CPS Technologies Corporation (CPSH) Q4 2018 Earnings Report, Transcript and Summary

Good evening. My name is Rochelle and I will be conference operator today. At this time, I would like to welcome everyone to the CPS Technologies 2018 Year-end Investor Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Mr. Ralph Norwood, Chief Financial Officer, you may begin your conference.

Thank you, operator, and good afternoon. I am joined today with Tom Breen, Senior Vice President for Sales and Marketing and Grant Bennett, our President and CEO. Before we begin the business portion of the call, I would like to point out to all of you the statements in this conference call that are not strictly historical or forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and should be considered as subject to the many uncertainties that exist in CPS' operations and environment. These uncertainties include economic conditions, market demands and competitive factors. Such factors could cause actual results to differ materially from those in any forward-looking statement. Now, I would like to turn the call over to Grant to offer his perspective on the fourth quarter's results.

Thank you, Ralph and good afternoon to each of you. As indicated in our press release, the fourth quarter was a very good quarter. We achieved a 60% increase in revenues versus the same quarter a year ago. We generated our largest quarterly operating profit in three years and we paid down completely our line of credit, so that we were debt free at year-end and remains so today. The Q4 revenues were $6.1 million as mentioned a 60% increase over the same period a year ago. Looking at the Q3 and Q4 revenues, we were running at an annual run rate of roughly $24 million in the last half of 2018. Revenues for the year 2018 were $21.6 million compared with $14.6 million for the previous year, an increase of 48%. Our Q4 operating profit was $208,000 compared to a loss of $396,000 for the previous year. The operating loss for 2018 narrowed to 900,000 compared with an operating loss of $1.9 million in 2017. Let me highlight some important trends and developments. Wonderfully customer demand particularly for traction applications remains strong and growing throughout the quarter. This increasing demand is driven by both increasing demand for trains particularly in China where the Financial Times indicates spending on high speed rail will increase 40% this year compared to last year. But this overall increasing demand around the world is also driven by increasing use of power modules and other applications such as power grids and wind turbines. We also continue to work with market leaders in the use of silicon carbide dye for power modules around the world, today a small but rapidly growing market segment. We have a positive outlook on the underlying market growth in the power module area and we feel that we're taking the right steps to capture this growth wherever it may be in the world. We continue to be very active in Asia although in the near-term, the 25% retaliatory tariffs imposed by the Chinese government on our base plates is limiting ourselves in China. We hope and believe that this condition will be temporary. Our quotation and qualification activities in Japan are increasing and we believe it's more likely than not that we'll be shipping meaningful production volumes to Japanese customers later this year. Besides the traction and power module area, another area for focus for us is in defense electronics in the U.S. Ten months ago, we brought onboard a salesman stationed in the Los Angeles area with the specific mission of identifying new defense applications and increasing our penetration of the major defense contractors. This focus is bearing fruit. We've identified several new applications for the use [indiscernible] and we've found new defense customers for existing applications. Compared to many commercial programs the volumes tend to be lower. However, the programs often run for many years and the margins tend to be higher. The number of new parts booked at defense contractors in 2018 increased by just over 50% compared to 2017 largely as a result of the increased sales efforts. As our performance increases, we're concurrently increasing our Investor Relations activities. Ralph Norwood and I presented at Noble Con 15, the annual investor conference sponsored by the Noble Capital Markets in February in Fort Lauderdale. The presentation we gave is available on the Investor Relations page of our Web site. We invite you to look at it, if you haven't done so. At the conference, we feel we accessed a new pool of potential investors and we enjoy two very busy days as almost every time slot was booked by potential investors. At this point, let me turn the call back to Ralph to provide more detail on the numbers for the quarter.

Thank you, Grant. Revenues for the fourth quarter totaled $6.1 million, a 60% increase over the fourth quarter a year ago and this was the fourth consecutive quarter where we have recorded sequential revenue growth. And those of you who follow the company are well aware a significant portion of our manufacturing cost is fixed and as a result changes in revenues have a significant impact on our gross margin. The increase in revenues in the fourth quarter versus the same quarter a year ago is the major reason, while our gross margin percentage increased from 15% to 20% in those corresponding periods. Selling, general and administrative costs totaled $1 million in both quarters. Although the fourth quarter of 2018 sales commissions were up significantly due to the increase in revenues, SG&A was flat in total versus last year as 2017 included severance cost, which was not repeated this year. Operating profit for the quarter was $208,000 which compares with an operating loss in the fourth quarter last year of $396,000 dollars. This improvement was due primarily to the increase in sales volume and is the highest quarterly level of operating profit since the first quarter of 2016 as Grant's mentioned. The last item to addressed is the tax provision, last year the tax expense was skewed by the impact of the Tax Cut and Jobs Act, which adversely affected tax cost in the quarter. This year during the fourth quarter, we established a valuation reserve of $3 million against nearly all of our deferred tax asset. We made this decision despite our strong performance and our expectation of continued strength and performance in the future. This decision to set up the reserve was driven by the accounting rules which argue for weighing historical results more heavily than future projections, but we need to emphasize that once we set up this reserve it has no effect on cash. It has no effect on the tax return and it has no impact on the tax credits themselves. The impact is strictly on the reporting of accounting net income and on the deferred tax asset side of the balance sheet. As a result of this reserve there will be a generally favorable accounting impact going forward. For the foreseeable future that is the next several quarters, earnings and losses if they occur before tax will approximate our earnings after tax. I do not expect this to change until we have several quarters of earnings to support the position that our tax credits will be fully utilized. Turning now to the balance sheet, we ended the year with $600,000 of cash and no bank borrowings as we paid off our line of credit during the quarter. This cash balance is down $700,000 from year-end 2017 due primarily to our losses from operations. Receivables totaled $3.1 million at the end of 2018, which represented 45-day sales outstanding, which is an unusually low number as we typically average about 60 days. However, since the sales during the fourth quarter were front-end loaded, the corresponding revenues were collected before year-end resulting in a lower receivable number. Inventories at the end of the year totaled $3.2 million, which is up over $1 million versus year-end 2017. This increase was due to two factors; first, our increase in business required more inventories; and secondly, the decision to accept responsibility for plating our products for major customer also added to the inventory totals. Despite the $1 million increase, our inventory turnover was a healthy 6x as measured over the past year. Continuing down the asset side of the balance sheet, you will see that net property, plant and equipment is down $200,000 as depreciation exceeded capital expenditures in the year by this amount. Finally, as I mentioned earlier we established $3 million reserve for our deferred tax asset. As a result, the book value of that asset was reduced by that amount. But, once again, we need to emphasize this was an accounting decision in no way affects cash. This asset will enable us to shield paying cash taxes on approximately $12 million of pre-tax future income. So, we'll still get the cash benefit of that and this is just an accounting non-cash adjustment. Turning to the liability side, payables and accruals in total amounted to $2.7 million, which is up about $1 million from a year ago, but is a reflection of the increase in our business and is not in any way reflect a change in our payment terms to suppliers. Finally, at the end of the quarter, our current ratio was a healthy 2.6 and our debt to equity was a low 0.5. We also have a committed line of credit of $1.5 million with Santander and this agreement goes through the end of June 2019. At this time, operator, we're ready to take some questions.

[Operator Instructions] Your first question comes from the line of Michael [indiscernible]. Your line is open.

Thank you. Can you all hear me?

Yes. Hello, Michael.

Hey folks. I wanted to just focus on your relationship with Cree. Just some simple factual questions in order if you don't mind. How long have you really had a connection with or been talking to doing stuff with Cree?

We have for -- several years we have been -- we've had interaction both with Cree and with what was formerly known as Arkansas Power International -- Arkansas Power Electronics International, APEI, before they were purchased by Cree, so several years.

Which came first? Arkansas Power or Cree?

I don't remember the answer to that question.

Okay.

All right. Thank you. [Operator Instructions] Your next question comes from the line of Lenny Dunn. Your line is open.

Hi. Good afternoon or evening.

Hi, Lenny.

Glad to see you in the black that's where I was really looking forward to. And I understand all this accounting with the tax doesn't make any difference. But, you felt it was necessary to take the entire amount as opposed to two thirds of it or just…

Well, that's a very good question and I will tell you the answer to that. Having had several discussions with our auditors, when you have to make an estimate and that's whether or not you have a bad debt or you have an insurance claim or in this case, tax credits, you need to have a basis for taking your percentage. We had no basis to take 10% or 30 or 70. So I talked to the appropriate people, I said, what do you do in that case? And they said you take it all. And I thought that's pretty darn conservative. But, okay, if that's the rules, we'll do it. So that's the answer.

Okay. But the reality is that if you continue to be profitable in some point you'll have to take some of it back based on the current four quarters or whatever?

That's true. But the way they explained it is, that this will be -- if we would have to string together in order of magnitude five to 10 consecutive profitable quarters for them to then allow us to take you back…

Before peers out before you could do it okay.

Yes.

All right. That is just curiosity because it just -- its numbers on a balance sheet that don't come to use of many.

That's right.

And the next thing is, I'm very glad you went to the Noble Conference. Do you have other conferences scheduled?

We had talked about Sidoti. Unfortunately, it just doesn't work for our trips Grant's going to be out of the country and so we're passing on that one. But we don't have any immediate ones, but we would expect one or two more in 2019, probably one in the second quarter and one in the fall. But we haven't schedule them just yet.

Okay. Thank you. [Operator Instructions] We have a follow up question comes from the line of Michael [indiscernible]. Your line is open.

Yes. On Cree again. So, I'm hearing about three years or so. And the key question is, what areas without SiC or silicon carbide more generally have you identified in terms of potential new products, new material solutions. What's really driving things?

Well Cree is the leader in the world in silicon carbide dye for power applications. And they are the technological leader in the world at least in our opinion. And we simply have a very close working relationship. And in those applications where AlSiC provides compelling advantages where we very much appreciate the opportunity, we have to be working with them.

All right. Thank you very much. [Operator Instructions] We have a follow up question from Lenny Dunn. Your line is open.

Yes. Hi. Just a couple of things. Obviously to get on a conference schedule and get good placement from a time standpoint, you'd want to do these things as soon as possible and obviously it has to work with your schedules, this is not a company with 10 executives, so I understand your schedule has to come first because we want you running the business, first, introducing the staff to new people, second. But I just wanted to emphasize that we'd love to see you get on schedule.

We will have to say Lenny, you were very helpful in guiding us to Nobel and we were quite impressed. We were impressed with the quality of investors there. We were very pleased, we went there, it caused us to sharpen our discussion of how we present the company as well. So, it was investment well worth the time and effort.

And we feel -- as Sidoti, it was a very productive conference. The last time we went in New York, it was nice to be in a different location. Just felt like to some degree we pulled in a different investor pool.

All right. Thank you very much. There are no further questions at this time. Over to presenters. Please continue.

Rochelle would you pool the participants one more time. I'm very confident there are at least a couple more interesting questions out there.

All right. Thank you. [Operator Instructions] We have a follow up question comes from the line of Michael [indiscernible]. Your line is open.

Third time is the charm. Here we go. How far out in terms of working either with R&D or research because Cree is really out there as far as looking forward to the future. Are you with Cree?

Yes, sure. Let me -- we of course need to fully abide by any non-disclosure agreements. But Tom take it, let me hand this call off to you.

Michael, thanks for that question. I appreciate and understand given Cree's reputation the focus and attention that you and others in the investor community are paying to that company. And to Grant's point, we can't get into the specifics on any single customer. But, we are under contract and have performed contracts with Cree as we have with most every other major dye or IGBT manufacturer around the world as it relates to silicon carbide. These are not yet high-volume production opportunities, but we're not doing things for free either. One thing I think it's important as this question comes up each quarter when we have these quarterly calls is, we should not lose sight of the fact that the silicon carbide, the more stressing design constraints that this equipment causes as in smaller dye higher voltages higher temperature. And the reason why it is perceived as to be such a great future, can frequently only be solved when you pair it with AlSic base plate. So, we feel we're uniquely positioned to take advantage of that market opportunity as they arrive not just from Cree, but from others. However, I think it's also important to keep in context that the adoption of silicon carbide for the high-volume applications is not going to happen overnight. In general, when our products are assembled into an IGBT, for example, the dye is the most expensive component in the entire assembly whether that's silicon or silicon carbide. And the reality is, these high-volume applications almost always are very, very price and cost sensitive. And so today silicon carbide is 3x more expensive than silicon at the dye level. Silicon carbide performance drives significant changes in the rest of the system design whether it's in the substrates or the dye attached materials or other IGBT components. And the reality is, today silicon carbide is perceived as less reliable than silicon. So, for high reliability applications, the world leaders, the large volume productions and the most significant and challenging applications reluctant to switch over completely. Having said all that, all of these technical challenges will be overcome. It's just that that adoption will take some time. CPS is in the right position not just with Cree, but with many other -- most of the other major companies in the world that we will benefit from that adoption and growth. But this is going to be measured in years not in quarters or in months. So, perhaps I'm lecturing the teacher here, but that is our perspective. We're very bullish on opposition and our financial plans and our five-year strategic plans take into account what that adoption curve is likely to be.

And Tom, if I could just to elaborate with an actual example. We're working with a major module manufacturer and an actual automotive producer a major worldwide automotive producer on a future generation product and the automotive OEM indicates to us that for the same car model, they are -- this is an electric vehicle, but they're going to be offering; one, the base model if you like with traditional Silicon IGBT module and the high-performance model of this same car is going to be with the silicon carbide dye inverter. And that they're working with us to provide the AlSiC base plate for the silicon carbide dye inverter. But any way that in my mind is a fascinating example that at least looking ahead two years or so when this particular program, we believe will go into production that they're offering both options as opposed to just one. Let me just say, however, that due to the fact that we don't have many trains in the U.S., we seeded the or conceded I should say the power module market to Japan and Europe and I'm delighted that with companies like Cree, the U.S. has an opportunity to come back in and begin to capture a greater share of that market.

All right. Thank you. We have the next question comes from the line of Randall [indiscernible]. Your line is open.

Hi. Congratulations on the operating profits. Nice to see.

Thank you.

Now you guys have had a couple quarters where you've done a little over $6 million. Is that sort of becoming maybe a new sort of base level to look at as we try to model where the company might be going this year?

We don't give a lot of guidance in that direction Randall. But let's see if I can -- to mention, this might be helpful. As we look to 2019, we would expect for the year to -- we're quite comfortable saying we will be in double digits as far as growth. And we're quite comfortable saying that we expect the second half to be greater than the first half. I hope that's helpful.

You do the math there. And fundamentally you're right. I would add that because of the nature of being a customer component supplier, we will always have volatility in quarter-to-quarter as our customers become -- our customer bases is more diversified. That will be limited a little bit, but still some quarter-to-quarter volatility. But, nonetheless, the math that Ralph points out certainly suggests on average $6 million is a good starting point.

All right. Thank you. We have a follow up question comes from the line of Lenny Dunn. Your line is open.

Yes. One is a request if you could compile an email list of people like me that when you have a news release or you have an earnings call or things like that if you're just email us and I kind of look your Web site regularly and find these things. But it is more convenient if you could send them out in an email. And it can't cost you anything. So, I would appreciate if you could start compiling an email list as probably other people that would appreciate it too.

Good point. We'll do it.

Okay. Thank you. And then, the last thing is, I again never want you to put out puffery type news releases, but if we can get some sort of news releases with some regularity maybe one a month, so we know how things are going. It would also be appreciated.

Very good. We agree in both points. The more the better as long as there's no puffery involved.

All right. Thank you. Next question comes from the line of Walter Schenker. Your line is open.

Hello gentlemen.

Hi.

Now that we've got you at $6 million quarters with quarterly variability. You just had a $6 million. What if anything is more to Ralph was unusual or not in that quarter in regard to $6 million of revenue and $200,000 of operating profits.

Good question. Yes, because we didn't have the $200,000 in the third quarter. Couple of things Walter, one is product mix does play a factor and it was more favorable in the fourth quarter than the third. The second point is, we do have some variability in our manufacturing operation. I'll give you a simple example is repair and maintenance on our machines. Some quarters it might be 50,000, in another quarter it might be 200,000 just because of the nature of our factory. And the difference there could be easily $100,000 one quarter versus the other. So, we had more than -- more benefits in the fourth quarter for those two reasons.

And therefore, I am supposed to expect again without making a forecast that the midpoint of the third and fourth quarters is more typical or hopefully the fourth quarter is more typical?

I think the fourth quarter would be on the high-end.

Okay. I appreciate it. Thank you.

We have a follow up question comes from the line of [indiscernible]. Your line is open.

A couple questions on different topics here. One is, I wondered if you could give us an update sort of on what's going on in the armor world? And maybe on your capacity to produce on that side? And then, secondly, if you could give us a little bit more color on what you see unfolding in Japan would be very helpful?

Thank you, Randall, it's Tom Breen. So, Grant had already mentioned the broader success we're having in the defense and aerospace market segment within that armor efforts continue to progress. Actually, this week we are hosting one of our important domestic armor customers, and their U.S. DoD end-user at our facilities to witness the fabrication of the complete armor solution not just the strike face component, which we've traditionally made. This follow-on order and that's subsequent to the one we mentioned in our October call is scheduled for the final environmental shock and vibe testing by the end-user a little later this year. This is a significant strategic milestone for CPS to effectively move up the food chain and be able to work with our domestic and international customers to provide more than one component. I've also spoken in the past about the U.S. Navy sea trials particularly in the last phone call and we continue to hear strong positive albeit anecdotal reports of success, one end-user jokingly or half jokingly informed our customer that the crew doesn't want to relinquish the equipment from the ship. In reality, there are much larger demands for U.S. aircraft carriers, so returning to port and scheduling the removal and the post sea trial testing has been delayed slightly. But, we remain quite bullish on that and other armor opportunities. As it relates to Japan, I guess I would say that we are active with many industry-leading companies in multiple countries throughout Asia fully engaged with the largest of the industry leaders at a technical sales and executive level. We have face-to-face meetings scheduled over the next 45 days both customers coming to CPS facilities and CPS going to customer facilities. And we're bullish about that continued growth in the defense and aerospace market segment in Asia, which includes Japan. I think that Grant already talked a little bit about the tariff situation in China, but in parallel with that, we also see an increase in customer activity in Japan that is a clear indication that the patent issue that's dogged us for a few years has been completely resolved. And as we discussed during those August and October calls, the production revenue from this geographic region and for the AlSiC product line were not a significant component of this year's revenue plan. But we do expect to be shipping meaningful production volumes later this year and that's out of -- principally out of Japan.

Grant here. Let me just elaborate on one point. We don't want to keep coming back to this topic. But our progress in Japan, really was frustrated by this claim of patent infringement and even though after several years of legal proceedings even though we had a ruling from the Japanese patent office in our favor. Nonetheless, the customers and about a year ago, we obtained that ruling which was definitive and clear. But, nonetheless, the Japanese customers are very, very cautious and what is happening is that even though the patent was narrowed and the ruling was in our favor -- what remains of the patent itself is expiring this year. And we believe part of what's happening is that now there is just absolutely no concern on any dimension because the patent that they were claiming, we were infringing will actually expire. That's just even a little clearer pathway to success there.

And Randall, one further point, you had asked about the capacity for armor. We do not foresee any infrastructure or facility limitations for the forecasted armor business for the next couple of years at least. It would strictly be a question of scaling the workforce to accommodate the larger volume and higher number of square meters of the panels that would need to be made. So, I hope that answers your question.

All right. Thank you. Your next question comes from the line is Michael [indiscernible]. Your line is open.

Thank you. Back to China. China trade, China tariffs and an outcome in China for you. Where does China rail stand with its own manufacturing and you versus Denka as far as working with partners and buying product in China.

Michael, thank you for that question. China -- CRC, the largest manufacturer of power modules in China has a fully -- has a full manufacturing capability based on my last tour and although they may not be approaching anywhere near their maximum capacity. There is ongoing business there. The reality is that right now Denka is the incumbent and CPS is working our way through the process to capture more market share there. The tariff -- the retaliatory tariffs of 25% have crimped our progress there, but we do believe we have a couple of paths forward with the customer -- with several customers in China actually. I will be visiting them in the middle of April to try to move that forward. Similar to my comment about Japan, however, we are expecting to move forward with additional orders and deliveries this year. They were never part of this 2019 revenue plan, but they are obviously strategic and moving us into a position to deliver higher volumes in 2020.

Thanks.

All right. Thank you. There are no further questions at this time. Over to presenters. You may continue.

Thank you very much for joining us. If you listen to the call we are always going to be factual. But, let me just say, I hope you can sense our enthusiasm for this year. We were hiring, we're busy from a sales and marketing point of view and we're looking forward to a very good year. Let me mention and remind you that our Annual Meeting is scheduled for Friday, April 26, in Boston and we certainly invite all of you to attend and meet and mingle with the management and the Board of Directors, if you're able to join us. We also welcome a visit by any of you to our facility here in Norton, Massachusetts at any time. Thank you very much for your attention and goodbye.

Thank you, presenters and this concludes today's conference call. Thank you all for participating. You may now disconnect.