Income Taxes

The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Deferred tax assets and liabilities are determined based on the difference between the financial statements carrying amounts and the tax basis of assets and liabilities using enacted tax rates in effect in the yearsyear in which the differences are expected to reverse.

In evaluating the Company’s ability to recover deferred tax assets in future periods, management considers the available positive and negative factors, including the Company’s recent operating results, the existence of cumulative losses and near term forecasts of future taxable income consistent with the plans and estimates that management uses to manage the underlying business. A significant piece of objective negative evidence evaluated was the cumulative loss incurred by the Company over the three year period ended December 31, 2017.2018. Such objective evidence limits the ability to consider other subjective evidence such as our projections for future growth.

On the basis of this evaluation as of September 30, 2018,2019, the Company’s management concluded that it is more likely than not that the Company will not be able to realize any portion of the benefit on the net deferred tax balance of $3,380,000$3,366.000 and therefore the Company continues to maintain a valuation allowance for the full amount of the net deferred tax balance. When sufficient positive evidence exists, the Company’s income tax expense will be charged with the increase or decrease in its valuation allowance. An increase or reversal of the Company’s valuation allowance could have a significant negative or positive impact on the Company’s future earnings.

For the three and nine months ended September 30, 2019, the Company did not record a current provision for either state tax or federal tax due to the losses incurred for both income tax and financial reporting purposes.

For the three and nine months ended September 30, 2018, the Company did not record a current provision for income taxes due to the availability of net operating loss carryforwards to offset taxable income for both federal and state tax purposes.

The Tax Cuts and Jobs Act was enacted on December 22, 2017. The Tax Act eliminates alternative minimum taxes and lowers the U.S. federal corporate income tax from 34% to 21% effective January 1, 2018. At December 31, 2017, the Company re-measured its net deferred tax assets using the new Federal Tax Rate and posted a one-time reduction of $1,765,000 in deferred tax assets and $1,765,000 to the valuation allowance to reflect the lower realization rate to be applied commencing in 2018.

Net Income (Loss) per Common Share

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares and common stock equivalents outstanding, calculated on the treasury stock method for options, stock grants and warrants using the average market prices during the period, including potential common shares issuable upon conversion of outstanding convertible notes, except if the effect on the per share amounts is anti-dilutive.

For the three and nine months ended September 30, 2018, a total of 2,500,000 common shares and 1,875,000 common shares from warrants issuable upon conversion of outstanding convertible notes were excluded from the computation of diluted net income per common share because their effect is anti-dilutive.

For the three and nine months ended September 30, 2017,2019, all common stock equivalents were excluded from the computation of diluted net loss per share because their effect is anti-dilutive. This included 2,500,000 common shares and 1,875,000 common shares from warrants issuable upon conversion of outstanding related party convertible notes, innotes. In addition, to 911,3411,208,367 common stock options in each respective period.period, were excluded from the computation of basic and diluted net income per common share because their effect is anti-dilutive.

For the three and nine months ended September 30, 2018, a total of 2,500,000 common shares and 1,875,000 common shares from warrants issuable upon conversion of outstanding related party convertible notes were excluded from the computation of diluted net income per share because their effect would have been antidilutive.

A reconciliation of the shares used in the calculation of basic and diluted earnings (loss) per common share is as follows:

Stock-Based Compensation

Stock-based compensation expense is estimated at the grant date based on the fair value of the award. The Company estimates the fair value of stock options granted using the Black-Scholes option pricing model. The fair value of restricted stock units granted is based on the closing market price of the Company’s common stock on the date of the grant. The fair value of these awards, adjusted for estimated forfeitures, is amortized over the requisite service period of the award, which is generally the vesting period.

Recently Adopted Accounting Standards

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”), which supersedes the revenue recognition requirements in ASC 605, “Revenue Recognition.” ASU 2014-09 is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. It also requires additional disclosure about the nature, amount, timing, and uncertainty of revenue, cash flows arising from customer contracts, including significant judgments and changes in judgments, and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company adopted the provisions of ASU 2014-09 on January 1, 2018, using the modified retrospective approach. Revenue from the Company’s sales continue to generally be recognized either when products are shipped (i.e. point in time) or under certain long-term government contracts, as the Company transfers control of the product or service to its customers (i.e. over time), which approximates the previously used percentage-of-completion method of accounting. As such, the adoption of ASU 2014-09 had no material impact to the Company’s financial position or results of operations; however, the Company has now presented the disclosures required by this new standard, refer to Note 2.

In February 2016, the FASB created Topic 842 and issued ASU 2016-02, Leases.Leases (Topic 842), which created new accounting and reporting guidelines for leasing arrangements. The new guidance in this update supersedes Topic 840, Leases. This ASU requires lesseesorganizations that lease assets to recognize a right-of-use assets and a lease liability, initially measured at the present value of the lease paymentsliabilities on the balance sheet. For public companies,sheet related to the amendmentsrights and obligations created by those leases, regardless of whether they are classified as finance or operating leases. Consistent with current guidance, the recognition, measurement, and presentation of expenses and cash flows arising from a lease primarily will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Earlier application is permitted. The Company is currently evaluating the impact of the adoption of ASU 2016-02depend on its classification as a finance or operating lease. The guidance also requires new disclosures to help financial statementsstatement users better understand the amount, timing, and disclosure.uncertainty of cash flows arising from leases.

In June 2018,The Company adopted the FASB issued ASU No. 2018-07, Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, which largely alignsrequirements of the measurement and classification guidance for share-based payments to nonemployees withnew standard effective January 1, 2019, using the guidance for share-based payments to employees. The ASU also clarifies that any share-based payment issued to a customer should be evaluated under ASC 606, Revenue from Contracts with Customers. The ASU requires a modified retrospective transition approach. This new guidance ismethod, which applies the provisions of the standard at the effective for fiscal years beginning after December 15, 2018, including interimdate without adjustment to the comparative periods within that fiscal year. We do not expectpresented.  The Company adopted the adoptionfollowing practical expedients and elected the following accounting policies related to this standard:

Adoption of this accounting standard updatehad no effect on the consolidated balance sheet as of January 1, 2019, and therefore, did not materially impact operating results or liquidity.  The Company signed an amended lease on its facility effective June 1, 2019, and recognized a lease right-of-use asset and corresponding lease liability of $0.8 million at June 1, 2019. Disclosures related to have a material impact on our consolidated financial statements.the amount, timing and uncertainty of cash flows arising from this lease are included in Note 7. 

NOTE 2 – REVENUE

The Company’s revenues are comprised of product sales as well as products and services provided under long-term government contracts with its customers. All revenue is recognized when the Company satisfies its performance obligation(s) under the contract (either implicit or explicit) by transferring the promised product or service to its customer either when (or as) its customer obtains control of the product or service. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer. A contract’s transaction price is allocated to each distinct performance obligation. The majority of the Company’s contracts have a single performance obligation, as the promise to transfer products or services is not separately identifiable from other promises in the contract and, therefore, not distinct. For contracts with multiple performance obligations, the Company allocates the contract’s transaction price to each performance obligation using the Company’s best estimate of a standalone selling price for each distinct product or service in the contract, which is generally based on an observable price.

Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products or providing services. As such, revenue is recorded net of returns, allowances, customer discounts, and incentives. Sales, value added,add, and other taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenues) basis. Shipping and handling costs are included in cost of goods sold.

The Company’s performance obligations under long-term government contracts are generally satisfied over time. Revenue from products or services transferred to customers over timeunder these performance obligations accounted for approximately 5.27%3.8% and 1.31%5.3% of revenue for the nine months ended September 30, 2019 and 2018, and 2017, respectively. Revenue under these long-term government contracts areThis revenue is generally recognized over time using an input measure based upon the proportion of actual costs incurred to estimated total project costs, which is a method used to best depict the Company’s performance to date under the terms of the contract.

Accounting for these long-term government contracts involves the use of various techniques to estimate total revenue and costs. The Company estimates profit on these long-term government contracts as the difference between total estimated revenue and expected costs to complete a contract and recognizes that profit over the life of the contract. Contract estimates are based on various assumptions to project the outcome of future events that may span several years. These assumptions include, among other things, labor productivity, costs and availability of materials, and timing of funding by the U.S. government. The nature of these long-term agreements may give rise to several types of variable consideration, such as claims, awards and incentive fees. Historically, these amounts of variable consideration are not considered significant. Additionally, contract estimates may include additional revenue for submitted contract modifications if there exists an enforceable right to the modification, the amount can be reasonably estimated and its realization is probable. These estimates are based on historical collection experience, anticipated performance, and the Company’s best judgement at the time. These amounts are generally included in the contract’s transaction price and are allocated over the remaining performance obligations. Changes in judgments on these above estimates could impact the timing and amount of revenue recognized with a resulting impact on the timing and amount of associated income. Under these long-term government contracts, the Company may receive payments from customers based upon contractual billing schedules; accounts receivable are recorded when the right to consideration becomes unconditional. In the event a contract loss becomes known, the entire amount of the estimated loss is recognized in the Consolidated Statements of Operations.

The majority of the Company’s revenue is from products and services transferred to customers at a point in time and werewas approximately 94.73%96.2% and 98.69%94.7% of revenue for the nine months ended September 30, 20182019 and 2017,2018, respectively. The Company recognizes revenue at the point in time in which the customer obtains control of the product or service, which is generally when product title passes to the customer upon shipment. In limited cases, title does not transfer and revenue is not recognized until the customer has received the products at its physical location.

As part of the adoption of Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606)”, the Company reviewed its sales by market area and reassigned certain customers within the existing markets. In addition, the Universities and National Lab market was renamed to Scientific/R&D. Sales by market area, as previously presented for the nine months ended September 30, 2017, were reclassified accordingly.

The following table summarizes the Company’s sales by market area:

Net sales by timing toof transfers of goods and services is as follows:

The timing of revenue recognition, billings and cash collections results in billed receivables, costs in excess of billings (contract assets), and billings in excess of costs (contract liabilities, previously deferred revenue) on the Consolidated Balance Sheet. Contract liabilities additionallyalso include customer advances or prepayments. Costs in excess of billings and billings in excess of costs associated with long-term government contracts were not significant at September 30, 20182019 or 2017. Revenue recognized during the nine months ended2018. At September 30, 2019 and 2018, the remaining revenue to be recognized from the long-term government contracts was $29,000 and 2017 that was included in contract liabilities at the beginning of the period was approximately $386,000, and $86,000, respectively.

On September 30, 2018,2019, the Company hashad approximately $6,251,000$5.4 million of remaining performance obligations, which is also referred to as backlog. Approximately 1%2.3% of the September 30, 20182019 backlog is related to projects that will extend beyond September 30, 2019.2020.

NOTE 3-3 - EQUITY COMPENSATION PROGRAM AND STOCK BASED COMPENSATION

The Company's results of operations for the three months ended September 30, 20182019 and 20172018, include stock-based compensation expense for stock option grants totaling $27,191$35,031 and $14,975,$27,192, respectively. Such amounts have been included in the accompanying Condensed Consolidated Statements of Operations within cost of goods sold in the amount of $7,598 ($4,027 for 2017), and selling, general and administrative expenses in the amount of $19,593 ($10,948 for 2017).

The Company's results of operations for the nine months ended September 30, 20182019 and 20172018, include stock-based compensation expense for stock option grants totaling $97,750 and $53,192, and $44,547, respectively. SuchThe following table shows the amounts have beenfor stock-based compensation included in the accompanying Condensed Consolidated Statements of Operations within cost of goods sold in the amount of $14,695 ($12,274 for 2017)sales and selling, general and administrative expenses inexpense for the amount of $38,497 ($32,273 for 2017).three and nine months ended September 30, 2019 and 2018:

As of September 30, 20182019 and 2017,2018, there were $207,725$231,066 and $104,467$207,725 of unrecognized compensation cost, net of estimated forfeitures, related to non-vested stock options, which are expected to be recognized over a weighted average period of approximately 1.71.96 years and 1.51.7 years, respectively.

There were 175,000200,000 and 180,000175,000 stock options granted during the nine months ended September 30, 20182019 and 20172018 respectively. The following range of weighted-average assumptions were used to determine the fair value of stock option grants during the nine months ended September 30, 20182019 and 2017:2018:

The following table represents stock options granted, exercised and forfeited during the nine months ended September 30, 2018:2019:

The following table represents non-vested stock options granted, vested and forfeited for the nine months ended September 30, 2018.2019:

NOTE 4-4 - STOCKHOLDERS’ EQUITY

The Company approved a matching contribution to participants in the Inrad Optics 401k Plan (the “Plan”) for the year ended December 31, 2017. In total, cash2018, in February 2019. Cash in the amount of $30,926$31,196 and 111,28898,189 common shares of Inrad Optics, Inc. with an equivalent value of $92,779 waswere contributed to the Plan in June 2018.the second quarter of 2019.

NOTE 5 – RELATED PARTY TRANSACTIONS

On April 12, 2018, the maturity dates of a $1,500,000 Subordinated Convertible Promissory Note to Clarex Limited (“Clarex”) and a $1,000,000 Subordinated Convertible Promissory Note to an affiliate of Clarex were each extended to April 1, 2021 from April 1, 2019.2018. The notes bear interest at an annual rate of 6%. Interest accrues yearly and is payable on maturity. Unpaid interest, along with principal, may be converted into securities of the Company as follows: the notes are convertible in the aggregate into 1,500,000 units and 1,000,000 units, respectively, with each unit consisting of one share of common stock and one warrant. Each warrant allows the holder to acquire 0.75 shares of common stock at a price of $1.35 per share. As part of the agreement, the expiration dates of the warrants were extended from April 1, 2022 to April 1, 2024. As of September 30, 2018,2019, the Company had accrued interest in the amount of $75,500$75,000 associated with these notes.

NOTE 6 – OTHER LONG TERM NOTES

Other Long Term Notes consist of the following:

NOTE 7 – LEASE AMENDMENT

The Company entered into an amendment and extension of its building lease on July 8, 2019, retroactive to June 1, 2019. Under the guidance of ASU 2016-02, Leases (Topic 842), the Company determines if such an arrangement contains a lease and whether that lease meets the classification criteria of a finance or operating lease at inception of the arrangement.  The Company determined that this lease is an operating lease and presented as a right-of-use lease asset, short term lease liability and long term lease liability on the consolidated balance sheet.  These assets and liabilities are recognized at the commencement date based on the present value of remaining lease payments over the lease term using the Company’s incremental borrowing rate.

Lease expense is recognized on a straight-line basis over the lease term and is included in cost of sales and general and administrative expenses on the consolidated statement of operations. 

An initial right-of-use asset of $0.8 million was recognized as a non-cash asset addition with the signing of the July 8, 2019, lease amendment. Cash paid for amounts included in the present value of operating lease liability was $0.1 million during the nine months ended September 30, 2019, and is included in operating cash flows.     

Operating lease costs were $0.1 million and $0.2 million during the three and nine months ended September 30, 2019. 

The following table presents information about the amount and timing of cash flows arising from the Company’s operating lease as of September 30, 2019:

Caution Regarding Forward Looking Statements

This Quarterly Report contains forward-looking statements as that term is defined in the federal securities laws. The Company wishes to insure that any forward-looking statements are accompanied by meaningful cautionary statements in order to comply with the terms of the safe harbor provided by the Private Securities Litigation Reform Act of 1995. The events described in the forward-looking statements contained in this Quarterly Report may not occur. Generally, these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of the Company’s plans or strategies, projected or anticipated benefits of acquisitions made by the Company, projections involving anticipated revenues, earnings, or other aspects of the Company’s operating results. The words “may”, “will”, “expect”, “believe”, “anticipate”, “project”, “plan”, “intend”, “estimate”,“may,” “will,” “expect,” “believe,” “anticipate,” “project,” “plan,” “intend,” “estimate,” and “continue”,“continue,” and their opposites and similar expressions are intended to identify forward-looking statements. The Company cautions you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks, and other influences, many of which are beyond the Company’s control, that may influence the accuracy of the statements and the projections upon which the statements are based. Factors which may affect the Company’s results include, but are not limited to, the risks and uncertainties discussed in Items 1A, 7 and 7A of the Company’s most recent Annual Report on Form 10-K for the year ended December 31, 2017,2018, as filed with the Securities and Exchange Commission on April 2, 2018.1, 2019. Any one or more of these uncertainties, risks, and other influences could materially affect the Company’s results of operations and whether forward-looking statements made by the Company ultimately prove to be accurate. Readers are further cautioned that the Company’s financial results can vary from quarter to quarter, and the financial results for any period may not necessarily be indicative of future results. The foregoing is not intended to be an exhaustive list of all factors that could cause actual results to differ materially from those expressed in forward-looking statements made by the Company. The Company’s actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. The Company undertakes no obligation to publicly update or revise any forward looking statements, whether from new information, future events, or otherwise.

Critical Accounting Policies and Estimates

Our significant accounting policies are described in Note 1 of the accompanying condensed consolidated financial statements and further discussed in our annual financial statements included in our annual report on Form 10-K for the year ended December 31, 2017.2018. In preparing our unaudited condensed consolidated financial statements, we made estimates and judgments that affect the results of our operations and the value of assets and liabilities we report. These include estimates used in evaluating intangibles for impairment such as market multiples used in determining the fair value of reporting units, discount rates applicable in determining net present values of future cash flows, projections of future sales, earnings and cash flow and capital expenditures. It also includes estimates about the amount and timing of future taxable income in determining the Company’s valuation allowance for deferred income tax assets. Our actual results may differ from these estimates under different assumptions or conditions.

For additional information regarding our critical accounting policies and estimates, see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our annual report filed with the Securities and Exchange Commission on Form 10-K for the year ended December 31, 2017.2018.

Results of Operations

Inrad Optics, Inc.’s business falls into two main categories: Optical Components and Laser Devices/Instrumentation.

The Optical Components category is focused on custom optics manufacturing. The Company specializes in high-end precision components. It develops, manufactures and delivers precision custom optics and thin film optical coating services through its Custom and Metal Optics operations. Glass, metal, and crystal substrates are processed using modern manufacturing equipment, complex processes and techniques to manufacture components, deposit optical thin films, and assemble sub-components used in advanced photonic systems. The majority of custom optical components and optical coating services supplied are used in inspection, process control systems, defense and aerospace electro-optical systems, laser system applications, industrial scanners, and medical system applications.

The Laser Devices/Instrumentation category includes the growth and fabrication of crystalline materials with electro-optic (EO) and non-linear optical properties for use in both standard and custom products. This category also includes the manufactured crystal based devices and associated instrumentation. The majority of crystals, crystal components and laser devices manufactured are used in laser systems, defense EO systems, medical lasers and R&D applications by engineers within corporations, universities and national laboratories.

The Company operates a manufacturing facility in Northvale, New Jersey and has its corporate offices in the same location.

Revenue

Sales for the three months ended September 30, 2018 increased by10.2%2019, were $2.2 million, a decrease of 20.3%, or $0.6 million, compared to $ 2,789,000 from $2,530,000$2.8 million for the comparable period last year.three months ended September 30, 2018. For the nine months ended September 30, 2018,2019, sales were $ 8,815,000, an increase$7.4 million a decrease of 20.7%15.5%, or $1.4 million, compared to $7,301,000sales of $8.8 million for the nine months endedmonth period ending September 30, 2017.2018.

Sales to the defense/aerospace market decreasedincreased by $422,000$0.2 million or 44.7%43.3% to $522,000$0.7 million in the three months ended September 30, 20182019, compared to $944,000 in$0.5 million for the comparable period last year.three months ended September 30, 2018. For the nine months endedending September 30, 2018,2019, sales were $1,948,000, a decrease of 18.8%to the defense/aerospace market increased $0.8 million, or 42.2%, to $2.8 million compared to $2,398,000 forsales of $1.9 million in the nine months endedmonth period ending September 30, 2017.2018. The decrease in defense/aerospace market duesignificant increase is mainly attributable to decrease in sales to multiple customers.increased demand for our products as military and defense spending has increased over the past year.

Process control and metrology (“PC&M”) sales were $1,350,000, up $307,000, or 29.5%,$1.0 million for the three months ended September 30, 20182019, a decrease of $0.4 million, or 29.6%, from $1.4 million for the comparable period last year.three months ended September 30, 2018. For the nine months ended September 30, 2018, PC&M2019, sales were $4,464,000, up 51.4%,$3.1 million compared to $2,948,000$4.5 million for the nine months ended September 30, 2017. Higher overallyear ago period, a decrease of $1.4 million or 31.3%. The continued reduction in demand for certain products in theour PC&M market resultedand the delayed delivery schedules from certain customers, particularly in the semi-conductor industry, has negatively impacted the sales increases to several large existing accounts infor the three and nine months ended September 30, 2018,2019, compared to the same period last year.September 30, 2018.

For the three months ended September 30, 2018,2019, sales to customers in the laser systems market were $324,000, up $87,000$0.4 million, an increase of $0.1 million, or 37%11.6%, from $237,000 in$0.3 million for the comparable period in 2017.three months ended September 30, 2018. For the nine months ended September 30, 2018,2019, sales in the laser systems market were $1,202,000 an increase by 49.8%$1.0 million compared to $802,000sales of $1.2 million for the nine months ended September 30, 2018, a decline of $0.2 million or 19.2%. The increase in sales for the same period in 2017. Shipments to one new customer in the second quarter of 2018 contributedthree months ended September 30, 2019, compared to the overall increase.three months ended September 30, 2018, was due to increases in shipments to several newer customers. The decrease in sales for the nine months ended September 30, 2019, compared to September 30, 2018, is due to the timing of delivery schedules to an international distributor and one large OEM, partially offset by increases in shipments to several newer customers.

Sales to customers in the Scientific/R&D market (formerly Universities & National Labs) were $593,000 up $286,000decreased by $0.4 million, or 93.5%72.6%, to $0.2 million for the three months ended September 30, 2018 from the comparable period last year. For the nine months ended September 30, 2018, sales were $1,201,000 an increase of $48,000 or 4.2%2019, compared to $1,153,000sales of $0.6 million for the ninethree months ended September 30, 2018. This resultedSales to customers in the Scientific/R&D market for the nine month period ending September 30, 2019, were $0.6 million, compared to $1.2 million, a decrease of $0.6 million or 46.7% for the nine month period ending September 30, 2018. The decrease for the quarter and nine months ending September 30, 2019, compared to the quarter and nine months ending September 30, 2018, is attributable to, in part, reduced revenue on a federal government R&D contract and reduced orders from an increase of shipments to National Laboratories.one national lab.

For the ninethree months ended September 30, 2019 and 2018, there were two customers in the process control and metrology marketeach period that represented 10%10.0% or more of total sales. For the nine months ended September 30, 2017,2019 and September 30, 2018, there were two customers eachthat represented 10% or more than 10.0% of total sales. One customer wassales in the process control and metrology market and the other customer was in the defense/aerospace market.each period.

The Company’s top five customers represented 54.5%46.1% of sales in the three month period ended September 30, 2018,2019, compared to 46.1%54.5% in the same period in 2017.2018. For the nine monthsmonth period ended September 30, 2019 and 2018, the Company’s top five customers represented 45.9% and 53.3% of sales, compared to 45.3% for the same period in 2017.respectively.

Orders booked during the first nine months of 20182019, totaled $6.7 million, compared to $8.6 million compared with $8.3 million infor the same period last year.

Order backlog was $6.3 million at September 30, 2019 and 2018, comparedwas $5.4 million and $6.3 million, respectively. A significant portion of the year-over-year decrease in the order backlog is due to $7.3 million at September 30, 2017.a delay in anticipated orders from several customers in the PC&M and Scientific/R&D markets.

Cost of Goods Sold

For the three months ended September 30, 20182019 and 2017,2018, cost of goods sold was $1,863,000$1.9 million, in each period, or 84.1% and $1,891,000 respectively,66.8% of total revenues, respectively. The impact of increased labor and service costs, as well as manufacturing overhead, resulted in an increase in costs of goods sold as a decreasepercentage of $28,000 or approximately 1.47 %. This represented 66.8% and 74.8% of sales, respectively.sales.

For the nine months ended September 30, 2018,2019, cost of goods sold were $6,460,000, an increase of $534,000 or 9.1%$6.0 million, compared to $5,926,000 in the same period in 2017.The increase was mainly attributable to higher sales in the nine months ended September 30, 2018$6.5 million, a decrease of $0.5 million or 7.1%, compared to the nine months endedmonth period ending September 30, 2017. Cost2018. The decrease is largely due to the decrease in sales, partially offset by an increase in material costs and labor costs year over year reflecting the mix of sales for the Company’s products. As a percent of total revenues, cost of goods sold decreased, as a percentage of sales for the nine months ended September 30, 2019 and 2018, compared to 2017, representingwere 80.6% and 73.3% and 81.2%,of total revenues respectively. The decrease is primarilyincrease in cost of goods sold as a percentage of sales reflects the increase in material and labor costs due to products mix.

Material costs increased by $65,000 or 15% in the three months ended September 30, 2018 compared to the same period last year. For the nine months ended September 30, 2018 and 2017, material costs were $1,815,000 or 21% of sales and $1,464,000, or 20% of sales respectively, primarily due to increase in sales and product mix.

For the three months endedSeptember30, 2018, manufacturing salaries and wages and related fringe benefits increased by approximately 2.7% or $28,000 from the comparable period in 2017. For the nine months endedSeptember30, 2018, manufacturing salaries and wages and related fringe benefits increased by approximately 1.3% or $40,000 from the nine months endedSeptember30, 2017.

Manufacturing expenses decreased by 1.9% for the three months endedSeptember30, 2018 compared to the same period in 2017 and decreased by 0.2% in the nine months endedSeptember30, 2018 compared to the nine months endedSeptember30, 2017.

Gross profit for the three months ended September 30, 20182019, was $926,000$0.4 million or 33.2%15.9% of sales, compared to $639,000$0.9 million or 25.2% of sales33.2% in the same quarter last year. Gross profit for the nine months ended September 30, 2018 and 20172019, was $2,355,000$1.4 million, or 19.4% of sales, compared to $2.4 million or 26.7% and $1,375,000 or 18.8% of sales, respectively.the decline reflecting the reduction in total sales and the impact of the material and labor costs related to the sales mix.

Selling, General and Administrative Expenses

Selling, general and administrative expenses (“SG&A” expenses) in the three and nine months ended September 30, 20182019, amounted to $579,000$0.6 million, or 27.3% of sales, and $2.0 million, or 26.9% of sales, compared to $0.6 million, or 20.8% of sales, and $1,648,000$1.6 million, or 18.7% of sales respectively. This compared to $639,000 or 25.2% of sales and $1,821,000 or 24.9% of sales, respectively, for the same periodsperiod a year ago. The increase in 2017.

This represented a decrease of approximately $59,000 or 9.3%SG&A expenses reflects costs related to recruiting and $173,000 or 9.5% inincreased staffing, increased travel and marketing expenses, and other administrative costs for the three and nine months endedSeptember30, 2018 from the comparable period last year. The decrease is mainly attributableyear to lower sales salaries and legal and accounting expenses. In addition, amortization of intangible assets was lower as the asset was fully amortized in 2018.date period.

Income (Loss) from Operations

The Company had incomeincurred a net loss from operations of $347,000$0.3 million for the three months ended September 30, 2019, compared with operating income of $0.3 million in the three months ended September 30, 2018 compared with a loss from operations $02018. The decrease in income primarily reflects the impact of the Company’s lower sales in the three months ended September 30, 2017. For2019, compared to the same period last year, coupled with an increase in the cost of goods sold and SG&A costs. The Company incurred a net loss from operations of $0.6 million for the nine months ended September 30, 2018, the Company’s operating profit was $706,0002019, compared with operating income of $0.7 million for the nine months ended September 30, 2018. The decrease in operating income for year to date period reflects lower sales, combined an operating loss of $447,000increase in the same period last year.certain SG&A costs.

Other Income and Expense

NetThere was no significant change in net interest expense for the third quarter ofthree months ended September 30, 2019, compared to the same period in 2018, and 2017as there was $40,000 and $40,000.no significant change in the Company’s borrowing level. Net interest expense for the nine months endedSeptember 30, 2019, compared to September 30, 2018, was $116,000 and $119,000, compared to $121,000 inrespectively. The decrease represents the same period in 2017.lower overall outstanding debt balance.

Income Taxes

For the three months and nine months endedSeptember 30, 2019, the Company did not record a current provision for either state tax or federal alternative minimum tax due to the losses incurred for both income tax and financial reporting purposes.

For the three months and nine months ended September 30, 2018, the Company did not record a current provision for income taxes due to the availability of net operating loss carryforwards to offset taxable income for both federal and state tax purposes.

For the three months endedSeptember30, 2017, the Company did not record a current provision for either state tax or federal alternative minimum tax due to the losses incurred for both income tax and financial reporting purposes.

Net Income (Loss)

The Company had a net income of $307,000 compared to a net loss of $40,000 in$0.3 million for the three months ended September 30, 2019, compared to a net income of $0.3 million for the three months ended September 30, 2018. The net loss primarily reflects the decrease in sales for the three months ended September 30, 2019, compared to the 2018 period, combined with the increase in costs of goods sold and 2017, respectively.SG&A expenses. For the nine months ended September 30, 2018,2019, the Company had net income of $585,000 compared withincurred a net loss of $567,000 for the nine months ended September 30, 2017. Higher$0.7 million, compared with net income of $0.6 million. Lower sales, andcombined with a more profitableless favorable product mix, in the threehigher related material costs and nine months ended September 30, 2018, combined with lowerhigher SG&A expenses werecosts led to the primarily factors in the increasedecrease in net income compared with the corresponding periods in the previous year.income.

Liquidity and Capital Resources

The Company’s primary source of liquidity is cash and cash equivalents and on-going collection of accounts receivable. The Company’s major use of cash in recent years has been for financing operations, for payment of accrued and current interest on convertible debt, for servicing of long term debt, and for capital expenditures.

As of September 30, 20182019 and December 31, 2017,2018, the Company had cash and cash equivalents of $890,000$0.8 million and $800,000,$1.2 million, respectively.

The Company occupies approximately 42,000 square feet of space located at 181 Legrand Avenue, Northvale, New Jersey pursuant to a net lease which was amended on July 8, 2019, retroactive to June 1, 2019, for an additional three year term. Under the terms of the lease, the Company is obligated for all real estate taxes, maintenance and operating costs of the facility.

On April 12, 2018, the maturity dates of a $1,500,000 Subordinated Convertible Promissory Note to Clarex Limited (“Clarex”) and a $1,000,000 Subordinated Convertible Promissory Note to an affiliate of Clarex were each extended to April 1, 2021 from April 1, 2019. The notes bear interest at an annual rate of 6%. Interest accrues yearly and is payable on maturity. Unpaid interest, along with principal, may be converted into securities of the Company as follows: the notes are convertible in the aggregate into 1,500,000 units and 1,000,000 units, respectively, with each unit consisting of one share of common stock and one warrant. Each warrant allows the holder to acquire 0.75 shares of common stock at a price of $1.35 per share. As part of the agreement, the expiration dates of the warrants were extended from April 1, 2022 to April 1, 2024. As of September 30, 2018,2019, the Company had accrued interest in the amount of $75,000 associated with these notes.

The following table summarizes net cash provided (used in) operating, investing and financing activities for the nine months ended September 30, 20182019 and 2017:2018:

Net cash provided by (used in)used in operating activities was $230,000$11,000 for the nine months ended September 30, 20182019, compared to net cash used inprovided by operations of ($206,000)$230,000 in the same period last year.

Net cash used in operating activities in the nine months ended September 30, 2019, resulted primarily from the net loss incurred for the period and a reduction in accounts receivable. The net cash provided by operating activities of $230,000 in the nine months ended September 30, 2018, resulted primarily from operating profits as well as reductions in accounts receivable, reductions in accountaccounts payable and accrued liabilities, and lower contract liabilities.

Net cash used in investing activities was ($131,000)$291,000 during the nine months ended September 30, 20182019, compared to ($95,000) used$131,000 in the same period last year mainly due to purchase of fixed assets.reflecting capital expenditures in both periods. Net cash used in financing activities was ($9,000) and ($105,000) during the nine months ended September 30, 2019 and 2018, and 2017, respectively, relatedrelates to required principal payments on other long term notes and reflecting the maturity of a term note payable to Valley National Bank in July 2017.payments.

Overall, cash and cash equivalents increased by $90,000 and decreased by ($406,000)$373,000 for the nine months ended September 30, 2019 and increased $90,000 in the 2018 and 2017, respectively.period.

Management believes, based on the Company’s operations and its existing working capital resources together with existing cash flows, that the Company has sufficient cash flows to fund operations through the next 12 months.at least November 14, 2020.

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is a smaller reporting company and not required to provide the information required under this item.

ITEM 4.CONTROLS AND PROCEDURES

Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of September 30, 20182019 (the “Evaluation Date”), have concluded that as of the Evaluation Date, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports we file or submit under the Exchange Act (1) is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms, and (2) is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosure.

There were no changes in our internal control over financial reporting during the quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

None.

Not applicable

None.

None.

Not applicable

None