NOTE 3. REVENUE

Revenue recognition

Our revenue is comprised of product, engineering services and repair services. All revenue is recognized when the Company satisfies its performance obligation(s) under the contract by transferring the promised product or service to our customer either when (or as) our customer obtains control of the product or service, with the majority of our revenue being recognized over time including goods produced under contract manufacturing agreements and services revenue. 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 our 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.

Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products or providing services. As such, revenue is recorded net of returns, allowances and customer discounts. Sales, value 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 majority of our revenue is derived from the transfer of goods produced under contract manufacturing agreements which have no alternative use and we have an enforceable right to payment for our performance completed to date. Our performance obligations within our contract manufacturing agreements are generally satisfied over time as the goods are produced based on customer specifications and we have an enforceable right to payment for the goods produced. If these requirements are not met, the revenue is recognized at a point in time, generally upon shipment. Revenue under contract manufacturing agreements that was recognized over time accounted for approximately 91% of our revenue for both the three and nine months ended September 30, 2018. Revenues under these agreements are generally recognized over time using an input measure based upon the proportion of actual costs incurred.

Accounting for contract manufacturing agreements involves the use of various techniques to estimate total revenue and costs. We estimate profit on these agreements as the difference between total estimated revenue and expected costs to complete the performance obligation within the terms of the agreement and recognize the respective profit as the goods are produced. The estimates to determine the profit earned on the performance obligation are based on anticipated selling prices and historical cost of goods sold and represent our best judgement at the time. Changes in judgements on these above estimates could impact the timing and amount of revenue recognized with a resulting impact on the timing and amount of associated profit.

On occasion our customers provide materials to be used in the manufacturing process and the fair value of the materials is included in revenue as noncash consideration at the point in time when the manufacturing process commences along with the same corresponding amount recorded as cost of goods sold. The inclusion of noncash consideration has no impact on overall profitability.

Contract Assets

Contract assets, recorded as such in the Condensed Consolidated Balance Sheets, consist of unbilled amounts related to revenue recognized over time. Significant changes in the contract assets balance during the nine months ended September 30, 2018 was as follows (in thousands):

Nine Months Ended September 30, 2018
Outstanding at January 1, 2018	$	6,459
Increase (decrease) attributed to:
Transferred to receivables from contract assets recognized	(5,727		)
Product transferred over time	6,344

Outstanding at September 30, 2018	$	7,076

We expect substantially all of the remaining performance obligations for the contract assets recorded as of September 30, 2018, to be transferred to receivables within 90 days, with any remaining amounts to be transferred within 180 days. We bill our customers upon shipment with payment terms of up to 120 days.

The following tables summarize our net sales by market for the three and nine months ended September 30, 2018 (in thousands):

	Three Months Ended September 30, 2018
	Product/ Service Transferred Over Time		Product Transferred at Point in Time		Noncash Consideration		Total Net Sales by Market
Aerospace and Defense	$	3,931	$	50	$	203	$	4,184
Medical	13,461		151		668		14,280
Industrial	9,486		1,116		492		11,094

Total net sales	$	26,878	$	1,317	$	1,363	$	29,558

	Nine Months Ended September 30, 2018
	Product/ Service Transferred Over Time		Product Transferred at Point in Time		Noncash Consideration		Total Net Sales by Market
Aerospace and Defense	$	12,675	$	170	$	599	$	13,444
Medical	34,513		720		1,605		36,838
Industrial	29,698		3,165		1,398		34,261

Total net sales	$	76,886	$	4,055	$	3,602	$	84,543

Impact of New Revenue Guidance on Financial Statement Line Items

The following table compares the reported condensed consolidated statement of operations and comprehensive income, balance sheets and cash flows, as of and for the three and nine months ended September 30, 2018, to the pro-forma amounts had the previous guidance been in effect (in thousands):

	Three Months Ended September 30, 2018				Nine Months Ended September 30, 2018
	As Reported		Pro forma as if the previous accounting guidance was in effect		As Reported		Pro forma as if the previous accounting guidance was in effect
Condensed Consolidated Statement of Operations
Net Sales	$	29,558	$	27,665	$	84,543	$	80,323
Cost of Goods Sold	26,171		24,454		74,311		70,291

Gross Profit	3,387		3,211		10,232		10,032

Income from Operations	649		472		1,263		1,063

Income Before Income Taxes	479		303		712		512

Income Tax Expense	115		115		350		350


Net Income	$	364	$	188	$	362	$	162


Net Income Per Common Share - Diluted	$	0.14	$	0.07	$	0.13	$	0.06

	As of September 30, 2018
	As Reported		Pro forma as if the previous accounting guidance was in effect
Condensed Consolidated Balance Sheet
Assets
Inventories	$	15,236	$	20,732
Contract Assets	$	7,076	$	—

Shareholders’ Equity
Retained Earnings	$	5,632	$	4,051

	Nine Months Ended September 30, 2018
	As Reported			Pro forma as if the previous accounting guidance was in effect
Condensed Consolidated Statement of Cash Flows
Net Income	$	362		$	162
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities
Change in Current Operating Items
Inventories	(1,959		)	(2,376		)
Contract Asset	(617		)	—

Net Cash Provided by Operating Activities	$	2,564		$	2,564