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.
Any forward-looking statements made herein are based on current expectations of the Company that involve a number of risks and uncertainties and should not be considered as guarantees of future performance. These statements are made under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the use of words such as “expect,” “anticipate,” “believe,” “intend,” “plans,” “predict,” or “will”. Although the Company believes that expectations are based on reasonable assumptions, management can give no assurance that the expectations will materialize. Many factors could cause actual results to differ materially from the Company’s forward-looking statements. These factors include the following, among other matters: the Company's ability to obtain and retain order volumes from customers who represent high proportions of revenue; the Company's ability to maintain the pricing model, offset higher costs with price increases and/or decrease the cost of sales; the variability of customer delivery requirements and the ability of the Company to anticipate and respond thereto; the level of sales of higher margin products and services and the Company's ability to increase such sales; volatility in commodity and energy prices; the Company's level of debt and provisions in the debt agreements which could limit the Company's ability to react to changes in the economy or its industry; the Company's ability to comply with the financial and other covenants contained in its credit agreement, including as a result of events beyond its control, which could result in an event of default; the Company’s reliance on revenue from exports and the impact on the Company’s financial results due to economic uncertainty, changes in trade policy and tariffs, tax laws and regulations, or downturns in foreign markets; and continued availability of supplies or materials used in manufacturing at competitive prices. 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.
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, 2018, 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, 2018.
Liquidity and Management’s Plan
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.
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 negative financial history and the current liquidity position, including $503 of cash as of September 30, 2019 and approximately $1,000,000 of borrowing capacity on its revolving line of credit with Rockland Trust (the “Revolver”). Management has performed an analysis to evaluate the entity’s ability to continue as a going concern for one year after the financial statements issuance date.
Management’s analysis includes forecasting future revenues, expenditures 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, its implementation of production efficiencies, and to improve overall financial performance. In addition, the Company has amended its bank debt agreement to eliminate its debt service coverage covenant for the three months ended September 30, 2019.
Based on management’s analysis, the Company believes that cash flows from its operations, together with its existing working capital, booked orders, expense management, and availability on its Revolver will be sufficient to fund operations at current levels and repay debt obligations over the next twelve months from the financial statements issuance date. However, there can be no assurance that the Company will be able to do so.
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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2019
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2018
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2019
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2018
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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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88.1
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85.3
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87.9
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84.8
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Gross profit
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11.9
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14.7
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12.1
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15.2
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Selling and marketing
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3.9
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3.8
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3.5
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3.8
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General and administrative
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16.2
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10.2
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16.4
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10.6
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Research and development
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0.6
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0.5
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0.6
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0.5
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Other expense
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2.9
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1.8
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2.4
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1.7
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Loss before income tax provision (benefit)
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(11.7)
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(1.6)
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(10.8)
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(1.4)
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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 income (loss)
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(11.7)
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%
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(1.6)
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%
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(10.8)
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%
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(1.4)
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%
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Net Sales
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Net sales
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2019
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2018
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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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4,331,280
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$
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5,001,660
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$
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(670,380)
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(13.4)%
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Net sales
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2019
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2018
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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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13,909,101
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$
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15,441,134
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$
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(1,532,033)
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(9.9)%
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The decrease in consolidated net sales for the three months ended September 30, 2019 versus the prior year period was due primarily to a decrease in net sales of sensors, and lesser decreases for thermoplastic injection molding and tooling.
The decrease in consolidated net sales for the nine months ended September 30, 2019 versus the prior year period was due primarily to a decrease in net sales of sensors and lesser decreases for machined components and thermoplastic injection molding, partially offset by increased tooling sales.
Gross Profit
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Gross profit
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2019
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2018
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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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517,398
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$
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735,024
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$
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(217,626)
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(29.6)%
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As a percentage of sales
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11.9%
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14.7%
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Gross profit
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2019
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2018
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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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1,681,671
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$
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2,344,204
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$
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(662,533)
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(28.3)%
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As a percentage of sales
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12.1%
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15.2%
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The decrease in consolidated gross profit for the three months ended September 30, 2019 versus the prior year period was due primarily to decreased gross profits for sensors and lesser decreases for thermoplastic injection molding and tooling.
Gross profit expressed as a percentage of sales from sensors and thermoplastic injection molding decreased by 38% and 6.6%, respectively. Gross profit as a percentage of sales from machined components increased by 68%.
The decrease in consolidated gross profit for the nine months ended September 30, 2019 versus the prior year period was due to decreased gross profits for sensors and for machined components.
Gross profit expressed as a percentage of sales from machined components decreased 48%. Gross profit as a percentage of sales from sensors decreased by 29%.
Selling and Marketing
The Company's consolidated selling and marketing expenses amounted to $170,065 (3.9% of net sales) for the three months ended September 30, 2019 as compared to $189,031 (3.8% of net sales) for the three months ended September 30, 2018, a cost decrease of 10.0%. For the three months ended September 30, 2019, the decrease was primarily due to lower marketing and consulting costs. Compensation was also lower due to the departure of a salesperson in the first quarter 2019.
The Company's consolidated selling and marketing expenses amounted to $486,450 (3.5% of net sales) for the nine months ended September 30, 2019 as compared to $583,606 (3.8% of net sales) for the nine months ended September 30, 2018, a decrease of 16.6%. This decrease was primarily due to lower marketing and consulting costs. Compensation was also lower due to the departure of a salesperson in the first quarter 2019.
General and Administrative
The Company's consolidated general and administrative expenses was $700,622 (16.2% of net sales) for the three months ended September 30, 2019 as compared to $509,179 (10.2% of net sales) for the three months ended September 30, 2018, an increase of $191,443, or 37.6%.
The increase in general and administrative expenses for the three months ended September 30, 2019 when compared to the same period in 2018 is due primarily to costs incurred associated with management and personnel restructuring and professional fees.
The Company's consolidated general and administrative expenses was $2,283,562 (16.4% of net sales) for the nine months ended September 30, 2019 as compared to $1,642,305 (10.6% of net sales) for the nine months ended September 30, 2018, an increase of $641,257, or 39%.
The increase in general and administrative expenses for the nine months ended September 30, 2019 when compared to the same period in 2018 is due primarily to costs incurred associated with management and personnel restructuring, the recording of severance pay for the outgoing COO, consulting services, and professional fees.
Research and Development
The Company's consolidated research and development expenses were level for the three months ended September 30, 2019 as compared to the three months ended September 30, 2018, at $26,578 and $25,372, respectively.
The Company's consolidated research and development expenses were level for the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018, at $80,357 and $80,094, respectively.
Other Expense, net
Other expense, net increased to $127,110 for the three months ended September 30, 2019, as compared to $88,613, for the three months ended September 30, 2018, an increase of $38,497. The increase in other expense, net was due to an $8,336 increase in interest expense, $12,000 received in 2018 in extension fees related to the sale of the buildings, and other miscellaneous costs, net of a gain on the sale of fully depreciated fixed assets.
Other expense, net increased to $328,010 for the nine months ended September 30, 2019, as compared to $261,334, for the nine months ended September 30, 2018, an increase of $66,677. The increase in other expense, net was due to a $38,085 increase in interest expense, $32,000 received in 2018 in extension fees related to the sale of the buildings, and other miscellaneous costs, net of a gain on the sale of fully depreciated fixed assets
Income Tax Provision
The tax provisions for the three months and nine months ended September 30, 2019 and 2018 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 months and nine months ended September 30, 2019 and 2018 of 0% is due to 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, 2019 was $0.18 per share as compared to a loss per share of $0.03 for the same period in 2018, an increase in loss per share of $0.15. The increase in loss per share for the three months ended September 30, 2019, is due in part to decreased net sales of $670,380, decreased gross profit of $217,626 and an increase of $173,683 in operating expenses.
Consolidated basic and diluted loss per share for the nine months ended September 30, 2019 was $0.52 per share as compared to a loss per share of $0.08 for the same period in 2018, an increase in loss per share of $0.44. The increase in loss per share for the nine months ended September 30, 2019, is due in part to decreased net sales of $1,532,033, decreased gross profit of $662,533 and an increase of $544,362 in operating expenses.
Off-Balance Sheet Arrangements
Lease expense under all operating leases for the three months ended September 30, 2019 and 2018 was $4,713 and $6,056, respectively. Lease expense for the nine months ended September 30, 2019 and 2018 was $15,900 and $17,977, respectively.
Liquidity and Capital Resources
Working capital was $2,325,095 as of September 30, 2019, as compared to $2,455,498 at December 31, 2018, a decrease of $130,403. The decrease in working capital is due primarily to inventory reductions partially offset by decreases in the Revolver, accounts payable, and contract liabilities.
Trade accounts receivable, net of allowance for doubtful accounts, were $2,379,496 and $2,325,804 at September 30, 2019 and December 31, 2018, respectively, an increase of $53,692.
Inventories decreased by $1,045,674 from December 31, 2018 to $2,639,385 as of September 30, 2019 due to the reduction of tooling in process related to tooling sales and ongoing efforts to reduce inventory levels.
Accounts payable decreased from December 31, 2018 to September 30, 2019 by $588,531, partially offset by a $320,092 increase in accrued expenses. The increase in accrued expenses and other current liabilities was primarily due to a severance arrangement with the former Chief Operating Officer of the Company, incentive compensation accruals, and increased accrued commissions for new programs including amounts for new outside sales representatives. Contract liabilities decreased by $536,079 due to the revenue recognition of several closed tooling projects.
Capital equipment expenditures of $161,928 for the nine months ended September 30, 2019 were primarily for robotic automation in custom molding.
At September 30, 2019 the Company’s total debt was $5,284,125 as compared to $5,972,470 at December 31, 2018, a decrease of $688,345. The decrease in total debt is due to payments made on the Revolver and on Term Notes, offset by $500,000 in proceeds from the issuance of subordinated notes issued in July 2019.
Amounts available to borrow under the Revolver are $1,013,270 at September 30, 2019.
No dividends were declared or paid in the three and nine months ended September 30, 2019 and 2018.
The Company believes that cash flows from its operations, together with its existing working capital, booked orders, expense management, and its Revolver, 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, 2019, the Company had cash on hand of $503, as the Company’s cash is swept daily against the Revolver in accordance with the Company’s credit agreement. For the nine months ended September 30, 2019, cash provided by operating activities was $171,084. Net cash provided by investing activities for the nine months ended September 30, 2019 was $534,008. Net cash used in financing activities for the nine months ended September 30, 2019 was $706,304. The net cash flows for the nine months ended September 30, 2019 are discussed in further detail below.
Operating Cash Flows
For the nine months ended September 30, 2019, net cash provided by operating activities was $171,084, primarily the result of the net loss, decreases in accounts payable and contract liabilities offset by cash provided from decreases in inventory and by increases in accrued expenses and other current liabilities as well as non-cash addbacks, primarily depreciation and amortization.
Investing Cash Flows
For the nine months ended September 30, 2019, net cash provided by investing activities was $534,008. Proceeds from the sale of vacant buildings plus some fully depreciated equipment provided $695,936, offset by $161,928 in cash used for capital expenditures, primarily internal tooling and robotic automation for custom molding.
Financing Cash Flows
For the nine months ended September 30, 2019, net cash used by financing activities was $706,304 consisting of Revolver and term note repayments of $1,206,304, offset by $500,000 received from the issuance of subordinated notes payable.