend the lease term from one to 10 years or more, and the exercise of lease renewal options under these leases is at our sole discretion. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.

During the nine months ended September 30, 2019, we renewed a lease on one of our facilities, resulting in the addition of $318,000 in right-of-use lease assets in exchange for operating lease liabilities.

Future minimum lease payment obligations under operating leases are as follows (in thousands):

On November 6, 2019, LGL Group contributed $3.35 million to the Sponsor to fund the Sponsor’s purchase of private warrants in a private placement that closed simultaneously with the consummation of the SPAC’s initial public offering (“IPO”). Each private warrant is exercisable to purchase one share of common stock of the SPAC at an exercise price of $11.50 per share, subject to adjustment. The proceeds from the private warrants will be added to the proceeds from the SPAC’s initial public offering to be held in a trust account. If the SPAC does not complete a business combination within 24 months from the closing of the SPAC’s initial public offering, the proceeds from the sale of the private warrants will be used to fund the redemption of the shares sold in the SPAC’s initial public offering (subject to the requirements of applicable law), and the private warrants will expire worthless. LGL is expected to own approximately 43.57% of the Sponsor immediately following any transaction.

On November 7, 2019, the SPAC raised $172.5 million through the sale of 17.25 million shares and was listed as a publicly traded company on the NASDAQ Capital Market under the ticker symbol ‘DFNSU’. The IPO closed on November 12, 2019.

Prior to and immediately following the IPO, the Sponsor held 4,312,500 shares of the SPAC, which are restricted and non-tradable. The Sponsor holds 20% of the shares in the SPAC along with 5,200,000 warrants at a strike price of $11.50.

There is no assurance that the SPAC will be successful in completing a business combination or that any business combination will be successful. LGL can lose its entire investment in the SPAC if a business combination is not completed within 24 months or if the business combination is not successful, which may adversely impact LGL’s stockholder value.

As a result of this transaction, certain of the current directors of LGL will be officers and/or directors of the SPAC, and will be treated as related or affiliated parties in future filings.

Marc Gabelli, our Non-Executive Chairman also serves as Chairman and CEO of the SPAC and has invested in the Sponsor. Timothy Foufas, a member of LGL’s board of directors, is also a member of the Sponsor and COO of the SPAC and has invested in the Sponsor. Patrick Huvane, LGL’s SVP of business development, is a member of both LGL and the SPAC’s management team. Michael J. Ferrantino, Jr., a member of LGL’s board of directors, is also a member of the Sponsor and a board member for the SPAC.

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Under separate arrangement, these people may be eligible to receive incentive compensation should the SPAC complete a successful acquisition.

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The following discussion and analysis of the Company's financial condition and results of operations should be read in conjunction with the accompanying 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, 2018. The terms “we,” “us,” “our,” and the “Company” refer to The LGL Group, Inc. and unless otherwise defined herein, capitalized terms used herein shall have the same meanings as set forth in our condensed consolidated financial statements and the notes thereto.

Forward-Looking Statements

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 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, 2018, filed with the SEC on March 21, 2019, this Quarterly Report on Form 10-Q 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 Quarterly Report on Form 10-Q. 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.

Results of Operations

Backlog

As of September 30, 2019, our order backlog was $23,285,000, which is an increase of 45.0% compared to the backlog of $16,062,000 as of September 30, 2018. The increase reflects the Company’s stronger execution in delivering design wins coupled with favorable market conditions. While we have been building backlog faster than our growth in revenues due primarily to orders being received sooner than planned, this quarter saw a reduction in backlog from the prior quarter as production increases that resulted in increased revenues more than offset our new orders, which had declined as expected this quarter following two record-breaking quarters. The backlog of unfilled orders includes amounts based on signed contracts as well as agreed letters of intent, which we have determined are firm orders likely to be fulfilled in the next 12 months.

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

Three months ended September 30, 2019 compared to three months ended September 30, 2018

Consolidated Revenues and Gross Margin

Total revenues for the three months ended September 30, 2019 were $8,588,000, an increase of $2,250,000, or 35.5%, from revenues of $6,338,000 for the three months ended September 30, 2018. Revenues increased across all product categories, including increased filter sales of $1,247,000, increased crystal and oscillator sales of $647,000, and increased sales of $263,000 from sales of purchased products, along with our time and frequency products, which increased $60,000.

Consolidated gross margin, which is consolidated revenues less manufacturing cost of sales, as a percentage of revenues increased slightly to 41.2% for the three months ended September 30, 2019, from 39.5% for the three months ended September 30, 2018. The increase reflects a shift in our product mix shipped during the quarter. The Company continues to execute its long-term strategic shift toward higher margin products, but there will be fluctuations of product mix in the short-term.

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Stock-Based Compensation

For both the three months ended September 30, 2019 and 2018, stock-based compensation expense was $5,000. Compensation expense related to stock-based compensation is recognized over the applicable vesting periods. As of September 30, 2019, there was approximately $14,000 of total unrecognized compensation expense related to unvested stock-based compensation arrangements.

Operating Income

Operating income of $1,122,000 for the three months ended September 30, 2019 was an improvement of $645,000 from operating income of $477,000 for the three months ended September 30, 2018. This was primarily due to the increase in revenues and improvement in gross margin from the changes in product mix noted above.

Other Income, Net

For the three months ended September 30, 2019, other income, net was $82,000, compared to $73,000 for the three months ended September 30, 2018. These balances are comprised of gains from our investment portfolio.

Income Tax Provision

We recorded a tax (benefit) provision of(3,326,000) and $67,000 for the three months ended September 30, 2019 and 2018, respectively. The benefit in the quarter ended September 30, 2019 is primarily due to our release of substantially all of the valuation allowance on the Company’s U.S. deferred tax assets, while the provision in the quarter ended September 30, 2018 resulted primarily from income in our foreign subsidiaries as all our U.S. taxable income had previously been sheltered by the valuation allowance.

Net Income

Net income for the three months ended September 30, 2019 was $4,530,000, compared to $478,000 for the three months ended September 30, 2018 due to the factors noted above. Diluted net income per share for the three months ended September 30, 2019 and 2018 was $0.91 and $0.10, respectively.

Nine months ended September 30, 2019 compared to nine months ended September 30, 2018

Consolidated Revenues and Gross Margin

Total revenues for the nine months ended September 30, 2019 were $23,058,000, an increase of $4,618,000, or 25.0%, from revenues of $18,440,000 for the nine months ended September 30, 2018. Revenues increased across all product categories including increased filter sales of $2,621,000, increased crystal and oscillator sales of $1,144,000, increased sales of $572,000 from purchased products, and increased sales from our time and frequency products of $200,000.

Consolidated gross margin, which is consolidated revenues less manufacturing cost of sales, as a percentage of revenues decreased slightly to 39.4% for the nine months ended September 30, 2019, from 39.6% for the nine months ended September 30, 2018. The decrease reflects a shift in our product mix shipped during the current year. The Company continues to execute its long-term strategic shift toward higher margin products, but there are still fluctuations of product mix in the short-term.

Stock-Based Compensation

For the nine months ended September 30, 2019 and 2018, stock-based compensation expense was $17,000 and $19,000, respectively. Compensation expense related to stock-based compensation is recognized over the applicable vesting periods. As of September 30, 2019, there was approximately $14,000 of total unrecognized compensation expense related to unvested stock-based compensation arrangements.

Operating Income

Operating income of $2,412,000 for the nine months ended September 30, 2019 was an improvement of $1,288,000 from operating income of $1,124,000 for the nine months ended September 30, 2018. This was primarily due to the increase in revenues, net of the reduction in gross margin from the changes in product mix noted above.

Other Income, Net

For the nine months ended September 30, 2019, other income, net was $352,000, compared to $164,000 for the nine months ended September 30, 2018. These balances are comprised primarily of gains from our investment portfolio.

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Income Tax Provision

We recorded a tax (benefit) provision of $(3,286,000) and $146,000 for the nine months ended September 30, 2019 and 2018, respectively. The benefit in the nine months ended September 30, 2019 is primarily due to our release of substantially all of the valuation allowance on the Company’s deferred tax assets, while the provision in the nine months ended September 30, 2018 results from income in our foreign subsidiaries as our U.S. taxable income had been previously sheltered by the valuation allowance.

Net Income

Net income for the nine months ended September 30, 2019 was $6,051,000, compared to $1,143,000 for the nine months ended September 30, 2018 due to the factors noted above. Diluted net income per share for nine months ended September 30, 2019 and 2018 was $1.22 and $0.24, respectively.

Liquidity and Capital Resources

As of September 30, 2019 and December 31, 2018, cash and cash equivalents were $11,161,000 and $15,508,000, respectively. In the first quarter of 2019, we invested $5,000,000 in an equity mutual fund, which is classified as marketable securities on our consolidated balance sheets.

Cash provided by operating activities was $1,089,000 and $689,000 for the nine months ended September 30, 2019 and 2018, respectively. The $400,000 increase was due to a year-over-year increase in net income of $4,908,000, offset by a year-over-year change in deferred tax benefit of $(3,334,000) and working capital accounts of $(1,174,000).

Cash used in investing activities for the nine months ended September 30, 2019 and 2018 was $5,826,000 and $12,507,000, respectively. The use of cash for the nine months ended September 30, 2019 was due to the purchase of $5,000,000 in marketable securities in the first quarter, combined with $826,000 in capital expenditures. Capital expenditures increased $594,000 due primarily to the replacement of the roof on our primary production facilities in Florida.

For the nine months ended September 30, 2019, cash provided by financing activities represented $390,000 received by the Company for the exercise of stock options. For the nine months ended September 30, 2018, financing activities represented $927,000 received by the Company for the exercise of stock warrants and $27,000 received by the Company for the exercise of stock options.

As of September 30, 2019, our consolidated working capital was $26,960,000, compared to $24,633,000 as of December 31, 2018. As of September 30, 2019, we had current assets of $31,845,000, current liabilities of $4,885,000 and a ratio of current assets to current liabilities of 6.52 to 1.00. As of December 31, 2018, we had current assets of $27,385,000, current liabilities of $2,752,000 and a ratio of current assets to current liabilities of 9.95 to 1.00. Management continues to focus on efficiently managing working capital requirements to match operating activity levels, and will seek to deploy the Company’s working capital where it will generate the greatest returns.

We believe that existing cash and cash equivalents, marketable securities, and cash generated from operations will be sufficient to meet our ongoing working capital and capital expenditure requirements for the next 12 months from the date of this filing.

Our 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.

Critical Accounting Policies

Our accounting policies and unaudited condensed consolidated financial statements have been established to conform with GAAP. The preparation of financial statements in conformity with GAAP requires us 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. We believe we have made these estimates and assumptions in an appropriate manner and in a way that accurately reflects our financial condition. We continually test and evaluate these estimates and assumptions using 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. We believe that the accounting policies related to the following accounts or activities are those that are most critical to the portrayal of our financial condition and results of operations and require the more significant judgments and estimates:

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There have been no significant changes to our critical accounting policies from those described 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, 2018, except as described in Note B.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

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Item 3.Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 4.Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our 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 us, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and we necessarily were required to apply our judgment in evaluating whether the benefits of the controls and procedures that we adopt outweigh their costs.

As required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, an evaluation as of September 30, 2019 was conducted under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures, as of September 30, 2019, were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal controls over financial reporting during the nine months ended September 30, 2019, or in other factors that could significantly affect these controls, that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II

OTHER INFORMATION

In the ordinary course of business, we may become subject to litigation or claims. We are not aware of any material pending legal proceedings, other than ordinary routine litigation incidental to our business, to which we are a party or to which our properties are subject.

Not applicable.

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. There is no expiration date for this program. As of September 30, 2019, the Company has repurchased a total of 81,584 shares of common stock under this program at a cost of $580,000, which shares are currently held in treasury; however, no shares were repurchased by the Company during the nine months ended September 30, 2019.

The following exhibits are included, or incorporated by reference, in this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2019 (and are numbered in accordance with Item 601 of Regulation S-K):

____________

* Filed herewith

** In accordance with Item 601(b)(32) of Regulation S-K, this Exhibit is not deemed "filed" for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section. Such certifications will not be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

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SIGNATURES

Pursuant to the requirements 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.

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