MICRON SOLUTIONS INC /DE/ - Quarter Report: 2017 September (Form 10-Q)







UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10‑Q



☒ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2017 or



☐ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ______ to ______

 

001-9731

(Commission file No.)



Micron Solutions, Inc.

(Exact name of registrant as specified in its charter)





25 Sawyer Passway

Fitchburg, Massachusetts  01420

(Address of principal executive offices and zip code)

 

(978) 345-5000

(Registrant's telephone number, including area code)



_________________________________________________________________

(Former name, former address and former fiscal year, if changed from last report)

  

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 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).   Yes ☒   No ☐



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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. (Check one):





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 10, 2017 there were 2,833,153 shares of the Company’s common stock outstanding.



 

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Micron Solutions, Inc. and Subsidiary

TABLE OF CONTENTS



 



 

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PART I - CONDENSED FINANCIAL STATEMENTS

Item 1.  Condensed Consolidated Financial Statements (unaudited) 



Micron Solutions, Inc. and Subsidiary

Condensed Consolidated Balance Sheets

(unaudited)









See accompanying notes to condensed consolidated financial statements.

 

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Micron Solutions, Inc. and Subsidiary

Condensed Consolidated Statements of Operations

(unaudited)







See accompanying notes to condensed consolidated financial statements.



 

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Micron Solutions, Inc. and Subsidiary

Condensed Consolidated Statements of Cash Flows

(unaudited)











See accompanying notes to condensed consolidated financial statements.

 

 

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1.  Basis of Presentation



The consolidated financial statements (the "financial statements") include the accounts of Micron Solutions, Inc.® (“Micron Solutions”) and its subsidiary, Micron Products, Inc.® ("Micron" and together with Micron Solutions, the “Company”).  All intercompany balances and transactions have been eliminated in consolidation.



The unaudited interim condensed consolidated financial statements and related notes have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC").  Accordingly, certain information and footnote disclosures normally included in complete financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been omitted pursuant to such rules and regulations.  These financial statements and related notes should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC on March 22, 2017.  



The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. The Company's balance sheet at December 31, 2016 has been derived from the audited financial statements at that date, but does not include all the information and footnotes required by GAAP for complete financial statements.



The information presented reflects, in the opinion of the management of the Company, all adjustments necessary for a fair presentation of the financial results for the interim periods presented. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates. 



Recent Accounting Pronouncements



In the normal course of business, management evaluates all new accounting pronouncements issued by the Financial Accounting Standard Board (“FASB”), Securities and Exchange Commission (“SEC”), Emerging Issues Task Force (“EITF”), or other authoritative accounting bodies to determine the potential impact they may have on the Company’s Consolidated Financial Statements. Based upon this review, except as noted below, management does not expect any of the recently issued accounting pronouncements, which have not already been adopted, to have a material impact on the Company’s consolidated financial statements.



ASU No. 2016-02, “Leases (Topic 842)”



In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842),” which requires companies to recognize all leases as assets and liabilities on the consolidated balance sheet. The standard retains a distinction between finance leases and operating leases, and the classification criteria for distinguishing between finance leases and operating leases are substantially similar to the classification criteria for distinguishing between capital leases and operating leases in the current accounting literature. The result of retaining a distinction between finance leases and operating leases is that under the lessee accounting model in Topic 842, the effect of leases in a consolidated statement of comprehensive income and a consolidated statement of cash flows is largely unchanged from previous GAAP.  The amendments in this standard are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Earlier application is permitted.   



As of the date of this report, the Company is the lessee of office equipment in a single operating lease and is the lessee of a parking lot as well as storage units.  The Company is not a lessor in any arrangements.  The Company is evaluating other supplier relationships to determine if such arrangements constitute a lease per this guidance.  The Company expects to complete its evaluation prior to the end of 2017 and will evaluate the impact of adoption at that time.  The Company does not expect any material impact on reporting or on the results of operations. 



ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”)



In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”). The core principle behind ASU No. 2014-09 is that an entity should recognize revenue in an amount that reflects the consideration to which the entity expects to be entitled in exchange for delivering goods and services. This model involves a five-step process that includes identifying the contract with the customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations in the contract and recognizing revenue when the entity satisfies the performance obligations. This ASU allows two methods of adoption; a full retrospective approach where historical financial information is presented in accordance with the new standard, and a modified retrospective approach where this ASU is applied to the most current period presented in the financial statements. In August 2015, the FASB issued ASU No. 2015-14 “Revenue from

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Contracts with Customers: Deferral of the Effective Date,” which deferred the effective date of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, with earlier application permitted as of annual reporting periods beginning after December 15, 2016.



As of the date of this report the Company has established a multi-disciplinary team including members of executive management, accounting, sales, operations and IT which is began implementation of a transition plan to the new guidance in the third quarter.  The team will evaluate all supply and manufacturing agreements with customers as well as the nature of other arrangements and relationships between the Company and all other customers (“arrangements”), to determine if a contract, as defined by the guidance, exists.  The Company has compiled a preliminary list of agreements and is evaluating them to determine if there is any potential impact to the accounting for the agreements under this guidance.  After evaluating the arrangements, the Company will determine the appropriate treatment for revenue recognition per the guidance compared to the Company’s present revenue recognition policy as outlined in the Company's Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC on March 22, 2017.  To date, the Company does not expect any material adverse financial impact from the adoption of this standard.



Operating matters and liquidity 



Due to a non-compliance with the debt service coverage ratio covenant at June 30, 2017, the Company and the bank entered into a forbearance agreement on September 29, 2017.  Under the agreement the bank agreed to forbear from collections on all outstanding debt prior to March 31, 2018, provided no further events of default occur, and agreed to extend the revolver to March 31, 2018 subject to certain modifications of the agreement.    Should a further event of default occur, the bank has the right to demand payments of all notes. 

Pursuant to the agreement, the interest rate under the revolver increased from the Prime Rate plus 0.25%, to the Prime Rate plus 1.00%, an increase of 75 basis points.  The Company also agreed to provide monthly financial reporting and daily cash sweeps and to a  modification of the equipment line of credit (the “equipment line”) to immediately terminate the availability of further advances under the equipment line rather than expiration thereof in November 2017 at which time the equipment line will convert into a five-year term note.  In addition, the bank agreed to modify the debt service coverage ratio calculation for the September 30, 2017 measurement date.  The Company is in compliance with this revised third quarter 2017 covenant calculation.    Additionally, under the agreement, and in accordance with its rights under subordination agreements between the bank and the Company’s subordinated note holders, the quarterly interest payments to the note holders have been deferred due to previous non-compliance with the debt service coverage ratio covenant until such time as the bank otherwise permits resumption thereof.



The Company is working with its bank under the extended credit facility while exploring alternative financing arrangements.  The Company believes that cash flows from its operations, together with its existing working capital, increased booked orders and other resources, and the expected securing of a new facility will be sufficient to enable the Company to fund operations at current levels and repay debt obligations over the next twelve months; however, there can be no assurance that the Company will be able to do so. 

   

Assessment of going concern 



The Company follows accounting standard ASU No. 2014-15, “Presentation of Financial Statements - Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”. The accounting standard requires management to evaluate whether there are conditions that give rise to substantial doubt as to the Company’s ability to continue as a going concern within one year from the date of issuance of these financial statements. Substantial doubt exists when conditions and events, considered in the aggregate, indicate that it is probable that a company will be unable to meet its obligations as they become due within one year after the financial statement issuance date. Management evaluations include identifying relevant conditions and events that were known and reasonably knowable as of the date these financial statements have been issued.



At December 31, 2016, 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 included the Company’s ability to renew the credit facility which was maturing in June 2017, negative financial history and the Company’s limited liquidity to meet the working capital needs to support the Company’s operations.  While the Company was successful in extending the credit facility to March 31, 2018, similar conditions existed as of September 30, 2017. 



As of the June 30, 2017 testing date, the Company was in compliance with the terms of the credit facility except with respect to the debt service coverage ratio covenant.  As a result of the non-compliance, the Company and the bank entered into a forbearance agreement on September 29, 2017.  Under the agreement the bank agreed to forbear from collections on all outstanding debt prior to March 31, 2018 and agreed to extend the revolver to March 31, 2018, subject to certain modifications to the agreement.  These

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modifications include an increase in interest rates, daily cash sweeps, terminating the availability of further advances under the equipment line and modification of the debt service ratio covenant calculation for the September 30, 2017 measurement date.  The Company is in compliance with this revised third quarter 2017 covenant calculation.



Management’s assessment included an analysis of the Company’s year to date 2017 results and financial forecasts looking forward twelve months from the date of these financial statements. Management’s assessment also considered the Company’s history of meeting financial covenants and being able to renew and refinance its debt obligations.



During the first two quarters of 2017, the Company made strategic decisions to take on new large orders, at aggressive initial pricing, in order to land follow-on orders with lower material costs.  During this period the Company incurred extraordinary costs related to the starting up of these new customers, including increased scrap, tooling, labor, rework, expediting charges from suppliers, shift premiums and overtime, in order to meet customer delivery requirements.  The Company landed the follow-on orders with the lower material costs and mitigated the startup costs of these new products.



The forecasts for the second half of 2017 and 2018 reflect the actual and expected results of cost savings measures and productivity improvements implemented, beginning at the end of the second quarter of 2017.  These include more efficient use of labor by reducing overtime and modifying production schedules, process improvements, improved material yields, and decreased overhead expenses in part by compensation reductions for all salaried personnel including executive officers.  In July 2017, the Company engaged a manufacturing consultancy firm with a focus on plastics, medical devices, contract manufacturing and outsourcing to analyze and benchmark the Company’s operations, suggest business development strategies and improve operating performance. Additionally, in August 2017, the Company engaged an investment banking firm to evaluate the overall strategic direction of the Company.



The implementation of the cost savings measures and improvements yielded results in the third quarter of 2017.  Despite a $482,638 decrease in net sales, gross profit increased $310,408, or 7.0%  when compared to the second quarter of 2017.  Further savings in operating expenses also contributed to the improvement in net loss from operations of $434,005 in the second quarter 2017 to a net loss from operations of $42,322, excluding non-recurring charges of $77,606 related to outside efficiency related consulting fees in the third quarter of 2017.  The Company anticipates continued margin improvement and operating results through the fourth quarter and into 2018.   



Management continues to work with its bank under the credit facility, which was extended to March 31, 2018, to further extend the credit facility while also exploring alternative financing arrangements. Based upon the continued results of cost savings measures and improvements as noted above, cash forecasts,  the expected fulfillment of booked orders from existing customers and new customer prospects, and the expected securing of a new credit facility, the Company expects to meet its debt obligations for the next twelve months, however there can be no assurance that the Company will be able to do so.  The financial statements do not include any adjustment that might result from the outcome of such uncertainties.

 

2.  Earnings per Share ("EPS")



Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding.  The computation of diluted earnings (loss) per share is similar to the computation of basic earnings (loss) per share except that the denominator is increased to include the average number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued.  In addition, the numerator is adjusted for any changes in net income (loss) that would result from the assumed conversions of those potential shares.    



For the three months ended September 30, 2017 and 2016, basic and diluted earnings per share was a loss of $0.06 per share and a loss of $0.02 per share, respectively.  For the nine months ended September 30, 2017 and 2016, basic and diluted earnings per share was a loss of $0.35 per share and a loss of $0.14 per share, respectively. 

 

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3.  Inventories



Inventories consist of the following:







Silver included in raw materials, work-in-process and finished goods inventory had an estimated cost of $506,991 and $521,745 as of September 30, 2017 and December 31, 2016, respectively. 

 

4.  Property, Plant and Equipment, net



Property, plant and equipment, net consist of the following:







For the three months ended September 30, 2017 and 2016, the Company recorded depreciation expense of $405,402 and $406,122, respectively.  For the nine months ended September 30, 2017 and 2016, the Company recorded depreciation expense of $1,207,283 and $1,150,683, respectively.

 

In  January 2016, the Company entered into a Purchase and Sale Agreement (the “Agreement”)  with a Buyer (collectively the “Parties”) to sell two unoccupied buildings, with approximately 52,000 square feet, and land, at its Fitchburg, Massachusetts campus. 



In December 2016, the Parties entered into a First Amendment to the Agreement (the “First Amendment”) which extended the time to close to January 13, 2018.   As part of the consideration for extending the Agreement the Buyer agreed to pay certain extension fees.

 

In January 2017, the Parties entered into a Second Amendment to the Agreement (the “Second Amendment”) to further extend the time to close to July 2018.   The Second Amendment permits the Buyer to assign the Agreement to a third party and extends the extension fees through July 2018 or the culmination of the Agreement.



On July 13, 2017, the Parties entered into a Third Amendment to the Agreement (the “Third Amendment”) to further extend the time to close to June 2019.  The Third Amendment permitted the Buyer to contract with outside parties to conduct certain due diligence activities on the property up until August 13, 2017.  Additionally, the Third Amendment further extended the extension fees through June 2019, or the culmination of the Agreement, and allows for the Buyer to defer the last six months of extension fees to be settled at closing.



On September 28, 2017, the Parties entered into a Fourth Amendment to the Agreement (the “Fourth Amendment”) to extend the time allowed to the Buyer to complete due diligence activities on the property from August 13, 2017 until October 13, 2017.



At September 30, 2017 and December 31, 2016, the real estate under agreement was classified as Assets Held for Sale valued at $688,750.  The carrying value approximated the fair value less the cost to sell.

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5.  Intangible Assets, net



The Company assesses the impairment of long-lived assets and intangible assets with finite lives annually or whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. For the three and nine months ended September 30, 2017 and 2016,  the Company did not impair any intangible assets. 



Intangible assets consist of the following:







For the three months ended September 30, 2017 and 2016, the Company recorded amortization expense of $602 and $439, respectively.  For the nine months ended September 30, 2017 and 2016, the Company recorded amortization expense of $1,588 and $1,318, respectively.  

 

6.  Debt



The following table sets forth the items which comprise debt for the Company:





Bank Debt



The Company has a multi-year credit facility with a Massachusetts based bank.  This credit facility consists of a revolving line of credit (the "revolver"), a commercial term loan and an equipment line of credit (“equipment line”).  The debt is secured by substantially all assets of the Company with the exception of real property.  



Due to a non-compliance with the debt service coverage ratio covenant at June 30, 2017, the Company and the bank entered into a forbearance agreement on September 29, 2017.  Under the agreement the bank agreed to forbear from collections on all outstanding debt prior to March 31, 2018, provided no further events of default occur, and agreed to extend the revolver to March 31, 2018 subject to certain modifications of the agreement.  Should a further event of default occur, the bank has the right to demand payments of all notes. 

Pursuant to the agreement, the interest rate under the revolver increased from the Prime Rate plus 0.25%, to the Prime Rate plus 1.00%, an increase of 75 basis points.  The Company also agreed to provide monthly financial reporting and daily cash sweeps and to a  modification of the equipment line to immediately terminate the availability of further advances under the equipment line rather than expiration thereof in November 2017 at which time the equipment line will convert into a five-year term note.  In addition, the bank agreed to modify the debt service coverage ratio calculation for the September 30, 2017 measurement date.  The Company is

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in compliance with this revised third quarter covenant calculation.  As a result of having entered into the agreement, all of the Company’s bank debt has been classified as current liabilities as of September 30, 2017. 



Revolver



The revolver provides for borrowings up to 80% of eligible accounts receivable and 50% of eligible raw materials inventory.  The interest rate on the revolver is calculated at the bank's prime rate plus 1.00%  (5.25% at September 30, 2017).  Amounts available to borrow under the revolver are $95,767 at September 30, 2017.



Commercial term loan



In November 2016, the Company refinanced its bank term debt, including the commercial term loan and three equipment term loans, along with $500,000 from the revolver, into a new $2,481,943 consolidated five year commercial term loan with a maturity date in November 2021.  The interest rate on the loan is a fixed 4.65% per annum and the loan requires monthly payments of principal and interest of approximately $46,500.



Equipment line of credit



In November 2016, the Company entered into the equipment line that allows for advances of up to $1.0 million under the Company's multi-year credit facility. The term of this equipment line is six years, maturing in November 2022, inclusive of a maximum one-year draw period. Repayment shall consist of monthly interest only payments, equal to the bank's prime rate plus 0.25% as to each advance commencing on the date of the loan through the earlier of: (i) one year from the date of the loan or (ii) the date upon which the equipment line is fully advanced (the “Conversion Date”). On the Conversion Date, principal and interest payments will be due and payable monthly in an amount sufficient to pay the loan in full based upon an amortization schedule commensurate with the remaining term of the loan.



Pursuant to the Company’s September 29, 2017 agreement with the bank, the bank terminated the availability of further advances under the equipment line rather than the expiration thereof in November 2017 at which time the equipment line will convert into a five-year term note.    At September 30, 2017,  $504,781 has been drawn on the equipment line.  At December 31, 2016, $102,500 had been drawn on the equipment line.



Debt issuance costs



The amount of the commercial term loan presented in the table above is net of debt issuance costs of $29,374 and $45,858 at September 30, 2017 and December 31, 2016, respectively.



Bank covenants



The credit facility contains both financial and non-financial covenants. The financial covenants include maintaining certain debt service coverage and leverage ratios. The non-financial covenants relate to various matters including notice prior to executing further borrowings and security interests, mergers or consolidations, acquisitions, guarantees, sales of assets other than in the normal course of business, leasing, changes in ownership and payment of dividends. 



As of the June 30, 2017 testing date, the Company was in compliance with the terms of the credit facility except with respect to the debt service coverage ratio covenant.  As a result of the non-compliance, the Company entered into the September 29, 2017 agreement with the bank whereby, among other things, the bank agreed to forbear collections of all outstanding debt prior to March 31, 2018.  In addition, the bank agreed to modify the debt service coverage ratio calculation for the September 30, 2017 measurement date.  The Company is in compliance with this revised third quarter covenant calculation.



Other Debt



Equipment notes



In January 2013, the Company entered into two equipment notes totaling $272,500 with a financing company to acquire production equipment. The notes bear interest at the fixed rate of 4.66% and require monthly payments of principal and interest of approximately $5,000 over a five year term maturing in January 2018.



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Subordinated promissory notes



In December 2013, the Company completed a private offering in which the Company sold an aggregate of $500,000 in subordinated promissory notes. The unsecured notes required quarterly interest-only payments at a rate of 10% per annum for the first two years.  In December 2015, the interest rate increased to 12% per annum.  Three related parties participated in the private offering as follows:  REF Securities, LLP, and with Mr. Rodd E. Friedman,  a director of the Company since July 21, 2017, a  beneficial owner of approximately 13% of the Company’s common stock, invested $100,000 in the offering; the Chambers Medical Foundation (the “Foundation”), beneficial owner of approximately 10% of the Company’s common stock, invested $100,000 in the offering; and Mr. E.P. Marinos, a director, invested $50,000 in the offering.  The Company’s Chairman of the Board is a co-trustee of the Foundation but has held no dispositive powers since his appointment as such. 

 

In October 2016, the Company and six of the seven investors in the private offering, aggregating $450,000 of the notes, including the three related parties holding $250,000 of the notes, agreed to extend the maturity dates of the notes to December 31, 2018 at a rate of 10% per annum.  One investor did not extend the maturity date and that $50,000 note was paid at maturity in December 2016.  The notes are subordinated to all indebtedness of the Company pursuant to its multi-year bank credit facility. Pursuant to the subordination agreements entered into among the bank, each of the note holders, and the Company upon issuance of the subordinated notes, quarterly interest payments to the note holders have been deferred due to the non-compliance with the debt service coverage ratio covenant until such time as the bank otherwise permits resumption thereof.



In connection with the subordinated promissory notes, the Company issued 100,000 warrants to purchase the Company's common stock, including 20,000 warrants to REF Securities, LLP, 20,000 warrants to the Foundation and 10,000 warrants to Mr. Marinos.  The warrants were exercisable through December 2016 at an exercise price of $3.51 per share.  In 2014, 30,000 warrants were exercised, including 20,000 by the Foundation.  In October 2016, in connection with the extension of the maturity dates of the subordinated promissory notes, the expiration date of the remaining 70,000 warrants was extended to December 31, 2018.  The exercise price remained unchanged at $3.51 per share.  The 70,000 warrants remain unexercised at September 30, 2017.



In the fourth quarter of 2016, the Company calculated the incremental fair value of extending the expiration date of the Notes and Warrants and determined that the amendment represented a debt modification in accordance with the guidance outlined in ASC-470, “Debt”.  Using the Black-Scholes model, and the 10% test, the Company determined that the incremental fair value of the warrants to be $18,310 which was recorded as a reduction against the Notes and an increase in Additional Paid-in Capital. 



The discount on the notes is being recognized as non-cash interest expense over the term of the notes. The Company recorded $2,218 and $6,727 for the three months ended September 30, 2017 and 2016,  and $6,921 and $20,763 for the nine months ended September 30, 2017 and 2016, respectively.    



The unamortized discount which is net against the outstanding balance of the subordinated promissory notes is $11,261 at September 30, 2017 and $17,989 at December 31, 2016.

 

7.  Income Taxes



No provision for income taxes has been recorded in the three or nine months ended September 30, 2017 or 2016, respectively.    The Company has a full valuation allowance against its deferred tax assets as of September 30, 2017 and December 31, 2016. 



At September 30, 2017,  the Company has federal and state net operating loss carryforwards totaling $9,124,000 and $8,196,000, respectively, which begin to expire in 2030. The Company also has federal and state tax credit carryovers of $303,000 and $357,000 respectively. The federal and state tax credits begin to expire in 2026 and 2027, respectively. 

 

8.  Commitments and Contingencies



Legal matters



In the ordinary course of its business, the Company is involved in various legal proceedings involving a variety of matters. The Company does not believe there are any pending legal proceedings that will have a material impact on the Company’s financial position or results of operations.



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Off-balance sheet arrangements



Lease expense under all operating leases was approximately $4,615 for the three months ended September 30, 2017 and 2016, respectively, and $13,114 and $14,444 for the nine months ended September 30, 2017 and 2016, respectively.    



9.  Shareholders’ Equity



Stock options and share-based incentive plan



The following table sets forth the stock option transactions for the nine months ended September 30, 2017:







For the three months ended September 30, 2017 and 2016, share based compensation expense related to stock options amounted to $5,083 and $4,492, respectively.  For the nine months ended September 30, 2017 and 2016, share-based compensation expense related to stock options amounted to $26,250 and $35,083, respectively.  Share based compensation is included in general and administrative expenses.



For the three months ended September 30, 2017, no options were granted or exercised, 3,000 options were forfeited and 2,000 options expired due to employee terminations.  For the three months ended September 30, 2016, no options were granted, exercised, forfeited or expired. 



For the nine months ended September 30, 2017, no options were granted or exercised, 7,000 options were forfeited and 2,000 options expired due to employee terminations.  For the nine months ended September 30, 2016, 5,000 options were granted and 15,000 options were exercised generating proceeds of $51,150.    



Warrants



For the three months ended September 30, 2017 and 2016, there were no warrants exercised. As of September 30, 2017,  70,000 warrants remain unexercised, including 20,000 held by the Company’s largest beneficial owner, REF Securities, LLP and with Mr. Rodd E. Friedman,  a director of the Company, and 10,000 held by Mr. E. P. Marinos, a director of the Company.  The warrants expire in December 2018.



Common Stock



For the three months ended September 30, 2017, the Company issued 12,154 shares of the Company’s common stock, pursuant to the 2010 Equity Incentive Plan, with a fair value of $47,250 for director fees in lieu of cash payments.  For the three months ended September 30, 2016, there were no such stock grants.



For the nine months ended September 30, 2017, the Company issued 16,514 shares of the Company’s common stock, pursuant to the 2010 Equity Incentive Plan, with a fair value of $58,500 for director fees in lieu of cash payments.  For the nine months ended September 30, 2016, there were no such stock grants.

 



 

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Item 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, 2016.



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, 2016, 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, 2016.



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 thirty-five percent of its revenue derived from exports.



Operating matters and liquidity



Due to a non-compliance with the debt service coverage ratio covenant at June 30, 2017, the Company and the bank entered into a forbearance agreement on September 29, 2017.  Under the agreement the bank agreed to forbear from collections on all outstanding debt prior to March 31, 2018, provided no further events of default occur, and agreed to extend the revolver to March 31, 2018 subject to certain modifications of the agreement.  Should a further event of default occur, the bank has the right to demand payments of all notes. 

Pursuant to the agreement, the interest rate under the revolver increased from the Prime Rate plus 0.25%, to the Prime Rate plus 1.00%, an increase of 75 basis points.  The Company also agreed to provide monthly financial reporting and daily cash sweeps and to a modification of the equipment line of credit (the “equipment line”) to immediately terminate the availability of further advances under the equipment line rather than expiration thereof in November 2017 at which time the equipment line will convert into a five-year term note.  In addition, the bank agreed to modify the debt service coverage ratio calculation for the September 30, 2017 measurement date.    The Company is in compliance with this revised third quarter 2017 covenant calculation.    Additionally, under the agreement, and in accordance with its rights under subordination agreements between the bank and the Company’s subordinated note holders, the quarterly interest payments to the note holders have been deferred due to the non-compliance with the debt service coverage ratio covenant until such time as the bank otherwise permits resumption thereof.



The Company is working with its bank under the extended credit facility while exploring alternative financing arrangements.  The Company believes that cash flows from its operations, together with its existing working capital, increased booked orders and other resources, and the expected securing of a new facility will be sufficient to enable the Company to fund operations at current levels and repay debt obligations over the next twelve months; however, there can be no assurance that the Company will be able to do so.



Assessment of going concern



The Company follows accounting standard ASU No. 2014-15, “Presentation of Financial Statements - Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”. The accounting standard

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requires management to evaluate whether there are conditions that give rise to substantial doubt as to the Company’s ability to continue as a going concern within one year from the date of issuance of these financial statements. Substantial doubt exists when conditions and events, considered in the aggregate, indicate that it is probable that a company will be unable to meet its obligations as they become due within one year after the financial statement issuance date. Management evaluations include identifying relevant conditions and events that were known and reasonably knowable as of the date these financial statements have been issued.



At December 31, 2016, 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 included the Company’s ability to renew the credit facility which was maturing in June 2017, negative financial history and the Company’s limited liquidity to meet the working capital needs to support the Company’s operations.  While the Company was successful in extending the credit facility to March 31, 2018, similar conditions existed as of September 30, 2017. 



As of the June 30, 2017 testing date, the Company was in compliance with the terms of the credit facility except with respect to the debt service coverage ratio covenant.  As a result of the non-compliance, the Company and the bank entered into a forbearance agreement on September 29, 2017.  Under the agreement the bank agreed to forbear from collections on all outstanding debt prior to March 31, 2018 and agreed to extend the revolver to March 31, 2018, subject to certain modifications to the agreement.  These modifications include an increase in interest rates, daily cash sweeps, terminating the availability of further advances under the equipment line and modification of the debt service ratio covenant calculation for the September 30, 2017 measurement date.  The Company is in compliance with this revised third quarter 2017 covenant calculation.



Management’s assessment included an analysis of the Company’s year to date 2017 results and financial forecasts looking forward twelve months from the date of these financial statements. Management’s assessment also considered the Company’s history of meeting financial covenants and being able to renew and refinance its debt obligations.



During the first two quarters of 2017, the Company made strategic decisions to take on new large orders, at aggressive initial pricing, in order to land follow-on orders with lower material costs.  During this period the Company incurred extraordinary costs related to the starting up of these new customers, including increased scrap, tooling, labor, rework, expediting charges from suppliers, shift premiums and overtime, in order to meet customer delivery requirements.  The Company landed the follow-on orders with the lower material costs and mitigated the startup costs of these new products.



The forecasts for the second half of 2017 and 2018 reflect the actual and expected results of cost savings measures and productivity improvements implemented, beginning at the end of the second quarter of 2017.  These include more efficient use of labor by reducing overtime and modifying production schedules, process improvements, improved material yields, and decreased overhead expenses in part by compensation reductions for all salaried personnel including executive officers.  In July 2017, the Company engaged a manufacturing consultancy firm with a focus on plastics, medical devices, contract manufacturing and outsourcing to analyze and benchmark the Company’s operations, suggest business development strategies and improve operating performance. Additionally, in August 2017, the Company engaged an investment banking firm to evaluate the overall strategic direction of the Company.



The implementation of the cost savings measures and improvements yielded results in the third quarter of 2017.  Despite a $482,638 decrease in net sales, gross profit increased $310,408, or 7.0 points when compared to the second quarter of 2017.  Further savings in operating expenses also contributed to the improvement in net loss from operations of $434,005 in the second quarter 2017 to a net loss from operations of $42,322, excluding non-recurring charges of $77,606 related to outside consulting fees in the third quarter of 2017.  The Company anticipates continued margin improvement and operating results through the fourth quarter and into 2018.  



Management continues to work with its bank under the credit facility, which was extended to March 31, 2018, to further extend the credit facility while also exploring alternative financing arrangements. Based upon the continued results of cost savings measures and improvements as noted above, cash forecasts,  the expected fulfillment of booked orders from existing customers and new customer prospects, and the expected securing of a new credit facility, the Company expects to meet its debt obligations for the next twelve months, however there can be no assurance that the Company will be able to do so.  The financial statements do not include any adjustment that might result from the outcome of such uncertainties.

 

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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.









Net Sales







The increase in consolidated net sales for the three months ended September 30, 2017 versus the prior year was due to an increase in net sales of sensors, partly offset by decreased net sales of machined orthopedic implant components and instruments as well as thermoplastic injection molding. 



For the three months ended September 30, 2017, net sales of sensors increased 33.4% when compared to the three months ended September 30, 2016.  The increase was largely due to a  53.1% increase in volume due largely to the timing of shipments, versus the recognition of revenue, related to supply agreements with certain foreign customers entered into in the third quarter of 2016.   Additionally, silver surcharge billed increased due in part to increased volume partly offset by a decrease in the weighted average price of silver as compared to the same period last year.  



The increase in net sales for the three months ended September 30, 2017 was partly offset by a 9.9% decrease in net sales of machined orthopedic implant components and instruments when compared to the same period in 2016.  The decrease was due to reduced demand for femoral components from one customer in part due to the customer’s vertical integration, beginning in the third quarter 2016. 



Also, partially offsetting the increase in net sales for the three months ended September 30, 2017 was a decrease of 7.3% in net sales of thermoplastic injection molding when compared to the three months ended September 30, 2016.  The decrease was due largely to decreased demand from customers in the automotive industry.  Additionally, tooling revenue decreased 72.0% due in part to the completion of a tooling program for a customer in the consumer products industry.







The increase in consolidated net sales for the nine months ended September 30, 2017 versus the prior year was due primarily to increases in net sales of sensors and thermoplastic injection molding,  partly offset by decreased net sales of machined orthopedic implant components and instruments. 



For the nine months ended September 30, 2017, net sales of sensors increased 16.2% when compared to the nine months ended September 30, 2016.  The increase was largely due to an 18.7% increase in volume.  Volume increased in part due to increased order volume from the Company’s top sensor customers.  Volume also increased in part due to the timing of shipments, versus the recognition of revenue, related to supply agreements with certain foreign customers entered into in the third quarter of 2016.  Additionally, silver surcharge billed increased due to increased volume. 



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Additionally, for the nine months ended September 30, 2017, net sales of thermoplastic injection molding increased 2.4% when compared to the nine months ended September 30, 2016.  The increase was due in part to increased sales volume of automotive components as well as increased sales volume of military and law enforcement components when compared to the same period in 2016. 



The increase in net sales for the nine months ended September 30, 2017, was partly offset by a 15.2%  decrease in net sales of machined orthopedic implant components and instruments when compared to the same period in 2016.  The decrease was due in part to reduced orders from one customer as a result of relabeling of product to a longer expiration date.  The decrease is also due to reduced demand of femoral components from one customer which vertically integrated beginning in the third quarter of 2016.  Partially offsetting the decrease was new business from new customers for which the Company has expanded its machining operations to include surgical instrumentation including cutting guides, as well as hip stems, keel trays and other orthopedic components beginning in the second quarter of 2016.



Gross Profit







The decrease in consolidated gross profit for the three months ended September 30, 2017 versus the prior year was due primarily to a decrease in gross profit from machined orthopedic implant components and instruments as well as thermoplastic injection molding,  partly offset by an increase in gross profit from sensors.

 

The decrease in gross profit for the three months ended September 30, 2017 was primarily due to a 45.9% decrease in gross profit from machined orthopedic implant components and instruments as compared to the same period in 2016.  The decrease was due in part to decreased sales due to lower demand from two customers, as noted above.  The decrease was also due in part to the Company offering aggressive initial pricing to secure new customers, as well the impact of reworking many of the related parts, as the Company refined its production process.   The increased costs included costs related to increased scrap, tooling, labor, rework, expediting charges from suppliers, shift premiums and overtime, in order to meet customer delivery requirements.  Gross margin as a percent of sales decreased 10.3 percentage points due to this rework and the investments in these new customers.



The decrease in gross profit for the three months ended September 30, 2017 was also due to a 15.4% decrease in gross profit from thermoplastic injection molding due largely to decreased sales volume from customers in the automotive industry.  Gross margin as a percent of sales decreased 3.0 percentage points due to customer and product mix.



The decreases in gross profit above were partially offset by an increase in sensors gross profit of 16.6% for the three months ended September 30, 2017 when compared to the same period last year.  The increase was due in part to certain production efficiency enhancements implemented in the third quarter of 2017 as well as increased volume from certain customers.  The increase was partly offset by price concessions resulting in margin deterioration.  Additionally, while net sales from silver surcharge billed increased based largely on volume, gross profit from silver surcharge billed decreased 11.2% due in part to the decrease in the weighted average cost of silver when compared to the same period last year. 



The decrease in gross profit above for the three months ended September 30, 2017 versus the prior year period was also partly offset as a result of  an 8.1% decrease in expenses for other indirect manufacturing overhead departments.     The lower expenses were due largely to lower engineering, mold shop maintenance and material handling expenses, partly offset by increased quality department expenses versus the same period in the prior year.







The decrease in consolidated gross profit for the nine months ended September 30, 2017 versus the prior year was due primarily to a decrease in gross profit from machined orthopedic implant components and instruments as well as thermoplastic injection molding, partly offset by an increase in sensors.



The decrease in gross profit for the nine months ended September 30, 2017 was primarily due to a 61.2% decrease in gross profit from machined orthopedic implant components and instruments as compared to the same period in the prior year.  The decrease was due in part to decreased sales due to lower demand from two customers, as noted above.  The decrease was also due in part to aggressive initial pricing to secure new customers, as well as the impact of reworking many of the related parts, as the Company refined its production process.  The increased costs included costs related to increased scrap, tooling, labor, rework, expediting

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charges from suppliers, shift premiums and overtime, in order to meet customer delivery requirements.  Gross margin as a percent of sales decreased 13.6 percentage points due to these investments in new customers.



The decrease in gross profit for the nine months ended September 30, 2017 was also due to a 6.6% decrease in gross profit from thermoplastic injection molding due largely to customer and product mix.  Gross margin as a percent of sales decreased 3.0 percentage points.



The decrease in gross profit for the nine months ended September 30, 2017 was partly offset by a 2.5% increase in sensors due largely to increased sales volume, partly offset by price concessions resulting in margin deterioration.  Gross margin as a percent of sales decreased 2.2 percentage points due to the aforementioned price concessions.



The decrease in gross profit above for the nine months ended September 30, 2017 versus the prior year period was also partly the result of a 15.1% increase in expenses for other indirect manufacturing overhead departments.   The higher expenses were due largely to higher quality expenses, largely associated with the machining product line, as well as higher mold shop maintenance and repairs due to an increase in machine utilization requirements as a result of increased volume of sensors and thermoplastic injection molding. 



Selling and Marketing



The Company's consolidated selling and marketing expenses amounted to $171,304  (3.5% of net sales) for the three months ended September 30, 2017 as compared to $303,279  (6.4% of net sales) for the three months ended September 30, 2016,  a decrease of $131,975, or 43.5%.  For the three months ended September 30, 2017, the decrease was primarily due to decreased compensation of $103,520 as a result of the departure of a sales person and customer service representative in the first quarter of 2017 and an additional sales person in the third quarter of 2017.  Additionally, commissions were lower by $30,137 due in part to fewer sales persons and due in part to the mix of commissionable parts.  Additionally, travel, advertising and marketing expenses were lower by $10,714 due to less travel and reduced attendance at trade shows.  Partially offsetting the decreases was an increase in professional services of $13,990 related to the development of an online marketing and lead generation program.



For the nine months ended September 30, 2017, the Company's consolidated selling and marketing expenses amounted to $671,997 (4.3% of net sales) as compared to $900,189  (6.1% of net sales) for the nine months ended September 30, 2016, a decrease of $228,192, or 25.3%.  For the nine months ended September 30, 2017, the decrease was primarily due to decreased compensation of $202,978 as a result of the departure of a sales person and customer service representative in the first quarter of 2017 and an additional sales person in the third quarter of 2017.  Additionally, commissions were lower by $45,769 due in part to fewer sales persons and the mix of commissionable parts.  Additionally, travel expenses were lower by $18,913 due in part to two fewer sales people and reduced attendance at trade shows.  Partly offsetting these decreases were increased marketing and advertising expenses related to trade shows, web site enhancements and the development of an online marketing and lead generation program.



General and Administrative



The Company's consolidated general and administrative expenses increased to $614,082  (12.5% of net sales) for the three months ended September 30, 2017 as compared to $482,115  (10.2%  of net sales) for the same period 2016,  an increase of $131,967, or 27.4%. 



The increase in general and administrative expenses for the three months ended September 30, 2017 compared to 2016 is due in part to non-recurring charges of $77,606 related to outside consulting services.  The increase was also due to an increase of $39,068 in bad debt expense, due to the prior year impact of insurance proceeds received related to collections of an outstanding insured receivable.  In addition, professional fees and consulting services increased $16,898 related to financial reporting and outsourcing the environmental, health and safety function partly offset by lower legal fees.  Additionally, compensation expense increased $10,360 due primarily to replacement hires and general and products liability insurance increased $9,018 due in part to increased premiums related to military and law enforcement operations and directors’ and officers’ insurance.  The increases were partly offset by decreases in office and computer supplies, investor relations and other expenses.



The Company’s consolidated general and administrative expenses increased to $1,783,590 (11.5% of net sales) for the nine months ended September 30, 2017, as compared to $1,664,182  (11.2% of net sales) for the same period 2016,  an increase of $119,408, or 7.2%.    



The increase in general and administrative expenses for the nine months ended September 30, 2017 compared to 2016 is due in part to non-recurring charges of $77,606 related to the outside consulting services in the third quarter of 2017.  The increase was also due to an increase of $95,635 of compensation expense due in part to the timing of replacement hires in accounting, IT and administration. Directors’ fees increased $39,750 due to the Board foregoing its fees for the second quarter of 2016.  Bad debt expense increased $27,951 due primarily to the prior year impact of insurance proceeds received related to collections of an outstanding insured receivable.  General and product liability insurance increased $18,661 due in part to increased premiums related to military

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and law enforcement operations and directors’ and officers’ insurance.  Additionally, accounting and other professional fees increased $44,153 due to financial reporting and outsourcing the environmental, health and safety function.



The increases in general and administrative expenses for the nine months ended September 30, 2017 as compared to 2016, were partly offset by a decrease of $60,212 in legal fees due in part to the prior year impact of corporate governance and shareholder relations matters, as well as a decrease of $51,600 in recruiting agency fees for three hires in 2016.  Investor relations expenses also decreased $24,706 when compared to the prior year period.



Research and Development



The Company's consolidated research and development expenses increased to $26,787  (0.5% of net sales) for the three months ended September 30, 2017 as compared to $24,534  (0.5% of net sales) for the three months ended September 30, 2016, an increase of $2,253, or 9.2%.  Research and development expenses increased to $84,427 for the nine months ended September 30, 2017 (0.5% of net sales) as compared to $74,792 for the nine months ended September 30, 2016, an increase of $9,635 or 12.9%.  The increases for the three and nine months ended September 30, 2017 and 2016, respectively, are due largely to an increase in compensation expense.



Other Expense, net



Other expense, net decreased to $60,939 for the three months ended September 30, 2017, as compared to $69,394, for the three months ended September 30, 2016, a decrease of $8,455.  The decrease in other expense, net was due largely to other income of $24,000 related to extension fees related to the real estate held for sale, partly offset by an increase in interest expense of $14,239, due to higher principal balances outstanding on the revolver.



For the nine months ended September 30, 2017, other expense, net decreased to $178,199 as compared to $192,063 for the nine months ended September 30, 2016, a decrease of $13,864.  The decrease in other expense, net was due largely to other income of $36,000 related to extension fees related to the real estate held for sale, as well as $21,750 of gains on the sale of fixed assets, partially offset by an increase of $42,073 of interest expense due to higher principal balances outstanding on the revolver.



Income Tax Provision



The tax provisions for the three and nine months ended September 30, 2017 and 2016 attributable to the U.S. federal and state income taxes are zero. The Company’s combined federal and state effective income tax rate from continuing operations for both the three and nine months ended September 30, 2017 and 2016 of 0% is due to the deferred tax assets being 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, 2017 was $0.06 per share as compared to $0.02 per share for the same period in 2016, an increase in loss per share of $0.04. The increase in loss per share for the three months ended September 30, 2017, is due largely to a decrease of $118,515 in gross profit despite a $194,965 increase in net sales compared to the prior year period. 



Consolidated basic and diluted loss per share for the nine months ended September 30, 2017 was $0.35 per share as compared to $0.14 per share for the same period in 2016, an increase in loss per share of $0.21. The increased loss per share for the nine months ended September 30, 2017, is due largely to a decrease of $713,173 in gross profit despite a $738,374 increase in net sales compared to the prior year period. 



Off-Balance Sheet Arrangements



Lease expense under all operating leases was approximately $6,625 and $4,615 for the three months ended September 30, 2017 and 2016, respectively, and were approximately $22,222  and $23,651 for the nine months ended September 30, 2017 and 2016, respectively.

 

Liquidity and Capital Resources



Working capital was $(1,014,292) as of September 30, 2017, as compared to $1,530,773 at December 31, 2016, a decrease of $2,545,065.  The decrease in working capital is due largely to the reclassification of $1,630,593 of term notes from long term to short term as a result of the non-compliance with the debt service coverage ratio covenant at June 30, 2017, and the Company entering into a forbearance agreement with its bank.  The decrease is also due to an increase of $1,284,205 in the revolver.  Cash and cash equivalents were $524,606 and $380,381 at September 30, 2017 and December 31, 2016, respectively, an increase of $144,225.  Substantially all of these funds are maintained in bank deposit accounts.

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Trade accounts receivable, net of allowance for doubtful accounts were $2,898,677 and $2,276,608 at September 30, 2017 and December 31, 2016, respectively, an increase of $622,069.  The increase is due largely to higher shipments at the end of the third quarter of 2017.



Inventories were $3,214,157 as of September 30, 2017, as compared to $3,060,085 at December 31, 2016, an increase of $154,072.  The increase was due largely to an increase in work-in-process inventory of $134,985.



Accounts payable were $1,711,661 and $1,744,261 at September 30, 2017 and December 31, 2016, respectively, a decrease of  $32,599 due largely to the timing of disbursements.  Other non-current liabilities decreased $156,953 from a decreased in long term deferred revenue.  Additionally, deferred revenue, current portion decreased $102,099. 



Accrued expenses and other current liabilities increased  $123,222 for the nine months ended September 30, 2017 as compared to December 31, 2016 due largely to an increase in payroll accruals based on timing of quarter end.  Other non-current assets decreased $147,085 as a result of a decrease in prepaid cost of goods sold related to deferred tooling revenue.    In addition, customer deposits increased $138,143 related to tooling. 

 

Capital equipment expenditures were $868,716 for the nine months ended September 30, 2017, due to investments in machinery and equipment primarily for the contract manufacturing of machined orthopedic implants and instruments as well as thermoplastic injection molding as compared to $1,069,325 in the same period in 2016.



At September 30, 2017, the Company’s total debt was $6,136,027 as compared to $4,778,637 at December 31, 2016, an increase of $1,357,390.  The increase is due largely to $1,284,205 in net borrowing from the revolver and $402,281 of borrowings from the equipment line of credit to fund working capital and finance investments in capital equipment, respectively, partially offset by payments of $381,682 on term debt. 



At September 30, 2017, total outstanding balance of the Company’s term debt was $2,093,133 as compared to $2,458,331 at December 31, 2016, a decrease of $365,198.



The Company has a multi-year credit facility with a Massachusetts based bank.  At September 30, 2017, this credit facility consisted of a revolving line of credit (the "revolver"), a commercial term loan and an equipment line of credit (“equipment line”).  The bank facility contains both financial and non-financial covenants, and is secured by substantially all assets of the Company with the exception of real property. 



Due to a non-compliance with the debt service coverage ratio covenant at June 30, 2017, the Company and the bank entered in to a forbearance agreement on September 29, 2017.  Under the agreement the bank agreed to forbear from collections on all outstanding debt prior to March 31, 2018, provided no further events of default occur, and agreed to extend the revolver to March 31, 2018 subject to certain modifications of the agreement.  Should a further event of default occur, the bank has the right to demand payments of all notes. 

The revolver provides for borrowings up to 80% of eligible accounts receivable and 50% of eligible raw materials inventory.  The interest rate on the revolver is calculated at the bank's prime rate plus 1.00% (5.25% at September 30, 2017). The revolver has a maturity date of March 31, 2018.   Amounts available to borrow under the revolver are $95,767 at September 30, 2017. 



The commercial term loan has a remaining principal balance of $2,078,006, net of debt issuance costs of $29,374, at September 30, 2017 and matures in November 2021.  The interest rate on the loan is a fixed 4.65% per annum and the loan requires monthly payments of principal and interest of approximately $46,500.



In November 2016, the Company entered into the equipment line that allows for advances of up to $1.0 million under the Company's multi-year credit facility. The term of this equipment line is six years, maturing in November 2022, inclusive of a maximum one-year draw period. Repayment shall consist of monthly interest only payments, equal to the bank's prime rate plus 0.25% as to each advance commencing on the date of the loan through the earlier of: (i) one year from the date of the loan or (ii) the date upon which the equipment line is fully advanced (the “Conversion Date”). On the Conversion Date, principal and interest payments will be due and payable monthly in an amount sufficient to pay the loan in full based upon an amortization schedule commensurate with the remaining term of the loan. 



Pursuant to the Company’s September 29, 2017 agreement with the bank, the bank terminated the availability of further advances under the equipment line rather than expiration thereof in November 2017 at which time the equipment line will convert into a five-year term note.    At September 30, 2017, $504,781 has been drawn on the equipment line of credit.  At December 31, 2016, $102,500 had been drawn on the equipment line of credit.



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The credit facility contains both financial and non-financial covenants. The financial covenants include maintaining certain debt service coverage and leverage ratios. The non-financial covenants relate to various matters including notice prior to executing further borrowings and security interests, mergers or consolidations, acquisitions, guarantees, sales of assets other than in the normal course of business, leasing, changes in ownership and payment of dividends. 



As of the June 30, 2017 testing date, the Company was in compliance with the terms of the credit facility except with respect to the debt service coverage ratio covenant.  As a result of the non-compliance, the Company entered into the September 29, 2017 agreement with the bank whereby, among other things, the bank agreed to forbear collections of all outstanding debt, prior to March 31, 2018.  In addition, the bank agreed to modify the debt service coverage ratio calculation for the September 30, 2017 measurement date.  The Company is in compliance with this revised third quarter 2017 covenant calculation.      



In January 2013, the Company entered into two equipment notes totaling $272,500 with a financing company to acquire production equipment. The notes bear interest at the fixed rate of 4.66% and require monthly payments of principal and interest of approximately $5,000 over a five year term maturing in January 2018.



In December 2013, the Company completed a private offering in which the Company sold an aggregate of $500,000 in subordinated promissory notes. The unsecured notes required quarterly interest-only payments at a rate of 10% per annum for the first two years.  In December 2015, the interest rate increased to 12% per annum.  Three related parties participated in the private offering as follows:  REF Securities, LLP, and with Mr. Rodd E. Friedman, a director of the Company since July 21, 2017, a  beneficial owner of approximately 13% of the Company’s common stock, invested $100,000 in the offering; the Chambers Medical Foundation (the “Foundation”), beneficial owner of approximately 10% of the Company’s common stock, invested $100,000 in the offering; and Mr. E.P. Marinos, a director, invested $50,000 in the offering.  The Company’s Chairman of the Board is a co-trustee of the Foundation but has held no dispositive powers since his appointment as such. 



In October 2016, the Company and six of the seven investors in the private offering, aggregating $450,000 of the notes, including the three related parties holding $250,000 of the notes, agreed to extend the maturity dates of the notes to December 31, 2018 at a rate of 10% per annum.  One investor did not extend the maturity date and that $50,000 note was paid at maturity in December 2016.  The notes are subordinated to all indebtedness of the Company pursuant to its multi-year bank credit facility. Pursuant to the subordination agreements entered into among the bank, each of the note holders and the Company upon issuance of the subordinated notes, quarterly interest payments to the note holders have been deferred due to the non-compliance with the debt service coverage ratio covenant until such time as the bank otherwise permits resumption thereof.



No dividends were declared or paid in the nine months ended September 30, 2017 and 2016.  



The Company believes that based upon the continued results of cost savings measures and improvements as noted above, cash forecasts, the expected fulfillment of booked orders from existing customers and new customer prospects, and the extension of the Company’s credit facility to March 31, 2018, the Company expects to continue to meet its obligations for the next twelve months.  Additionally, management continues to work with its bank under the extended credit facility while exploring alternative financing arrangements.  The financial statements do not include any adjustment that might result from the outcome of such uncertainties.



Summary of Changes in Cash Position



As of September 30, 2017, the Company had cash on hand of $524,606. For the nine months ended September 30, 2017, net cash used in operating activities was $297,156.  Net cash used in investing activities for the nine months ended September 30, 2017 was $863,423. Net cash provided by financing activities for the nine months ended September 30, 2017 was $1,304,804.  The net cash flows for the nine months ended September 30, 2017 are discussed in further detail below.



Operating Cash Flows 



For the nine months ended September 30, 2017, net cash used in operating activities was $297,156. Cash used in operating activities was primarily impacted by the net loss of $990,757 as well as an increase of $638,069 in accounts receivable,  an increase in inventory of $154,072, a decrease in other non-current liabilities of $156,953, as well as a decrease in deferred revenue, current portion, of $102,099.



These uses of cash were partly offset by non-cash add-backs for depreciation and amortization of $1,208,872, share-based compensation of $84,750, non-cash interest expense of $23,211 and an increase of $16,000 in the allowance for doubtful accounts.  Cash was provided by an increase of $123,222 in accrued expenses and other current liabilities, an increase in customer deposits of $138,143, a decrease of $147,085 in other non-current assets and a decrease in prepaid expenses and other current assets of $57,860.



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Investing Cash Flows



For the nine months ended September 30, 2017, net cash used in investing activities was $863,423. The net cash used was largely for capital expenditures of $868,716, largely for machinery and equipment, primarily for the contract manufacturing of orthopedic implants and instruments as well as thermoplastic injection molding.



Financing Cash Flows



For the nine months ended September 30, 2017, net cash provided by financing activities was $1,304,804. Cash was provided by net proceeds of $1,284,205 from the Company's revolver and proceeds of $402,281 from the equipment line of credit.  These proceeds were partly offset by payments on term notes payable of $381,682.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk



Not Applicable.



Item 4.  Controls and Procedures



Evaluation of Disclosure Controls and Procedures



Our principal executive officer and principal financial officer (“the Certifying Officers”) have evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)).  Based on such evaluation, our Certifying Officers have concluded the Company's disclosure controls and procedures, as of the end of the period covered by this report, were effective.



The effectiveness of a system of disclosure controls and procedures is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of internal controls, and fraud. Due to such inherent limitations, there can be no assurance that any system of disclosure controls and procedures will be successful in preventing all errors or fraud, or in making all material information known in a timely manner to the appropriate levels of management.



Changes in Internal Control over Financial Reporting



During the three months ended September 30, 2017 there have been no changes in the Company's internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

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PART II - OTHER INFORMATION



Item 6. Exhibit Index







 

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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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