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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
At March 31, 2017, the outstanding balance on the Company’s revolver under its credit facility was $2,610,795. The revolver has a maturity date of June 2017 (see Note 6
to the condensed, consolidated financial statements
). On May 9, 2017, the bank approved the renewal of the revolver for a one year term, expiring June 30, 2018 under substantially the same terms as the current revolver (see Note 10
to the condensed, consolidated financial statements
).
While the Company has experienced net losses in seven of its last nine quarters, the Company believes that the renewal of the revolver,
cash flows from its operations, together with its existing working capital, increased booked orders and other resources will be sufficient 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
T
he 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 new 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, t
he 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 revolver which matures in June 2017, negative financial history and the Company’s limited liquidity to meet the working capital needs to support the Company’s operations.
Similar conditions existed at March 31, 2017.
Management’s assessment included an analysis of the Company’s financial forecasts. Management’s assessment also considered the Company’s history of meeting financial covenants and being able to renew and refinance its debt obligations. Based on the renewal of the Company’s revolver
(see Note 10 to the condensed, consolidated financial statements)
, cash forecasts, expected
fulfillment of booked orders from existing customers, new customer prospects, and the closing on the sale of certain real estate held for sale, the Company expects to continue to meet its financial covenants and its obligations for the next year.
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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2017
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2016
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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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Cost of sales
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86.0
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86.3
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Gross profit
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14.0
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13.7
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Selling and marketing
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5.0
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5.9
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General and administrative
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11.7
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13.9
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Research and development
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0.6
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0.5
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Other expense
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0.8
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1.2
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Loss before income taxes
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(4.1)
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(7.8)
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Income tax provision
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—
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—
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Net loss
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(4.1)
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%
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(7.8)
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%
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Net Sales
The Company's consolidated net sales for the
three months ended March 31, 2017
was
$5,264,977
, a
n
in
crease of
$281,696
, or
5.7%
, when compared to the consolidated net sales of
$4,983,281
for the
three months ended March 31, 2016
. The
increase
in net sales for the
three months ended March 31, 2017
was due primarily to a
n
in
crease in net sales
of
thermoplastic injection molding
and
net tooling revenue, partially offset by decreased net sales of sensors and
orthopedic implant
components
and instruments.
Net sales of thermoplastic injection molding for the three months ended March 31, 2017
increased 27.5% over the same period in 2016. The increase was due 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.
Additionally, n
et sales of tooling, net of deferred revenue,
increased due largely to tooling for new components from new and existing customers
, for both the thermoplastic injection molding and machining product lines
across the medical and military
, industrial
and law enforcement industries.
These increases
above
were partially offset by a decrease in net sales of sensors of 9.6% for the three months ended March 31, 2017 compared to the three months ended March 31, 2016
.
The decrease was largely due to lower shipments and price concessions compared to the same period last year, partially offset by an increase in silver surcharge billed due to an increase in the weighted average
cost
of silver.
These increases
above
were also partially offset by a decrease in net sales of orthopedic implant components and instruments of 5.5% for the three months ended March 31, 2017 when compared to the same prior year period. The decrease is due primarily to reduced demand of femoral components from one large customer
beginning in the third quarter of 2016. Partially offsetting the decrease was new business from three 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 Company's gross profit for the
three months ended March 31, 2017
was
$738,095
, an in
crease of
$52,976
, or
7.7%
, when compared to gross profit of
$685,119
for the same period in 201
6
. Gross profit as a percentage of sales for the
three months ended March 31, 2017
increased to
1
4
.
0
%, or
0.3
points from 13.7
% for the
three months ended March 31, 2016
.
The increase in gross profit was due primarily to an increase in gross profit from thermoplastic injection molding
, net tooling and sensors, partially offset by lower gross profit from orthopedic implant components and instruments.
The increase in gross profit for the three months ended
March 31, 2017
was primarily due to a
2
4.5
% increase in gross profit
from thermoplastic injection molding due largely to increased sales volume. Gross margin as a percent of sales decreased by 0.8 points due to customer and product mix.
Gross profit for the three months ended March 31, 2017 al
so increased as a result of increased sales of tooling from new and existing customers across the medical and military and law enforcement industries.
G
ross profit for
sensors
the three months ended March 31, 2017 increased 0.3%
. Lower shipment volume and price concessions resulted in margin deterioration which was offset by
an increase in
the
weighted average cost
of silver.
The increase in gross profit above
, for the three months ended March 31, 2017 versus the same prior year period,
was
partly offset by a decrease in gross profit of 28.7% from orthopedic implant compone
nts and instrumentation
. The decrease in gross profit was due largely to additional time and materials for reworking new components from new customers
in the first two months of the quarter
as the Company
refined the manufacturing process for
the new product offerings
for completion and shipment of parts in March.
The
in
crease in gross profit for the
three months ended March 31, 2017 versus the same prior year period was also
partly offset by
a 24.9% increase in
expenses for
other
indirect
manufacturing overhead departments
.
The
higher
expenses were
due
in part to higher mold shop maintenance and repairs due to an increase in machine utilization requirements as a result of increased volume of thermoplastic injection molding. The higher expenses were also due in part to increased engineering and quality costs largely associated with the machining product line.
Selling and Marketing
The Company's consolidated selling and marketing expenses amounted to
$265,873
(
5.0%
of net sales) for the
three months ended March 31, 2017
as compared to
$293,346
(
5.9%
of net sales) for the
three months ended March 31, 2016
,
a
decrease
of
$27,473
, or
9.4%
. For the
three months ended March 31, 2017
, the decrease was primarily due to de
creased compensation of $
38,253
as a result of
the departure of a sales person and customer service representative in the first quarter of 2017.
Additionally, commissions decreased $13,752 due in part to the mix of commissionable parts. Partially offsetting these decreases was an increase of $24,532 in other sales and marketing expenses in part related to
new marketing materials and attendance at
trade shows.
General and Administrative
The Company's consolidated general and administrative expenses decreased to
$616,829
(
11.7%
of net sales) for the
three months ended March 31, 2017
as compared to
$690,635
(
13.9%
o
f net sales) for the
three months ended March 31, 2016
a decrease of
$73,806
, or
10.7%
. The decrease in general and administrative expenses
is
mainly
due to
lower legal fees and lower consulting fees. Legal fees for the three months ended March 31, 2017 decreased from same prior year period by $45,527 due to
legal fees related to investor relations in the
first quarter of 2016. Consulting fees were $58,748 lower than the same prior year quarter due largely to $51,600 of recruiting agency fees related to the replacement of three positions in the first quarter of 2016.
Research and Development
The Company's consolidated rese
arch and development expenses in
creased to
$29,296
(
0.6%
of net sales) for the
three months ended March 31, 2017
as compared to
$25,843
(
0.5%
of net sales) for the
three months ended March 31, 2016
, a
n
increase
of
$3,453
.
Other Expense, net
Other expense, net decreased to
$39,812
for the
three months ended March 31, 2017
, as compared to
$59,443
, for
the
three months ended March 31, 2016
, a decrease of
$19,63
1
.
The decrease in other expense was due largely to gains on sales of fixed assets of $12,315 in the three months ended March 31, 2017. In addition, in the three months ended March 31, 2017 the Company received other income of $12,000 from extension fees related to the assets held for sale. The decreases in other expense were partly offset by an increase in interest expense of $3,681 due to higher principal balances outstanding on the revolver.
Income Tax Provision
The tax provisions for the
three months ended March 31, 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 months ended March 31, 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 March 31, 2017
was $0.08
per share as compared to basic and diluted
loss
of $0.
1
4
per share for the
same period in 2016
, a de
crease
in the loss per share
of $0.
06
. The de
crease in
the loss
per share for the
three months ended March 31, 2017
, is due
to an increase in net sales and a decrease in operating expenses
for the three months ended March 31, 2017 compared to the three months ended March 31, 2016.
Off-Balance Sheet Arrangements
Lease expense under all operating leases was approximately
$7,230
and
$3,322
for the three months ended
March 31, 2017
and 2016, respectively.
Liquidity and Capital Resources
Working capital was
$1,139,314
as of
March 31, 2017
, as compared to
$1,530,773
at
December 31, 2016
, a decrease of
$391,459
. Cash and cash equivalents were
$265,142
and
$380,381
at
March 31, 2017
and
December 31, 2016
, respectively, a
decrease
of
$115,239
. Substantially all of these funds are maintained in bank deposit accounts.
Trade accounts receivable, net of allowance for doubtful accounts were
$3,241,771
and
$2,276,608
at
March 31, 2017
and
December 31, 2016
, respectively, a
n
increase
of
$965,163
due to higher
net
sales in
the last two weeks of
March 2017
.
Inventories were $
3,353,283
at
March 31, 2017
, as compared to $
3,060,085
at December 31, 201
6
, an increase of
$293,198
.
Work-in-process inventory increased $188,263
primarily as a result of increased orthopedic implant components and instruments as well as an increase in silver in work-in-process. Finished goods inventory increased $77,199 due in part to the increase in the value of silv
er in finished goods inventory as well as higher inventory being held at customer locations.
Accounts payable
were $2,076,887 and $1,744,261 at March 31, 2017 and December 31, 2016, respectively, an
increase
of
$
332
,
626
due
largely to the timing of disbursements
.
Accrued expenses and other current liabilities increased $
101,48
5
for the
three
months ended
March 31, 2017
as compared to
December 31, 2016
due in part to an
increase
in
payroll accruals
based on timing of quarter end
. These increases were partly offset by decreases in the current portion of deferred revenue
of $38,224 and
customer deposits of $28,648, both related to tooling.
Capital equipment expenditures were
$493,576
for the
three months ended March 31, 2017
, due to investments in machinery and equipment primarily for the contract manufacturing of orthopedic implants and instruments as well as custom injection molding as compared to $
373,259
in the same period in 201
6
.
At
March 31, 2017
,
the Company’s total debt was $
5
,
800
,
325
as compared to $4,
778,637
at December 31, 201
6
, an increase of $
1
,021,688
. The in
crease is due largely to $825,000 in net borrowing from the revolver and $31
4
,449 of borrowings from the equipment line of credit to fund working capital and finance investments in capital equipment, respectively,
partially offset by payments
of $
126
,
125
on term debt.
The total outstanding balan
ce of the Company’s term debt de
creased $
119,979
to $2
,338,352 at March 31, 2017
as compared to $
2,458,331
at December 31, 201
6
due to regular payments on the term debt
.
The Company has a multi-year credit facility with a Massachusetts based bank. At March 31, 2017
,
this credit facility consisted of a revolving line of credit (the "revolver"), a commercial term loan and an equipment line of credit. The bank facility contains both financial and non-financial covenants, all of which the Company is in compliance with at March 31, 2017. The debt is secured by substantially all assets of the Company with the exception of real property.
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, 2017). The revolver has a maturity date of June 2017. Amounts available to borrow under the revolver are
$848,719
at March 31, 2017.
On May 9, 2017, the Company’s bank
approved the renewal of
the Company’s revolver for a one year term, expiring June 30, 2018, under substantially the same terms as the current revolver, subject to certain closing requirements. The Company expects to close on the renewal prior to the end of June 2017.
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.
In November 2016, the Company entered into an equipment line of credit under that allows for advances of up to $1.0 million under the Company's multi-year credit facility. The term of this equipment line of credit 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 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. At March 31, 2017, $416,949 has been drawn on the equipment line of credit. At December 31, 2016, $102,500 had been drawn on the equipment line of credit.
The bank facility 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 was in compliance with all bank covenants as of March 31, 2017.
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. The Company’s two largest beneficial owners of stock and a director participated in the private offering as follows: REF Securities, LLP, 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.
No dividends were declared or paid in the
three months ended March 31, 2017 and 2016
.
The Company believes that the renewal of the revolver,
cash flows from its operations, together with its existing working capital, increased booked orders and other resources will be sufficient 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.
Summary of Changes in Cash Position
As of
March 31, 2017
, the Company had cash on hand of
$265,142
. For the
three months ended March 31, 2017
, net cash
used in
operating activities was
$652,90
6
. Net cash used in investing activities for the
three months ended March 31, 2017
was
$475,657
. Net cash provided by financing activities for the
three months ended March 31, 2017
was
$1,013,324
.
The net cash flows for the
three months ended March 31, 2017
are discussed in further detail below.
Operating Cash Flows
For the
three months ended March 31, 2017
, net cash
used in
operating activities was
$652,90
6
. Cash
used in
operating activities was
impacted
by
an increase of $959,163,
an increase in inventory of
$293,19
8
,
the
net loss of $213,715
as well as decrease in deferred revenue, current portion, of $38,224 and customer deposits of $28,648.
These uses of cash were partly offset
by non-cash add-backs for depreciation and amortization of $
395,
559
and
share-based compensation of $
26,221
. Cash was provided
by an increase of $332,626 in accounts payable
,
an increase of $101,48
5
in
accrued expenses
and other current liabilities.
Investing Cash Flows
For the
three months ended March 31, 2017
, net cash used in investing activities was
$475,657
. The net cash used was for capital expenditures of
$493,576
, largely for machinery and equipment, primarily for the contract manufacturing of orthopedic implants and instruments as well as custom injection molding equipment.
Financing Cash Flows
For the
three months ended March 31, 2017
, net cash provided by financing activities was
$1,013,324
. Cash was provided by net proceeds of $
82
5,000
from the Company's revolver and
proceeds of $
314
,
449
fr
om the equipment line of credit
. These proceeds were offset by payments on term notes payable of $
126,125.