It
em
2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements that involve a number of risks and uncertainties. There are a number of factors that could cause the Company’s actual results to differ materially from those forecasted or projected in such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company is under no obligation and does not intend to update, revise or otherwise publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of any unanticipated events. More information about factors that potentially could affect the Company's financial results is included in the Company's filings with the SEC, including its Annual Report on Form 10-K for the year ended
December 31, 2015
.
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, 2015
, 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, 2015
.
Overview
Arrhythmia Research Technology
®
, Inc., a Delaware corporation ("ART"), through its wholly-owned Massachusetts subsidiary, Micron Products
®
, Inc. (“Micron” and together with ART, 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 and patient-specific finished orthopedic implant components. The Company has custom thermoplastic injection molding capabilities as well, and provides a full array of design, engineering, production services and management. The Company competes globally, with
more than
forty percent of its revenue derived from exports.
The Company's subsidiary, RMDDxUSA Corp. and its Prince Edward Island subsidiary RMDDx Corporation (collectively "WirelessDx"), discontinued operations in 2012, filed for relief under Chapter 7 (Liquidation) of the United States Bankruptcy Code in May 2014 and in March 2015, the Chapter 7 Order was formally discharged and the case was closed.
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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March 31,
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2016
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%
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2015
|
%
|
Net sales
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100.0
|
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100.0
|
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Cost of sales
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86.3
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86.4
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Gross profit
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13.7
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13.6
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Selling and marketing
|
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5.9
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4.4
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General and administrative
|
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13.9
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11.1
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Research and development
|
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0.5
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1.6
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Other expense
|
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1.2
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0.9
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Income (loss) from continuing operations before
income taxes
|
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(7.8)
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(4.4)
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Income tax provision
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—
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—
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Income (loss) from continuing operations
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(7.8)
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(4.4)
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Income from discontinued operations
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—
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6.2
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Net (loss) income
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(7.8)
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%
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1.8
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%
|
Net Sales
The Company's consolidated net sales for the
three months ended March 31, 2016
was
$4,983,281
, a
decrease
of
$875,061
, or
14.9%
, when compared to the consolidated net sales of
$5,858,342
for the
three months ended March 31, 2015
.
The
decrease
in net sales for the
three months ended March 31, 2016
was due to a decrease in
net
sensor
sale
s
and net sales of orthopedic implant components, partially offset by increased sales of custom thermoplastic injected molding.
Net sales of sensors decreased 18.2% for the three months ended March 31, 2016 when compared to the same period last year. While sensor volume increased 12.6% over the same quarter last year, net sales decreased due to customer mix, product mix and the industry’s continuing trend toward smaller parts. S
ilver surcharge billed decreased
24.1
% due
in part
to
the industry trend toward smaller parts and less silver as well as a
12.1%
decrease in the weighted average price of silver for the three months ended
March
3
1
, 201
6
, as compared to the same period in 201
5
.
Additionally, net sales of orthopedic implant component
s
for the three months ended March 31, 2016 decreased 25.1% due to
lower than expected volume from a large customer as compared to the same period in 2015, as well as product mix.
The decrease in net sales
was
partially offset by a
3.0
% increase in net sales of
custom thermoplastic injection molding
for the three months ended
March
3
1
, 201
6
as compared to the same period in 201
5 due to increased order volume of medical and automotive components
.
Gross Profit
The Company's gross profit for the three months ended March 31, 2016 was $685,119, a decrease of $111,277, or 14.0%, when compared to gross profit of $796,396 for the same period in 2015. Gross profit as a percentage of sales for the three months ended March 31, 2016 increased to 13.7%, or 0.1 points from 13.6% for the three months ended March 31, 2015.
The decrease in gross profit was due to a 35.2%, decrease in gross profit from sensors which was due largely to price reductions as well as customer and product mix. Sensors gross profit as a percentage of sales decreased 4.9 points due primarily to the reduction in net sales and selling price. Additionally, gross profit from machined orthopedic implants decreased 19.6% largely due to lower volume combined with increased labor costs related to process validation efforts. However, machined orthopedic implants gross profit as a percentage of sales increased slightly, 1.2 points, due partly to product mix and improved efficiencies. Gross profit also decreased in part due to the timing of deferrals and the recognition of deferred revenue.
The decrease in gross profit was partially offset by a 7.7% increase in gross profit of custom thermoplastic injection molding for the three months ended March 31, 2016 when compared to the same period in 2015 due to increased demand of medical and automotive components. Custom thermoplastic injection molding gross profit as a percentage of sales increased 1.4 points due primarily to product mix. Also impacting gross profit was a decrease in expenses in the Quality and other manufacturing overhead departments as adjustments were made in part as a result of lower sales in the quarter. Quality and other manufacturing overhead expressed as a percentage of sales decreased to 8.9% for the three months ended March 31, 2016 as compared to 10.2% in the same period last year.
Selling and Marketing
The Company's consolidated selling and marketing expenses amounted to
$293,346
(
5.9%
of net sales) for the
three months ended March 31, 2016
as compared to
$257,972
(
4.4%
of net sales) for the
three months ended March 31, 2015
, a
n
increase
of
$35,374
, or
13.7%
.
For the
three months ended March 31, 2016
,
t
he
increase was primarily
due
to increased wages, taxes and benefits of $85,896 as a result of two additional salespersons hired in the fourth quarter of 2015. In addition, travel increased $3,480 due to trade shows and customer relations. The increase was offset by a decrease in c
ommissions
of $
29,405
as a result of
lower net sales as compared to the same period in the prior year
and a decrease in marketing expenses of $32,424
.
General and Administrative
The Company's consolidated general and admi
nistrative expenses in
creased to
$690,635
(
13.9%
of net sales) for the
three months ended March 31, 2016
as compared to
$648,227
(
11.1%
of net sales) for the
three months ended March 31, 2015
an increase
of
$42,408
, or
6.5%
.
The increase in general and administrative expenses is due primarily to $51,600 of recruiting agency fees related to the replacement of three positions. Legal fees increased $25,869 as compared to the prior year quarter. In addition, directors’ fees increased $20,000
as a result of adding two new Directors
in 2015 and
one in
February 2016.
These increases were partially offset by decreased wages, taxes and benefits of $25,780 due to the timing of replacement hires for three positions. In addition, consulting fees related to environmental, health and safety decreased $21,500 due to bringing this function in house. Additionally accounting related expenses decreased $14,211 due in part to savings realized from new SEC filing software.
There were multiple smaller variances in
computer supplies, bank fees, software expenses, stock based compensation and insurance on accounts receivable
for the three months ended March
3
1
, 201
6
versus the same period in the prior year.
Research and Development
The Company's consolidated research and development expenses decreased to
$25,843
(
0.5%
of net sales) for the
three months ended March 31, 2016
as compared to
$92,561
(
1.6%
of net sales) for the
three months ended March 31, 2015
, a
decrease
of
$66,718
, or
72.1%
. The
decrease
is due
in part to
decrease
d compensation
of
$24,615 due to reorganization as well as a
$
42,103
decrease in
internal research and development costs for the development of new products and capabilities related to medical device components
.
Other Expense
, net
Other expense, net in
creased to
$59,443
for the
three months ended March 31, 2016
, as compared to
$52,184
, for
three months ended March 31, 2015
, an in
crease of
$7,259
. The in
crease in other expense was
due to a gain on the sales of fixed assets of $11,029 in 2015 versus no sales in 2016. In addition, interest expense decreased $5,473 in 2016 as a result of continued pay down of term debt.
Income Tax Provision
The tax provisions for the
three months ended March 31, 2016 and 2015
attributable to the U.S. federal and state income taxes on our continuing operations
are zero
. The Company’s combined federal and state effective income tax rate from continuing operations for both the
three months ended March 31, 2016 and 2015
of
0%
is
due to the deferred tax assets
being fully
reserved for with a valuation allowance.
Income from Discontinued Operations
The Company's subsidiary, RMDDxUSA Corp. and its Prince Edward Island subsidiary RMDDx Corporation (collectively "WirelessDx"), discontinued operations 2012, filed for relief under Chapter 7 (Liquidation) of the United States Bankruptcy Code in 2014 and on March 20, 2015, the Chapter 7 Order was formally discharged and the case was closed.
For the three months ended March 31, 2015 net income of $362,610 was recorded from discontinued operations as a result of the write-off of the remaining liabilities of $320,056 and the reversal of accumulated other comprehensive income of $42,553 from cumulative translation adjustments from RMDDx Corporation.
Earnings (Loss) Per Share
Consolidated basic and diluted loss per share for the
three months ended March 31, 2016
was $0.1
4
per share as compared to basic and diluted earnings of $0.0
4
per share for the same period in 201
5
, a decrease of $0.1
8
per share. The decrease in earnings per share for the
three months ended March 31, 2016
, is due largely to the decreased gross profit in sensors
.
The basic and diluted earnings per share for the three months ended March 31, 2015 were impacted by income from discontinued operations of RMDDxUSA which received relief under Chapter 7 of the United States Bankruptcy Code and was formally discharged in March 2015.
Off-Balance Sheet Arrangements
T
he Company
has
two operating leases for office equipment. Lease expense under all operating leases was approximately $1,822 for the three ended
March 31
, 201
6 and 2015, respectively
.
Liquidity and Capital Resources
Working capital was
$2,520,332
as of
March 31, 2016
, as compared to
$2,509,588
at
December 31, 2015
, an
increase
of
$10,744
. The
increase
is due primarily to
an increase
in accounts receivable, which is mostly offset by increases in accounts payable, accrued expenses and other current liabilities and customer deposits.
Cash and cash equivalents were
$220,299
and
$272,291
at
March 31, 2016
and
December 31, 2015
, respectively, a
decrease
of
$51,992
. Substantially all of these funds are maintained in bank deposit accounts.
Trade accounts receivable were
$3,339,549
and
$2,798,353
at
March 31, 2016
and
December 31, 2015
, respectively, a
n
in
crease
of
$541,196
due in part to the
timing of an
increase in net sales for the month of March 2016
as compared to December 201
5.
Inventories were
$2,115,071
at
March 31, 2016
, as compared to
$2,118,712
at
December 31, 2015
, a
de
crease
of
$3,641
.
Accounts payable increased $
118,143
due
largely to the timing of disbursements.
Accrued expenses and other current liabilities increased $
98,993
as compared to
December 31, 2015
due largely to an increase of $79,461 for accruals for goods received not yet invoiced. Additionally, the Company accrued $20,950 in the first quarter 2016 related to customer rebates and recorded increased legal accruals of $17,536. These increases were partially offset by a $25,685 reduction in accrued commissions.
Customer deposits increased $266,255 due to an increase in tooling orders.
Capital equipment expenditures were
$373,259
for the
three months ended March 31, 2016
, due to investments in machinery and equipment primarily for the contract manufacturing of orthopedic implant components as well as
injection
molding equipment
as compared to $242,390 in the same period in 2015
.
At March 31, 2016
,
the Com
pany’s total debt was $4,363,865
as compared to $4,031,767 at December 31, 2015, an increase of $3
32,098
or 8.2%
due primarily to a net increase of $470,000 on the revolver
. The
total outstanding
balance
of the Company’s term debt decreased $144,82
3
to $1,565,46
4
at March 31, 2016
as compared to $1,710,287 at December 31, 2015. The Company also had a balance of
$336,850 on an equipment line of credit and $480,056 of subordinated promissory notes as discussed in more detail below.
The
Company
has
a multi-year credit facility with a Massachusetts bank. Under this credit facility
t
he
Company has a
revolving line of credit (the "revolver"), commercial term loan, two equipment term loans and an equipment line of credit as detailed below. The bank facility contains both financial and non-financial covenants, all of which the Company is in compliance with at
March
3
1
, 201
6
.
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 0.25% (3.
75
% at
March 31, 2016
). The balance outstanding on the revolver was $
1,981,495
as of
March 31, 2016
.
The revolver has a maturity date of
June 30, 2017.
Amounts available to borrow under the revolver are
$264,731
at March 31, 2016.
The commercial term loan has a five year term with a maturity date in March 2018. The interest rate on the loan is a fixed 4.25% per annum, and requires monthly payments of approximately $28,000. At
March 31, 2016
, the balance of the commercial term loan was $
638,199
.
The original equipment line of credit allowed for advances of up to $1.0 million and included a one-year draw period during which payments were interest only. The draw period ended March 29, 2014 and the then outstanding balance on the equipment line of credit of $740,999 was converted to a five-year term loan with monthly payments of approximately $14,000 consisting of principal and interest at a fixed rate of 4.65%. The balance of th
is
equipment term loan was $
465,36
8
as of
March 31, 2016
.
On June 26, 2014, the Company entered into an equipment line of credit that allowed for advances of up to $1.0 million and included a one-year draw period during which payments were interest only. The draw period ended June 26, 2015 and the then outstanding balance on the equipment line of credit of $415,785 was converted to an equipment term loan with a five-year term, maturing on of June 26, 2020. The equipment term loan requires monthly payments of approximately $8,000, consisting of principal and interest at a fixed rate of 4.67% beginning in July 2015.
The balance of th
is
equipment term loan was $
359,625
as of
March
3
1
, 201
6
.
On
June 19, 2015, the Company entered into a new equipment line of credit for $1.0 million under the Company's multi-year credit facility. At March 31, 2016, $336,850 has been drawn on the new equipment line of credit. The term of this equipment line of credit is six years, maturing on June 19, 2021, 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 of credit 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.
The borrowing agreement, under the bank facility as described above, contains both financial and non-financial covenants. The financial covenants include maintaining certain debt 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.
The Company is in compliance with all covenants at March 31, 2016.
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. The outstanding balance of these equipment notes at June 30, 2015 was $
102,272
.
In December 2013, the Company completed a private offering in which the Company sold an aggregate of $500,000 in subordinated promissory notes. The notes are unsecured and require quarterly interest-only payments at a rate of 10% per annum. On the second anniversary following issuance, the interest rate increases to 12% per annum. The notes mature in December 2016 at which point the outstanding balance is due in full. The subordinated promissory notes may be prepaid by the Company at any time following the first anniversary thereof without penalty. The notes are subordinated to all indebtedness of the Company pursuant to the bank credit facility.
In connection with the subordinated promissory notes, the Company issued warrants to purchase the Company's common stock at $3.51 per share. The warrants expire in December 2016. The proceeds were allocated between the notes and warrants on a relative fair value basis resulting in $416,950 allocated to the notes and $83,050 allocated to the warrants as part of Additional-Paid-in-Capital. The total discount on the notes is being recognized as non-cash interest expense over the term of the notes. For the
three months ended March 31, 2016 and 2015
, the Company recorded $
6,921
of non-cash interest expense related to the amortization of the discount. The unamortized discount which is net against the outstanding balance of the subordinated promissory notes is $
19,944
at
March 31, 2016
and $
26,865
at
December 31, 2015
.
No dividends were declared or paid in the
three months ended March 31, 2016 and 2015
.
The Company believes that cash flows from its operations, together with its existing working capital, the revolving line of credit and other resources, will be sufficient to fund operations at current levels and repay debt obligations over the next twelve months.
The Company continues to develop opportunities within new and existing channels where the Company can maximize its return on investments in capital equipment, research and development, marketing and human resources.
Summary of Changes in Cash Position
As of
March 31, 2016
, the Company had cash on hand of
$220,299
. For the
three months ended March 31, 2016
, net
cash
used in
operating activities was
$55,0
60
.
Net cash
used in
investing activities for the
three months ended March 31, 2016
was
$373,259
. Net cash
provided by
financing activities for the
three months ended March 31, 2016
was
$376,32
7
. All of the above were from continuing operations. The net cash flows for the
three months ended March 31, 2016
are discussed in further detail below.
Operating Cash Flows
For the
three months ended March 31, 2016
, net cash
used in
operating activities was
$55,060
due largely to the increase of $541,196 in accounts receivable due to increased sales in March 2016 when compared to sales in December 2015, and the timing of accounts receivable collections.
This increase was offset by net cash provided by accrued expenses and other current liabilities which
increased $
350,95
4
due in part to an increase of
$266,255 in customer deposits and an increase of
$
79,461
for inventory received but not invoiced at
March
3
1
, 201
6
as compared to December 31, 201
5.
Additionally,
as of March 31, 2016, there was an increase in accounts payable of
$
118,143
.
Cash provided by operating activities was also impacted by non-cash add-backs for depreciation and amortization of $
361,440, share-based compensation of $15,133 and non-cash interest expense of $6,921
.
Investing Cash Flows
For the
three months ended March 31, 2016
, net cash used in investing activities was
$373,259
. The net cash used was for capital expenditures of
$373,259
, largely for machinery and equipment, primarily for the contract manufacturing of orthopedic implant components as well as for molding equipment.
Financing Cash Flows
For the
three months ended March 31, 2016
, net cash
provided by
financing activities was
$376,32
7
. Cash was provided by
net
proceeds of $
470
,000 from the Company's revolver and offset by payments on term notes payable of $
144,823
. Additionally, there were proceeds of $
51,1
50
from the exercise of stock options.