Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Except for historical information contained herein, this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, as amended. These statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. These forward-looking statements were based on various factors and were derived utilizing numerous important assumptions and other important factors that could cause actual results to differ materially from those in the forward-looking statements. Important assumptions and other factors that could cause actual results to differ materially from those in the forward-looking statements, include but are not limited to: competition in the Company’s existing and potential future product lines of business; the Company’s ability to obtain financing on acceptable terms if and when needed; uncertainty as to the Company’s future profitability, uncertainty as to the future profitability of acquired businesses or product lines, uncertainty as to any future expansion of the Company. Other factors and assumptions not identified above were also involved in the derivation of these forward-looking statements and the failure of such assumptions to be realized as well as other factors may also cause actual results to differ materially from those projected. The Company assumes no obligation to update these forward looking statements to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements. Past results are no guaranty of future performance. You should not place undue reliance on any forward-looking statements, which speak only as of the dates they are made. When used in this Report, the words “believes,” “anticipates,” “expects,” “estimates,” “plans,” “intends,” “will” and similar expressions are intended to identify forward-looking statements.
Results of Operations
Three and Nine Months Ended September 30, 2019 vs. September 30, 2018
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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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Revenue
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$
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5,704,882
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$
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4,027,768
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$
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14,100,261
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$
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19,616,879
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Cost of revenue
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4,305,059
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4,083,752
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12,595,340
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14,795,731
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Gross profit
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1,399,823
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(55,984
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)
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1,504,921
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4,821,148
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Operating expenses
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Research and development
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112,724
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240,613
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453,724
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465,536
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Selling and shipping
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175,760
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331,280
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680,183
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1,244,004
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General and administrative
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1,359,910
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2,225,593
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4,728,021
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6,434,123
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Total operating expenses
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1,648,394
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2,797,486
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5,861,928
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8,143,663
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Operating loss
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(248,571
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(2,853,470
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(4,357,007
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(3,322,515
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)
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Other income (expense):
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Interest income
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26,774
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40,720
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115,643
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86,994
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Interest expense
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(124,449
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(114,692
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(365,255
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)
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(355,325
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Other Income
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207,237
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-
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207,237
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-
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Total other income (expense), net
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109,562
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(73,972
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(42,375
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(268,331
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Loss before income tax
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(139,009
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)
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(2,927,442
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)
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(4,399,382
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)
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(3,590,846
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)
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Income tax benefit
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(1,000
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)
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(424,640
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(691,697
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(315,922
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)
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Net loss
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$
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(138,009
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$
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(2,502,802
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(3,707,685
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$
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(3,274,924
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Three Months Ended September 30, 2019 vs. September 30, 2018
Revenue
Our revenue for the three months ended September 30, 2019 was $5.7 million compared to $4.0 million for the three months ended September 30, 2018, resulting in an increase of 41.6% which was primarily attributable to increased revenue of $1.7 million from our CVD Equipment segment related to spare parts and equipment sales.
The revenue contributed for the three months ended September 30, 2019, by the CVD Equipment segment, of $4.4 million, which totaled 76.7% of our overall revenue, was 72.0% or $1.8 million more than the segment’s $2.5 million contribution made in the prior year, which totaled 63.1% of our overall revenue. This revenue increase is the result of $1.4 million and $.4 million from spare parts and equipment sales, respectively.
Revenue for our SDC segment was $.9 million in three months ended September 30, 2019 as compared to $1.0 million in three months ended September 30, 2018, a decrease of $.1 million.
Revenues for our CVD Materials segment were $.4 million in the three months ended September 30, 2019 as compared to $.5 million for the three months ended September 30, 2018, a decrease of $.1 million.
Gross Profit
Gross profit for the three months ended September 30, 2019 amounted to $1.4 million, with a gross profit margin of 24.5%, compared to a gross profit of ($55,984) and a gross profit margin of (1.4%) for the three months ended September 30, 2018. In addition to the higher level of sales during the quarter increasing our gross profit, we achieved improvements in our operating efficiencies, lowered our costs and achieved improved mix of product revenues resulting in our gross profit margin percentage improvement.
Research and Development, Selling and General and Administrative Expenses
Research and Development
Due to the technical development required on our custom orders, our research and development team and their expenses are charged to costs of goods sold when they are working directly on a customer project. When they are not working on a customer project, they work in our Application Laboratory and their costs are charged to research and development. For the three months ended September 30, 2019, our research and development expenses totaled $113,000 compared to $241,000 for the three months ended September 30, 2018.
Selling
Selling expenses were $.2 million or 3.1 % of the revenue for the three months ended September 30, 2019 as compared to $.3 million or 8.2% for the three months ended September 30, 2018. The decrease was primarily the result of reduced employee related costs and lower trade show expenses.
General and Administrative
General and administrative expenses for the three months ended September 30, 2019 were $1.4 million or 23.8% of revenue compared to $2.2 million or 55.3% for the three months ended September 30, 2018, a decrease of $.8 million. The decrease in these expenses is primarily the result of reductions in employees and the related payroll and benefit costs, decreased stock compensation costs of $181,000 and decreased outside systems and finance consulting costs of $84,000. In addition, a $200,000 reduction of expenses was the result of the recovery of a contingent earnout not achieved by MesoScribe Technologies.
Operating Loss
As a result of the increased revenues, improved gross profit margins and reduced expenses, we recorded an operating loss of ($.3 million) for the three months ended September 30, 2019 as compared to an operating loss of ($2.9 million) for the three months ended September 30, 2018,
Other income (expenses)
Other income (expenses) were $110,000 and ($74,000) for the three months ended September 30, 2019 and 2018, respectively. This increase in income is primarily the result of subleasing a portion of its CVD Materials facility and receiving $207,000 in rental income during 2019.
Income Taxes
For the three months ended September 30, 2019, we recorded an income tax benefit of $1,000 as compared to $425,000 for the three months ended September 30, 2018. For the three months ended September 30, 2019 and 2018, our tax rate was primarily affected by permanent differences related to contingent consideration liability in the three months ended September 30, 2019 related to MesoScribe Technologies and the effect of the Company’s foreign operations resulting in an effective tax rate of 1.0% and 14.5%, respectively.
While we have substantially reduced our net loss in the three months ended September 30, 2019 to $138,000, we continue to evaluate for potential utilization of the Company’s deferred tax asset on a quarterly basis, reviewing our economic models, including projections and timing of orders, the commencement of operations of the new CVD Materials segment and cost containment measures.
Net loss
As a result of the foregoing factors, we reported a net loss of ($.1 million), or ($0.02) per basic and diluted share, for the three months ended September 30, 2019, as compared to net loss of ($2.5 million), or ($0.39) per basic and diluted share for the three months ended September 30, 2018.
Nine Months Ended September 30, 2019 vs. September 30, 2018
Revenue
Our revenue for the nine months ended September 30, 2019 was $14.1 million compared to $19.6 million for the nine months ended September 30, 2018, resulting in a decrease of $5.5 million or 28.1% which was primarily attributable to the completion of orders received from our largest customer in the prior year.
The revenue contributed for the nine months ended September 30, 2019, by the CVD Equipment segment, of $9.6 million, which totaled 68.0% of our overall revenue, was 35.6% or $5.3 million less than the segment’s $14.9 million contribution made in the prior year, which totaled 75.9% of our overall revenue.
Revenue for our SDC segment was $3.3 million for the nine months ended September 30, 2019 as compared to $3.5 million for the nine months ended September 30, 2018, a decrease of $.2 million or 6.2%. The SDC segment represented 23.1% and 17.7% of our total revenue during the nine months ended September 30, 2019 and 2018, respectively.
Revenues for our CVD Materials segment were $1.3 million in the nine months ended September 30, 2019 as compared to $1.3 million for 2018.
Gross Profit
Gross profit for the nine months ended September 30, 2019 amounted to $1.5 million, with a gross profit margin of 10.6%, compared to a gross profit of $4.8 million and a gross profit margin of 24.6% for the nine months ended September 30, 2018. The decreased gross profit and gross profit margin were the result of the reduction in sales from our largest customer in the prior year, while costs, principally payroll, which decreased, remained at higher levels to support our anticipated expansion of the CVD Materials segment and future growth.
Research and Development, Selling and General and Administrative Expenses
Research and Development
Due to the technical development required on our custom orders, our research and development team and their expenses are charged to costs of goods sold when they are working directly on a customer project. When they are not working on a customer project, they work in our Application Laboratory and their costs are charged to research and development. For the nine months ended September 30, 2019, our research and development expenses totaled $454,000 compared to $465,000 for the nine months ended September 30, 2018.
Selling
Selling expenses were $.7 million or 4.8% of the revenue for the nine months ended September 30, 2019 as compared to $1.2 million or 6.3% for the nine months ended September 30, 2018. The decrease was primarily the result of reduced employee related costs and trade show expenses as a result of the overall lower sales.
General and Administrative
General and administrative expenses for the nine months ended September 30, 2019 were $4.7 million or 33.5% of revenue compared to $6.4 million or 32.8% for the nine months ended September 30, 2018, a decrease of $1.7 million. The decrease in these expenses is primarily the result of reductions in employees and the related payroll and benefit costs, decreased stock compensation costs of $227,000 and decreased outside systems and finance consulting costs of $142,000. In addition, a $200,000 reduction of expenses was the result of the recovery of a contingent earnout not achieved by MesoScribe Technologies.
Operating Loss
As a result of the decreased revenues and gross margins, we recorded an operating loss of ($4.4 million) for the nine months ended September 30, 2019 as compared to an operating loss of ($3.3 million) for the nine months ended September 30, 2018, which was driven primarily by the reduced revenue from our largest customer in the prior year.
Other (expenses)/Income
Other expenses were $42,000 and $268,000 for the nine months ended September 30, 2019 and 2018, respectively. This reduction in net expenses is primarily the result of subleasing a portion of its CVD Materials facility and receiving $207,000 in rental income during 2019.
Income Taxes
For the nine months ended September 30, 2019, we recorded an income tax benefit of $692,000 as compared to $316,000 for the nine months ended September 30, 2018. For the nine months ended September 30, 2019 and 2018, our tax rate was primarily affected by permanent differences related to contingent consideration liability in the nine months ended September 30, 2019 related to MesoScribe Technologies and the effect of its foreign operations resulting in an effective tax rate of 15.7% and 8.8%, respectively.
While we have substantially reduced our net loss in the three months ended September 30, 2019 to $138,000, we continue to evaluate for potential utilization of the Company’s deferred tax asset on a quarterly basis, reviewing our economic models, including projections and timing of orders, the commencement of operations of the new CVD Materials segment and cost containment measures.
Net loss
As a result of the foregoing factors, we reported net loss of ($3.7 million), or ($0.57) per basic and diluted share, for the nine months ended September 30, 2019, as compared to net loss of ($3.3 million), or ($0.51) per basic and diluted share for the nine months ended September 30, 2018.
Liquidity and Capital Resources
As of September 30, 2019, we had aggregate working capital of $9.7 million compared to aggregate working capital of $15.4 million at December 31, 2018. Our cash and cash equivalents at September 30, 2019 and December 31, 2018 were $6.7 million and $11.4 million, respectively. The decrease in working capital of $5.7 million is primarily attributable to the overall reduction in sales and resulting operating loss for the period and debt service payments of approximately $.9 million related to our investment in the CVD Materials building purchased on November 30, 2017. We have continued to invest in activities primarily related to preparing CVD Materials at the new location which commenced small scale operations during the third quarter of 2019. Our total capital invested in the nine months ended September 30, 2019 was $2.1 million, primarily related to building improvements and machinery for the CVD Materials operations and we also incurred operating costs of approximately $232,000, exclusive of interest expense. During the year, we received rental income of approximately $207,000.
Accounts receivable, net of allowance for doubtful accounts, decreased by $1.0 million or 24.4% at September 30, 2019, to $3.1 million compared to $4.1 million at December 31, 2018. This decrease is principally due to the timing of shipments and customer payments.
Inventories as of September 30, 2019 decreased by $100,000 to approximately $1.8 million.
We have a loan agreement with HSBC USA, N.A. (the “HSBC”) which is secured by a mortgage on our Central Islip headquarters at 355 South Technology Drive. The loan is payable in 120 consecutive equal monthly installments of $25,000 in principal plus interest and a final balloon payment upon maturity in March 2022. The balances as of September 30, 2019 and December 31, 2018 were approximately $2.4 million and $2.7 million respectively. Interest accrues on the loan, at our option, at the variable rate of LIBOR plus 1.75% or Prime less 0.5%.
On November 30, 2017, we purchased the premises located at 555 North Research Place, Central Islip, NY which is intended to house the CVD Materials segment. The purchase price of the land and the building was $13,850,000 exclusive of closing costs.
As part of the acquisition, our newly formed wholly-owned subsidiary, 555 N Research Corporation (the” Assignee”) and the Islip IDA, entered into a Fee and Leasehold Mortgage and Security Agreement (the ”Loan”) with HSBC in the amount of $10,387,500, which was used to finance a portion of the purchase price to acquire the premises located at 555 North Research Place, Central Islip, New York (the ”Premises”). The Loan was evidenced by the certain note, dated November 30, 2017 (the ”Note”), by and between Assignee and the Bank, and secured by a certain Fee and Leasehold Mortgage and Security Agreement, dated November 30, 2017 (the “Mortgage”), as well as a collateral Assignment of Leases and Rents (“Assignment of Leases”).
The Note is payable in 60 consecutive equal monthly installments of $62,481, including interest. The balances as of September 30, 2019 and December 31, 2018 were approximately $9.8 million and $10.0 million respectively. The Note bears interest for each Interest Period (as defined in the Note), at the fixed rate of 3.9148%. The maturity date for the Note is December 1, 2022. As a condition of the Bank making the Loan, we were required to guaranty Assignee’s obligations under the Loan.
At December 31, 2018, we were not in compliance with the single financial covenant (fixed charge coverage ratio) contained in the Mortgage. On March 26, 2019 the Company received a waiver from HSBC until April 1, 2020. On August 5, 2019, the Company entered into a Mortgage Modification Agreement which replaced the former covenant with a Minimum Liquid Assets covenant. The Company is in compliance with its obligations under the mortgage at September 30, 2019.
At December 31, 2018 we had reduced our employee headcount by 15% to 197 as compared to December 31, 2017. At September 30, 2019 we have further reduced our headcount by 15% to 168 employees, and we are continuing to evaluate our staffing levels to support the new CVD Materials facility which commenced small scale operations during the third quarter of 2019, and the level of current and expected orders. During the third quarter of 2019, we increased our revenue sequentially by $786,000 or 16.0% as compared to the second quarter of 2019, and with improved margins and reductions in expenses we reduced our net loss by $1.3 million or 90.1% to a net loss of $138,000. In addition, during the third quarter of 2019 we received orders of $7.9 million for future delivery, which exceeded our 2019 Q1 and Q2 orders of $6.5 million and $3.3 million, respectively. While we continue to monitor and take action to reduce our expenses, we believe that our cash and cash equivalent positions and cash flow from operations will be sufficient to meet our working capital and capital expenditure requirements for the next twelve months of the filing date of this Form 10-Q.
Off-Balance Sheet Arrangements.
We have no off-balance sheet arrangements at this time.