CPS Technologies Corporation (CPSH) Q3 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to CPS Technologies Corp. Third Quarter Investor Conference. At this time, all participant lines are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Chuck Griffith. Thank you. Please go ahead, sir.

Thank you, operator, and good afternoon, everyone. I'm joined today by 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 that statements in this conference call that are not strictly historical are 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 the impact of COVID-19, economic conditions, market demands and competitive factors. Such factors could cause actual results to differ materially from those in any forward-looking statements. Now I'll turn the call over to Grant to offer his perspectives on the third quarter's results.

Thank you, Chuck, and welcome. Before I begin, let me just mention, we understand there was a delay by our press release service in issuing the press release, but it is – it has been released, and so you should be able to access it currently. Evidently, table formatting even stymies the professionals occasionally. Again, we appreciate you joining us. Today, we announced revenues of $4.5 million and an operating profit of $253,000 for the quarter ended September 26, 2020. This compares with revenues of $4.4 million and an operating loss of $479,000 for the quarter ended one year ago. For the nine months ending September 26, 2020 revenues were $16.7 million with an operating profit of $1.2 million. This compares with revenues of $16 million and an operating loss of $966,000 for the same nine-month period ended a year ago. For both the quarter and the nine months just ended, revenues were up slightly, operating income was up very significantly. While we're generally pleased with the bottom lines for both the quarter and the nine periods just ended, in the third quarter our top line was increasingly negatively affected by the coronavirus pandemic. We ship each year to approximately 80 customers and our largest three customers have historically accounted for 50% to 70% of our revenues. In the third quarter, two of these three customers notified us that they were reducing purchases significantly. In one case, the reduction was immediate. And in the other case, the reduction began in the last month of the quarter. These reductions in demand from these two large customers account for more than 100% of the difference in revenue between our first and third quarters this year. As you know, we sell baseplates for power modules to both these large customers, who in turn produce power modules for use in trains, subway cars, and wind turbines, as well as the electrical grid; due to COVID, use of air and rail transportation, including public transportation is down very sharply and operators in particular in Europe and the U.S. are delaying expansion and replacement of train sets. For example, I just saw yesterday that New York City subway ridership is down 70% last month compared to a year ago. It's the delays and the postponing of some of these programs, which has affected our customers' demand in the near-term and in turn affected us. In spite of the acute near-term challenge, there may be somewhat of a modest silver lining to the COVID issue. A recent UBS investment bank study forecast, that one effect, one long-term effect of the pandemic in Europe, maybe a modest shift from air to railway travel as things returned to normal. We are confident, demand for baseplates will return to previous levels and continue to grow due to the underlying growth in rail travel and wind turbines, and importantly, due to the increased use of these modules in the electrical grid. However, we do expect reduced baseplate demand to continue through the next several quarters. While the short-term demand from these two customers is down significantly, revenues from our other approximately 75 to 80 customers were up slightly, despite the pandemic. After Chuck summarizes our financial results, I'd like to describe some of the developments among these other customers that give us a positive and optimistic outlook, despite the pandemic. In the third quarter, we continue to make excellent progress on improving our bottom line. We've stopped producing some unprofitable products. We've improved pricing in many products, and very importantly, we've improved operating efficiencies in our manufacturing operations. For the nine-month period just ended, the improvement in operating profit compared to the same period a year ago is a swing of $2.2 million. Let me turn the time over to Chuck to review the financial results in more detail.

Thanks, Grant. So revenues for the quarter did total $4.5 million, which represented a 2% increase over the $4.4 million in quarter three of last year. This increase is primarily due to price increases. Gross margin for the quarter amounted to 21% of sales compared to 5% of sales in the third quarter last year. The largest factor affecting this percentage was new contracts with our three largest customers as we've discussed in the past. Selling, general and administrative costs totaled $684,000 compared to last year's $702,000. This was due to lower sales commissions. While overall revenue was slightly up, it was down with the higher commission customers, and that's what caused that decrease in SG&A. The company generated an operating profit for the quarter of $253,000, which compared to an operating loss in Q3 of 2019 of $479,000. Turning to the balance sheet, we ended the quarter with about $113,000 of cash and $835,000 of borrowings against our line of credit. This net cash of minus $722,000 is an improvement of our cash position from the end of Q2, when the cash was minus $910,000. Accounts receivable as of September 26, totaled $4.4 million compared to $2.8 million, September 28, 2019. Our days sales outstanding totaled 80 days at the end of the quarter compared to 57 days at the end of the third quarter in 2019. The increase is due to the elimination of the prompt pay discount, which we've discussed in the past and increased sales also to a particular customer that has extended payment terms. Inventories totaled $4.2 million at September 26, 2020 compared to $2.8 million at September 28, 2019. The inventory turnover in the most recent four quarters was 4.9 times compared to 6.2 times for the four quarters ended September 28, 2019. The decrease in turns is directly related to the decrease in purchases by our largest customers as Grant discussed earlier. We do expect to work this inventory level down over the next several months and don't see it as a major issue. Turning to the liability side. You'll see the $835,000 drawn on our line of credit. Payables and accruals totaled $2.4 million at September 26, 2020, up slightly from $2.2 million, September 28, 2019. You'll also see the inclusion of a note payable, not in last year's liabilities. This is due to the financing of new equipment in both the first and third quarters of this year. And for further discussion, I will turn the call back over to Grant.

Thank you, Chuck. Let me comment on some of the developments and projects in our pipeline that underlie our positive and optimistic outlook for the future despite the pandemic. We've commented for several quarters that we have focused on more deeply penetrating the U.S. defense electronics, aerospace and space sectors. We continue to make excellent progress in these areas in terms of new design wins. As you know, AlSiC components made by CPS are on the international space station and on all current generation GPS satellites. We announced in August that we produced an AlSiC hermetic package for the power supply for the SHERLOC scientific instrument on the Perseverance Mars Rover that was recently launched. We supplied this product directly to the Jet Propulsion Laboratory. We've since learned that one of our customers also supplied a key component incorporating an AlSiC heat spreader made by us for the Mars Rover. So we have at least two components on the Perseverance Rover that sometime in January, hopefully, will be on the surface of Mars. We recently shipped several much larger AlSiC components, which will be key parts of the main scientific instruments of the methane sat, a joint U.S.-New Zealand scientific satellite scheduled for launch in 2022, which will measure methane emissions from oil and gas fields worldwide. The prime contractor for the scientific instruments in this remarkable program is Ball Aerospace. These applications demonstrate the benefits, primarily increased reliability and reduced weight of AlSiC in aerospace and space applications. I mentioned them individually to highlight the fact that in each case, the CPS content on each program is increasing. As the design and engineering teams at our major OEMs become more familiar with AlSiC, the rate of design wins is increasing, and the use of AlSiC in any given program is also increasing. A second area, those of you who follow the power semiconductor world are aware of the projected growth of silicon carbide power semiconductors in power modules. We are shipping baseplates into several silicon carbide power module programs, most programs still in the prototype and customer sampling phases at our customers. But based on customer provided forecasts and RFQs, we're seeing for these baseplates from our customers, we expect one or more of these silicon carbide based modules going into volume production as soon as the second half of next year. We believe that we're well positioned in this market segment, both in the U.S. and in Europe. A third area, we have not mentioned armor for several quarters. The last time we did mention armor, we indicated that we were largely finished with the technical development and that we were focusing on market development and sales activities. We recently received some very positive indications that we are likely to receive a production order for an armor product produced by CPS, which has been thoroughly evaluated, ballistically tested and field tested over the last five years by the U.S. Department of Defense. We don't have the order yet, but we received very positive indications that suggest it's likely. These are examples of an exciting pipeline of future products and future growth. Where COVID-19 not in the pitcher, we believe 2020 would have been a record year in terms of both revenues and profits. As we consider 2021, any forward-looking comments must begin with the clear caveat that the pandemic is injecting considerable uncertainty at customers and suppliers, so conditions can, and may change quickly. While we must tone down our optimism for at least the fourth quarter of this year and the first quarter of 2021, and realistically, perhaps the second and third quarters of next year, we continue to be very optimistic about the future optimistic that the effects of the pandemic will eventually end and more importantly, optimistic that our product pipeline will generate exciting future growth. Let me stop there and open the floor for questions.

[Operator Instructions] Your first question comes from the line of Lenny Dunn [Mutual Trust Company]. Your line is now open.

Good afternoon and congratulations.

Hi, Lenny.

Hi. Yes, it was just you navigated through a very difficult situation very well. So I'm pleased. And also understand that we're looking at this as it is, as opposed to what it would have been if we didn't have this pandemic going on, but the world is certainly different. I'm not as pessimistic as you in that. I think by the second calendar quarter next year, we could see in the type of business that we're in a more normalized situation. So what you have is, excuse me, is a nice portfolio of products that certainly are necessary. And I think things pick up with rail and I think things, the space thing is certainly not going to be a huge on its own, but it certainly is something that can get you lots of other business because if it's good enough for a space, it's good enough for almost anything else you could use your products for. So I do think it's a very strong positive. And the armor business, I see the world we live in being something that is going to be in high demand. So the future could be pretty good. And as long as you can operate profitably in these adverse circumstances, I think profits could grow very quickly as you get into the second calendar quarter of next year, but if you want to comment on anything I just said, I'd appreciate it.

Sure. Lenny, thank you very much. We certainly – we shy away from giving guidance, and under the current environment we shy away even more. But having said that let me give a little bit of guidance. Our large customers typically provide us with a rolling, one-year forward rolling forecast. And I mentioned two of our three largest customers demand has declined. The third incidentally demand is up and they continue to give us a rolling forecast for a whole year. But the other two are only forecasting out the next two quarters simply because there is so much uncertainty. And at least in one case, as we'd look in the fourth quarter, we were recently notified that they're going to be shutting their manufacturing operations down for three weeks at the end of the year. And so there is some uncertainty in the real short-term due to the pandemic. But we also – we do our best to try and understand what's really going on, that is driving demand. And we also believe and hope that for these two large customers that things could improve in the second half of next year. I hope I stated especially clearly that if we pull these two customers out of the equation, revenues were up in spite of the pandemic. And obviously some individual customers are down, some are up, but we – the underlying drive to diversify the customer base is absolutely proceeding. And we think we could have a reasonable year next year in spite of the pandemic.

Okay. And why would I think your customers, not you, be that profoundly affected as you're stating even in the near-term because they're not selling to just to be to restaurants or bars or travel industry, it's just – it would seem like…

Let me jump in for a second. So one in particular notified us that their customer put their orders or basically delayed shipments on those orders, which cause our customer delay purchases from us. And that customer we're pretty sure is a railroad company, who is not buying new equipment temporarily because they – their ridership is way down during the pandemic. And so I think that's probably one really good example of why this is happening right now, even in our industry.

Okay. But I think people will have confidence in the railroad industry quite a bit before they have it in the aero industry. So it would seem like…

Yes, I agree. I agree. But that's just happens to be, our customer called us and said, this is why.

Very good. We're anxious to enter everyone has – anyone who wants to ask a question. Lenny, maybe we could encourage you to let someone else have the floor and come back with another question, if you have one.

No. Please go ahead and take whatever calls are available to you.

Very good. Thank you.

Thank you.

Next question comes from the line of Sam Rebotsky [ph]. Your line is now open.

Yes. Hi. It's a renewal of revisiting an investment of American research and development. I invested in ARD way back when they first invested into digital equipment. So hopefully you could do for CPSH what they did for all their other investments.

Well, thank you. They are – they remain our larger shareholder.

Okay. That's good. Now tell me, is there a backlog that you, I don't know, did you mention on the backlog what the numbers are? And what the follow of a shipments are that we expect to be shipped?

Okay. Let me comment on that. The world's changed so that the backlog is difficult to define exactly. Bear with me while I just explain. We of course have a clearly defined backlog of purchase orders with firm commitments and with ship dates. But increasingly what customers do is we enter into a contract typically for a year or two years with an agreed upon price and with a volume range of product, and then the customer releases individual shipments on a weekly or monthly basis. And so do we put into the backlog there estimated volume for the year? Or do we put in just the one or two forward-looking weeks or months that have actually been released? That's where the backlog becomes confusing to communicate. But let me say that the – it really is only these two large customers in what is known as traction industry, primarily railway, but also importantly, these modules go into wind turbines into grids, that it's only in that case that the forecast have been significantly reduced. You have our year-to-date financial results. Typically, as we go into a year, about 80% of the revenue that we have in our plan is either under the kind of contract I just described or is from backlog. And having said that, we're now involved in negotiations for next year for some of these yearlong contracts. But in short, we think with the exception of these two large customers that we describe, all indications are that demand should be reasonably strong with the rest of our customers.

Okay. And would you say your backlog is increasing? Would you say, do you work on one shift or two shifts? And further question, you recently hired Charles Da Rosa, Vice President of operations. Did he replace somebody? Or is he an addition?

We’re operating three shifts a day, five days a week. The third shift is so much smaller than the second shift, which in turn is smaller than the first shift so that we have considerable capacity available, but the nature of the manufacturing operations indicate that it's most cost effectively to operate three shifts. You must have something with a bad date on it. Charlie Da Rosa is indeed an employee. And I think he's been here 10 years.

I'm sorry. I made a mistake. You added key addition to your engineering team.

Right.

Bill Holmes. I'm sorry.

Yes, you’re referring to Bill Holmes. Yes, we're delighted. Bill recently joined us one area that is growing, and we'll talk more about this in our year-end results. But our hermetic packaging product line is growing, and Bill Holmes was brought on board primarily to assist in that area, but also a component area, but he's on board and brings many years of experience. We're happy to have him.

And he does not replace somebody. He's – it's a new position.

Yes. Wonderful. Wonderful. Looking forward to your improving as this COVID goes away and getting good results. Good luck.

Thanks very much.

Thank you.

Next question comes from the line of Steven Carter [ph]. Your line is now open. Steven Carter [ph], your line is now open.

Hello? Hello?

Hello. Hi. Yes, I just had a quick question. You all mentioned earlier about the armor contract with the Department of Defense. Do you all have any idea about like what kind of revenue that might bring and like when you might hear something about like, timing loss, about that contract?

We hope to have a contract by the end of the year. And let me simply say the impact on, why don’t we count and say materiality is 5%?

If it's 5%, it's material.

Let me just say it would have a materially positive impact on our revenues we believe.

Okay. And I think you all did it overall. I think you all done a good job. I mean, you all still managed to keep the bottom line profitable, even though the revenue is down. And I think all you all doing a fantastic job. So keep up the good work and hopefully I'll get that contract and keep going.

Thanks.

That's all I have.

Thank you.

All right, thank you.

[Operator Instructions] There are no further questions at this time. Presenters, you may continue.

Okay. Thank you very much. Let me just comment on one or two other elements. As we all go through this pandemic together, really the most important element for all of us is the health of our family members, the health of our employees. And we're pleased that CPS is a healthy place to be. We have been operating throughout the pandemic. We are rigorously following CDC and OSHA guidance. We take employee's temperature at the beginning of each shift, as we've mentioned before, we've staggered our shifts to reduce employee overlap, that we rearranged workstations, et cetera. And we feel like we're in a new normal, which is sustainable from an operational point of view. None of you are traveling I'm sure. But so when the pandemic does pass, we'd like to invite you to come in and see what we do. And in the meantime, we'll simply wish you well, stay healthy and please feel free to contact Chuck or myself with any questions you might have. And with that we'll thank you and sign off.

Thanks everyone,

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