It
em 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements that involve a number of risks and uncertainties. There are a number of factors that could cause the Company’s actual results to differ materially from those forecasted or projected in such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company is under no obligation and does not intend to update, revise or otherwise publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of any unanticipated events. More information about factors that potentially could affect the Company's financial results is included in the Company's filings with the SEC, including its Annual Report on Form 10-K for the year ended
December
31, 2017
.
Overview
Micron Solutions
®
, Inc., a Delaware corporation ("Micron Solutions”), through its wholly-owned Massachusetts subsidiary, Micron Products
®
, Inc. (“Micron” and together with Micron Solutions, the "Company"), is a diversified contract manufacturing organization (“CMO”) that produces highly-engineered, innovative medical device components requiring precision machining and injection molding. The Company also manufactures components, devices and equipment for military, law enforcement, automotive and consumer product applications. The Company is engaged in the production and sale of silver/silver chloride coated and conductive resin sensors used as consumable component parts in the manufacture of integrated disposable electrophysiological sensors. These disposable medical devices are used worldwide in the monitoring of electrical signals in various medical applications. The Company's machining operations produce quick-turn, high volume patient-specific and off-the-shelf orthopedic implants and instruments. The Company’s machining operations also include laser marking, automated polishing, passivation and coating. The Company has thermoplastic injection molding capabilities as well, and provides a full array of design, engineering, production services and management. The Company competes globally, with
approximately
forty-five
percent of
its revenue derived from exports.
Critical Accounting Policies
The critical accounting policies utilized by the Company in preparation of the accompanying financial statements are set forth in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended
December
31, 2017, under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. There have been no material changes to these policies since
December
31, 2017
exc
ept for the implementation of
ASU No. 2014-09, “Revenue from Contracts with Customers” as described in Note 2 to these financial statements.
Liquidity and Management’s Plan
At
September
30, 2018, the Company identified certain conditions and events which in the aggregate required management to perform an assessment of the Company’s ability to continue as a going concern. These
conditions
i
ncluded the Company’s recurring losses from operations and the resulting reliance on outside financing to support operations.
Management believes that the Company can continue as a going concern for a period of twelve months from the date of issuance of these financial reports. Management’s assessment includes forecasting future revenues and cash flows, taking into consideration past performance and the requirements under the credit agreement. Revenue and cash flow forecasts are dependent on the Company’s ability to fill booked orders from existing customers, its ability to close new and expanded business and continued availability under the revolving line of credit. Management believes it is probable that its plans will be effectively implemented and therefore, the accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.
Results of Operations
The following table sets forth, for the periods indicated, the percentages of the net sales represented by certain items reflected in the Company's statements of operations.
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Three Months Ended
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Nine Months Ended
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September
30,
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September
30,
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2018
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2017
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2018
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2017
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Net sales
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100.0
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%
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100.0
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%
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100.0
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%
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100.0
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%
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Cost of sales
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85.3
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85.9
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84.8
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88.9
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Gross profit
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14.7
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14.1
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15.2
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11.1
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Selling and marketing
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3.8
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3.5
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3.8
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4.3
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General and administrative
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10.2
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12.5
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10.6
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11.5
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Research and development
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0.5
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0.5
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0.5
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0.5
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Other expense
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1.8
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1.2
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1.7
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1.1
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Loss before income tax provision (benefit)
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(1.6)
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(3.6)
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(1.4)
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(6.3)
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Income tax provision (benefit)
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—
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—
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—
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—
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Net loss
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(1.6)
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%
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(3.6)
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%
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(1.4)
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%
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(6.3)
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%
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Net Sales
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Net sales
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2018
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2017
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$ Change
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% Change
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Three months ended
September
30,
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$
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5,001,660
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$
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4,908,088
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$
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93,572
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1.9%
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The increase in consolidated net sales for the three months ended
September
30, 2018 versus the prior year period was due primarily to an increase in net sales of tooling, as well as increases in net sales of thermoplastic injection molding and sensors. This was partly offset by decreased net sales of machined orthopedic implant components and instruments.
For the three months ended
September
30, 2018, net sales of tooling increased 72.8% when compared to the same period in the prior year. The increase was due primarily to new tooling for customers in the automotive, medical device as well as the military and law enforcement industries. Net sales of thermoplastic injection molding for the three months ended
September
30, 2018, increased 1.5% based largely to increased net sales in automotive and medical device industries, partly offset by decreased net sales in the military and law enforcement and consumer products industries. Additionally, net sales of sensors for the three months ended
September
30, 2018, increased 0.3%. The increase in net sales of sensors was due to a 2.7% increase in volume over the same period last year, partly offset by lower silver surcharge revenue due in part to the timing of shipments versus the changes in the daily spot rate of the price of silver.
Partly offsetting the increase in net sales for the three months ended
September
30, 2018, was a 4.2% decrease in net sales of machined components when compared to the same period last year. This decrease in machin
ed components was due in part to
delays in orders from two customers
, from whom we expect to receive orders in the first quarter 2019
. One customer moved their operations and delayed orders and another customer introduced a new revision. In addition, the Company began production on a new defense related project but was not running at full production for the month of September.
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Net sales
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2018
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2017
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$ Change
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% Change
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Nine months ended
September
30,
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$
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15,441,134
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$
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15,563,791
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$
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(122,657)
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(0.8)%
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The decrease in consolidated net sales for the nine months ended
September
30, 2018 versus the prior year period was due to a decrease in net sales of thermoplastic injection molding and tooling. This was partly offset by increased net sales of sensors and machined orthopedic implant components and instruments.
For the nine months ended
September
30, 2018, net sales of thermoplastic injection molding decreased 8.1% when compared to the same prior year period. The decrease was due in part to lower demand in the military and law enforcement industry. The decrease was also due in part to the vertical integration of a single medical device customer and lower net sales in the consumer products industry. Additionally, net sales of tooling decreased 28.8% due primarily to decreased tooling for the automotive, medical device and military and law enforcement industries.
Partly offsetting the decreases above was a 5.8% increase in net sales of machined orthopedic implant components and instruments for the nine months ended
September
30, 2018. The increase was due primarily to increased demand of knee implant components from two customers partly offset by one customer who vertically integrated their machining of knee implant components beginning in the third quarter of 2017. Additionally, orders of machined components for
a
new defense program began in
September 201
8.
Also partly offsetting the decreases for the
nine months ended
September
30, 2018, was a 4.6% increase in net sales of sensors due largely to a 5.1% increase in volume compared to the same period in 2017. Silver surcharge billed increased 0.8% based partly upon an increase in volume over the same period last year, partly offset by lower silver surcharge revenue due in part to the timing of shipments versus the changes in the daily spot rate of the price of silver.
Gross Profit
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Gross profit
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2018
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2017
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$ Change
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% Change
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Three months ended
September
30,
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$
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735,024
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$
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692,245
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$
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42,779
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6.2%
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As a percentage of sales
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14.7%
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14.1%
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The increase in consolidated gross profit for the three months ended
September
30, 2018 versus the prior year period was due to an increase in gross profit from sensors, thermoplastic injection molding and net tooling, partly offset by lower gross profit from machined orthopedic implant components and instruments.
Increased
gross profit on sensors are a result of increased volume, customer mix, improved raw materials yield and efficiency improvements in both the molding and plating operations. Despite the increase in volume, gross profit from silver surcharge decreased due to the decrease in the weighted average price of silver.
The increase in consolidated gross profit was also due in part to a 3.6% increase in gross profit from thermoplastic injection molding due in part to customer and industry mix. Net sales increased in the automotive and medical device industries, partly offset by decreased sales in the military and law enforcement and consumer products industries. Gross profit as a percentage of sales increased 0.6 percentage points.
Additionally, the increase in consolidated gross profit was due in part to a 22.5% increase in gross profit from tooling. The increase was primarily the result of higher net sales in the three months ended
September
30, 2018 compared to 2017. However, gross profit as a percentage of sales decreased 10.7 percentage points over the same period last year.
The increase
in consolidated gross profit
explained
above for the three months ended
September
30, 2018 versus the prior year period, w
as
partl
y offset by a 27.0% decrease
in gross profit from
machined orthopedic implant components and instruments. Th
e decrease was due in part to a
decrease in net sales as noted above. Additionally, the Company improved its production processes resulting in reduced rework, scrap, tooling, labor, outside expediting charges, shift premiums and overtime to meet customer delivery requirements when compared to the third quarter of 2017. Gross
profit as a percentage of sales decreased 3.7 percentage points.
During the three months ended
September
30, 2018, other indirect manufacturing overhead expenses increased by 12.8% when compared to the same period in the prior year. This was largely due to higher machinery and facility maintenance costs.
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Gross profit
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2018
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2017
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$ Change
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% Change
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Nine months ended
September
30,
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$
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2,344,204
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$
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1,727,456
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$
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616,748
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35.7%
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As a percentage of sales
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15.2%
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11.1%
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The increase in consolidated gross profit for the nine months ended
September
30, 2018 versus the prior year period was due to an increase in gross profit from sensors and machined orthopedic implant components and instruments, partly offset by decreased gross profit from thermoplastic injection molding and net tooling.
Increased gross profit from sensors was due largely to increased sales as noted above, which was driven by both increased volume and
customer mix as well as
improved raw materials yield and efficiency improvements in both the molding and plating operations.
Additionally, t
he increase was due in part to a 114.5% increase in gross profit from machined orthopedic implant components and instruments.
The increase was due in part to an increase in net sales as noted above. Additionally, the Company improved its production processes resulting in reduced rework, scrap, tooling, labor, outside expediting charges, shift premiums and overtime to meet customer delivery requirements when compared to the nine months ended
September
30, 2017. Gross profit as a percentage
of sales increased 11.8 percentage points.
Partly offsetting the increase was a decrease in consolidated gross profit from thermoplastic injection molding of 14.5% due primarily to lower net sales as described above. Additionally, the lower gross profit was partly the result of a decrease in gross profit as a percentage of sales which decreased 2.1 percentage points due in part to the impact of the vertical integration of production by a customer with a higher profit margin as well as increased scrap over the same prior year period.
Also partly offsetting the increase above was a decrease of 18.5% from net tooling due largely to lower net sales. However, gross profit as a percentage of sales increased 3.8 percentage points.
Selling and Marketing
The Company's consolidated selling and marketing expenses amounted to $189,031 (3.8% of net sales) for the three months ended
September
30, 2018 as compared to $171,304 (3.5% of net sales) for the three months ended
September
30, 2017, an increase of $17,727 or 10.3%.
For the three months ended
September
30, 2018, the increase was due primarily to a $19,538 increase in commissions as well as an increase in professional services due to the engagement of a sales representative in the second quarter of 2018. Partly offsetting these increases were decreased expenses related to cloud based marketing services as well as lower expenses related to travel, office and computer supplies, and depreciation.
The Company's consolidated selling and marketing expenses amounted to $583,607 (3.8% of net sales) for the nine months ended
September
30, 2018 as compared to $671,997 (4.3% of net sales) for the nine months ended
September
30, 2017, a decrease of $88,392, or 13.2%.
For the nine months ended
September
30, 2018, the decrease was primarily due to decreased compensation of $79,351 due partly to compensation adjustments implemented in the third quarter of 2017 as well as the use of independent manufacturers’ sales representatives in the first half of 2018. Additionally, professional services decreased due to the impact of $18,000 of recruiting agency fees in the first quarter of 2017. The decrease was also due in part to decreased expenses related to advertising and marketing, travel, trade show attendance, office and computer supplies and depreciation expense. Partly offsetting these decreases was increased commissions of $13,874, largely in the third quarter of 2018, as mentioned above.
General and Administrative
The Company's consolidated general and administrative expenses decreased to $509,179 (10.2% of net sales) for the three months ended
September
30, 2018 as compared to $614,082 (12.5% of net sales) for the three months ended
September
30, 2017, a decrease of $104,903, or 17.1%.
The decrease in general and administrative expenses for the three months ended
September
30, 2018 when compared to 2017 is due in part to the prior year impact of non-recurring charges of $77,606 related to outside consulting services. Compensation expenses decreased $23,089 due in part to compensation adjustments for salaried employees and executives implemented in the third quarter of 2017 as well as the outsourcing of the Company’s environmental, health and safety functions. Partly offsetting these decreases was an increase in outside consulting fees of $26,387 related to outsourcing the IT function and $12,737 for outsourcing the environmental, health and safety function.
The Company's consolidated general and administrative expenses decreased to $1,642,306 (10.6% of net sales) for the nine months ended
September
30, 2018 as compared to $1,783,590 (11.5% of net sales) for the nine months ended
September
30, 2017, a decrease of $141,284 or 7.9%.
The decrease in general and administrative expenses for the nine months ended
September
30, 2018 compared to 2017 is due largely to decreased compensation expense of $118,295 due in part to compensation adjustments for salaried employees and executives implemented in the third quarter of 2017 as well as the impact of outsourcing of the Company’s IT and environmental, health and safety functions. Additionally, the decrease is due in part to the prior year impact of non-recurring charges of $77,606 related to outside consulting services. Accounting, taxes and reporting services decreased by $36,867. These decreases were partly offset by an increase of $31,913 for non-recurring professional consulting fees related to the implementation of new revenue recognition accounting guidance. Additionally, the decreases were partly offset by increases in professional and outside consulting services due to the outsourcing of both the IT and environmental, health and safety functions.
Research and Development
The Company's consolidated research and development expenses decreased to $25,372 (0.5% of net sales) for the three months ended
September
30, 2018 as compared to $26,787 (0.5% of net sales) for the three months ended
September
30, 2017, a decrease of $1,415, or 5.3%.
The Company's consolidated research and development expenses decreased to $80,094 (0.5% of net sales) for the nine months ended
September
30, 2018 as compared to $84,427 (0.5% of net sales) for the nine months ended
September
30, 2017, a decrease of $4,333, or 5.1%.
The decreases for the three and nine months ended
September
30, 2018 and 2017 were due to salary reductions implemented in the third quarter of 2017.
Other Expense, net
Other expense, net increased to $88,613 for the three months ended
September
30, 2018, as compared to $60,939, for the three months ended
September
30, 2017, an increase of $27,674. The increase in other expense, net was due largely to an $18,094 increase in interest expense which was due in part to $13,249 of deferred financing amortization as a result of the new credit agreement entered into in
December 201
7, as well as $4,845 higher interest expense due in part to higher interest rates, despite a decrease in outstanding debt when compared to
June
30, 2018. Partly offsetting the increase in other expense, net was an increase of $24,000 from extension fees related to the assets held for sale.
Other expense, net increased to $261,334 for the nine months ended
September
30, 2018, as compared to $178,199, for the nine months ended
September
30, 2017, an increase of $81,135. The increase in other expense, net was due largely to a $59,302 increase in interest expense due in part to $32,004 of deferred financing amortization as a result of the new credit agreement entered into in
December 201
7, as well as $27,298 due in part to higher interest rates, despite a decrease in outstanding debt when compared to
December
31, 2017. Other expense, net also increased due in part to the impact of a $21,750 gain on the sale of fixed assets in the nine months ended
September
30, 2017.
Income Tax Provision
The tax provisions for the three and nine months ended
September
30, 2018 and 2017 attributable to the U.S. federal and state income taxes are $0. The Company’s combined federal and state effective income tax rate for the three and nine months ended
September
30, 2018 and 2017 of 0% is due to the deferred tax assets being nearly fully reserved for with a valuation allowance.
Earnings (Loss) Per Share
Consolidated basic and diluted loss per share for the three months ended
September
30, 2018 was $0.03 per share as compared to a loss of $0.06 per share for the
same period in 2017, a decrease in loss per share of $0.03. The decrease in loss per share for the three months ended
September
30, 2018, is due in part to increased net sales of $93,572, increased gross profit of $42,779 and a reduction of $88,591 in operating expenses.
Consolidated basic and diluted loss per share for the nine months ended
September
30, 2018 was $0.08 per share as compared to a loss of $0.35 per share for the
same period in 2017, a decrease in loss per share of $0.27. The decrease in loss per share for the nine months ended
September
30, 2018, is due largely to an increase in gross profit of $616,748, as well as a decrease of $234,007 in operating expenses compared to the prior year period.
Off-Balance Sheet Arrangements
Lease expense under all operating leases for the three months ended
September
30, 2018 and 2017
was $6,056 and $
4,615
respectively. For the
nine
months ended
September
30, 2018 and 2017, lease expense under all operating leases was $1
9
,
164
and
$
13
,
114 respectively.
Liquidity and Capital Resources
Working capital was
$2,621,501
as of
September
30, 2018
, as compared to $2,548,692 at
December
31, 2017, an increase of
$72,809
. The increase in working capital is due primarily to increases in accounts receivable and inventory and a decrease in
short term debt
, partly offset by an increase in
accrued expenses and other current liabilities as well as
contract liabilities related to tooling contracts. Cash on hand decreased $95
4,
148
, due largely to net payments on the Revolver of $
334,830,
the discharge of
subordinated debt of $350,000 and payment on term notes of $
304
,
762
.
Trade accounts receivable, net of allowance for doubtful accounts, were
$2,929,717
and $2,595,248 at
September
30, 2018
and
December
31, 2017, respectively, an increase of
$334,469
.
The increase is due
largely
to higher sales in the
third
quarter of 2018 compared to the fourth quarter of 2017.
I
nventories
increased by
$4
07
,
586
from
December
31, 2017 to
September
30, 2018, due
prim
arily to an increase in work-in-process of $
253
,
22
9
driven largely by an increase in tooling in-process.
Accounts payable
decreased $8
6
,
616
from
December
31, 2017 to
September
30, 2018
due to the timing of
cash
disbursements. Accrued expenses and other current liabilities increased $
297,228
in part due to
the timing of inventory receipts and
an
increase in accrued payroll
. Contract liabilities increased $
186
,
761
due to increased customer deposits and advance invoicing for in-process tooling.
Capital equipment expenditures were
$456,488
for the
nine months ended
September
30, 2018
, due
in part
to expenditures related to
machinery and equipment for the contract manufacturing of machined components in the medical device and military and law enforcement industries, as well as
computer software and hardware,
and
thermoplastic injection molding and quality inspection equipment compared to $
868,716
for the
nine
months ended
September
30, 2017 for machinery and equipment primarily for the contract manufacturing of machined orthopedic implants and instruments as well as thermoplastic injection molding.
At
September
30, 2018, the Company’s total debt was $5,
601
,
702
as compared to $6,575,241 at
December
31, 2017, a decrease of $
973,539
. The de
crease is due
in part
to
$304,762
in payment
s
on term debt as well as the discharge of $350,000 of subordinated debt and
net payments on the Revolver of $
334,830
.
The Company has a three-year credit agreement with a Massachusetts trust company.
The
credit agreement
includes a revolving line of credit of up to $5.0
million
, a machinery and equipment term loan of $2.5
million
and a real estate term loan of $2.0
million
.
The credit agreement contains both financial and non-financial covenants, and is secured by substantially all assets of the Company and a mortgage encumbering certain real property.
The Revolver is subject to certain borrowing base limitations, primarily related to conditions of the Company’s accounts receivable and inventory. The credit agreement provides for a daily sweep of cash balances against the balance of the Revolver.
Amounts available to borrow under the Revolver are
$1,509,555 at
September
30, 2018
.
The Term Loans require aggregate monthly principal payments of approximately $38,095, payable on the first day of each month. The Equipment Loan is based upon an 84 month amortization with a balloon payment of approximately $1,458,333 due and payable in full upon maturity on
December
29, 2020. The Real Estate Loan is based upon a 240 month amortization with a balloon payment of approximately $1,708,333 due and payable in full upon maturity on
December
29, 2020.
On
December
29, 2017, as part of entering into the credit agreement
mentioned above
, the Company obtained funds to discharge the subordinated debt. On
January
2, 2018, the Company discharged the notes, totaling
an aggregate principal amount
of
$350,000, including the subordinated notes held by three
related parties
. The Company carried $350,000 as restricted cash at
December
31, 2017 for this purpose.
No dividends were declared or paid in the
three or
nine months ended
September
30, 2018 and 2017
.
The Company believes that cash flows from its operations, together with its existing working capital, booked orders, the credit agreement and other resources, will be sufficient to fund operations at current levels and repay debt obligations over the next twelve months
from the date these financial statements were issued
; however, there can be no assurance that the Company will be able to do so.
Summary of Changes in Cash Position
As of
September
30, 2018
, the Company had cash on hand of $
2,
840
, as the Company’s cash is swept daily against the Revolver in accordance w
ith the Company’s credit agree
ment. For the
nine months ended
September
30, 2018
, n
et cash provided by operating activities was
$528,
982
. Net cash used in investing activities for the
nine months ended
September
30, 2018
was
$459,149
. Net cash used in financing activities for the
nine months ended
September
30, 2018
was
$1,023,981
. The net cash flows for the
nine months ended
September
30, 2018
are discussed in further detail below.
Operating Cash Flows
For the
nine months ended
September
30, 2018
, net cash provided by operating activities was
$528,
982
. Cash provided by operating activities was primarily impacted by an increase of
$297,228 in accrued expenses and other current liabilities as well as an increase of $186,761
in contract liabilities related to
customer deposits for tooling. C
ash provided by operating activities was also impacted by non-cash add-backs for depreciation and amortization of $
1,130,000
, share-based compensation of $
90
,
541
and non-cash interest expense of $
50,443
.
These sources of cash were partly offset by uses of cash as a result of an increase of $483,847 in inventory, an increase of $334,469 in accounts receivable, an increase of $98,922 in prepaid expenses and other current assets as well as a decreas
e in accounts payable of $86,616
.
Investing Cash Flows
For the
nine months ended
September
30, 2018
, net cash used in investing activities was
$459,149
. The net cash used was for capital expenditures of
$456,488
,
due in part to expenditures related to machinery and equipment for the contract manufacturing of machined components in the medical device and military and law enforcement industries, as well as
computer software and hardware,
and
thermoplastic injection molding and quality inspection equipment.
Financing Cash Flows
For the
nine months ended
September
30, 2018
, net cash used in financing activities was
$1,023,981
. Cash was used for net payments
on the Revolver of $334,830, the discharge of subordinated debt of $350,000 and payments on term notes of $304,762, and debt issuance costs of $34,389.