Cps Technologies Corp/De/ Q1 FY2020 Earnings Call

Good afternoon. My name is Ivo, and I'll be your conference operator today. At this time, I would like to welcome everyone to CPS Technologies First Quarter Conference Call. Thank you. It is now my pleasure to turn the call over to your first presenter, Mr. Chuck Griffith. The floor is yours. You may begin.

Thank you, operator, and good afternoon. 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.

Thank you, Chuck, and welcome to each one of you. Thank you for joining us. It's a beautiful day here in Massachusetts, and I hope it is wherever you are. I'm pleased to report our first quarter 2020 revenues of $6.5 million and operating profit of $622,000. This compares with revenue of $5.3 million and an operating loss of $744,000 for the same period a year ago. Our first quarter results build nicely on our fourth quarter 2019 results, which were revenues of $5.4 million and operating profit of $368,000, suggesting over the last 6 months, operating profit near $1 million. Our revenues of $6.5 million represent the highest quarterly revenue in our company's history, and the operating profit of $622,000 is the fourth highest operating profit in our history. Let me provide additional context by commenting on 3 topics: first, some specific details relating to Q1 results; second, the status and our progress on our longer-term strategic initiatives, which certainly impacted Q1 results and will impact future quarters; and thirdly, after Chuck discusses our Q1 financial results, I'd like to comment on the elephant in the lobby of all businesses today, namely the COVID-19 pandemic. So first, some additional information regarding the first quarter results. In the last 2 quarterly calls, I've commented on the fact that in the third quarter last year, we entered into new contracts with our 3 largest customers. One contract was for 1 year. The other 2 contracts are for 2 years. All 3 contracts called for higher prices and higher volumes. The phase-in period or phase-in timing of the price and volume changes vary from contract to contract, but these changes began to be phased in in Q4 of last year, continued to be phased in in Q1 and will be fully phased in by the end of Q2, our current quarter. These increased volumes and increased prices obviously had a positive impact on our Q1 results and they should continue to do so. In our fourth quarter conference call, we mentioned a focused effort to improve our product mix, namely to focus on those products where we bring the greatest value and, therefore, can generate a more attractive margin. This initiative also contributed to our Q1 results. We've stopped making some products that were not profitable.

Ivo, we have heard that some investors are still trying to join the call but have been unable to. Can you address that or confirm if there is an issue on your side?

Here in our end, speaker, we only have 2 lines waiting to be answered by the operator.

So those 2 will be... All right. Okay. So again, let me continue. We've talked about new contracts. We've talked about a focused effort to improve product mix. In our fourth quarter conference call, we also mentioned that we entered into a credit line with an expanded credit line with the explicit objective of allowing us to stop giving discounts for early payment of invoices. Payment terms tend to be much longer in Europe; 60, 90, 120 days are common. In the past, we've been giving discounts for early payment. These discounts come right off the top and bottom line. With the added credit line, we've stopped giving these discounts and that also had a positive impact on our Q1 results and will continue to do so in the future. Secondly, let me pull the camera back a little bit and comment on our key strategic initiatives. One key initiative is to deepen our penetration of the U.S. aerospace and defense electronics markets. Our sales and marketing team and our operations team are performing well in achieving new design wins, new bookings, and in producing and shipping new products into the U.S. aerospace and defense customers. As an example, in Q1, with help from 2 defense contractors and an outside analytical laboratory, the material properties of our AlSiC, for example, the coefficient of thermal expansion and the thermal conductivity were evaluated at cryogenic temperatures. This data is critical input for customers using our material in applications where the product sees cryogenic temperatures. We were very pleased with the properties, and this data is now opening new opportunities for us, primarily in the satellite area. A second initiative is to continue to capture the growth in the high-voltage IGBT or power module market on a worldwide basis. This is a market segment with underlying growth, we believe, for many years to come as these modules are used in a larger number of applications, such as the electrical grid. Chuck will comment that we've made some capital investments, both in production and analytical equipment that will allow us to continue to improve our products in this market and further differentiate us from our competition. A third initiative is to expand the use of AlSiC in hermetic package applications. This is, in many ways, tied into the first initiative of deepening our penetration in the aerospace and defense electronics market. We are making progress in this area as well. For example, we have an AlSiC hermetic package that is on the Perseverance, which is the most recent NASA Mars rover scheduled to be launched this summer. It's a – obviously, on one hand, a very small market. On the other hand, the product wasn't adopted for that application without a thorough understanding of its benefits.

Thank you, Grant. Revenues for the quarter, as Grant already said, totaled $6.5 million representing a 24% increase compared to Q1 last year. This increase was due to pricing increases implemented in the last quarter of 2019 and this first quarter of 2020 as well as unit volume increases. Gross margin for the quarter amounted to 24% of sales compared to 3% in the first quarter last year. The largest factor affecting this percentage was sales volume, which speaks for itself. In addition, the total manufacturing costs from quarter-to-quarter were down. A number of factors contributed to this, both within and outside of our control, for example, improved product yields are within our control, a relatively mild winter reduced some of our utility expenses and that would, of course, be outside of our control. Selling, general and administrative costs totaled $929,000 compared to last year's $904,000. Sales commissions due to increased sales volumes accounted for more than the net increase in this amount. There were a number of other individual pluses and minuses, net of which somewhat reduced the additional commission expense. The company experienced an operating profit for the quarter of $622,000, which compared to a loss from operations in quarter 1, 2019, of $744,000. Turning to the balance sheet, we ended the quarter with about $122,000 of cash and about $1.58 million of borrowings against our line of credit. This net cash of minus $1.46 million reflects the elimination of the prompt pay discount with our largest customer. Additionally, lower sales in January resulted in lower collections in March, while sales were growing. This increased our outstanding accounts receivable, which were financed through additional borrowing. Accounts receivable at March 28, 2020, totaled $6 million compared with $4.1 million at March 30, 2019. Our days sales outstanding totaled 77 days at the end of the quarter compared to 54 days in the first quarter of 2019. In addition to the elimination of the prompt pay discount mentioned, our #2 customer has longer payment terms, as Grant mentioned, in Europe, and had significantly increased sales in Q1 2020. Inventories totaled $3.6 million at March 28, 2020, compared to $3.1 million at March 30, 2019. The inventory turnover for the most recent 4 quarters was 6.0x compared to 5.9x for the 4 quarters ended March 30, 2019. Going back through the second quarter of 2018, our inventory turns have ranged from 5.9 to 6.2. So these numbers are consistent with our expectations. Finally, you'll note that our net property plant and equipment was up from last year, mainly due to the purchase of a new piece of equipment, allowing us to make significant improvements in our QA department. Turning to the liability side, you'll see the $1.6 million drawn on our $2.5 million line of credit. Payables and accruals totaled $3.3 million at March 28, 2020, down from $2.2 million at March 30, 2019. You'll also see the inclusion of a new note payable. This is due to the financing of the previously mentioned QA equipment.

Thank you, Chuck. I wanted to separate comments about our results from comments about COVID-19 to emphasize the fact that our fundamentals are strong and from my perspective, very attractive. We are very fortunate that COVID-19, while certainly having an impact today on our business does not appear, at least as of today, to alter any of these attractive fundamentals. This is certainly not the case for many other businesses in different sectors. We consider ourselves very fortunate that the COVID-19 epidemic, again, we don't believe it alters the fundamental attractive elements that underlie our business. Having said that, let me comment on what impact COVID-19 is having on us today. I know many of you listened in on our recent annual meeting, and we spent some time on COVID-19 in that meeting. But let me just try to provide a quick summary. Because we are in the defense industrial base, we are deemed by both state and federal government as an essential business and are requested to remain open. So we have been operating throughout the pandemic. All of our major customers also remain open and operating. Some smaller customers have closed some production facilities at least temporarily. All of our major suppliers also remain open and operating. So we have not seen, and as of today, do not foresee any direct issues with our supply chain. We have heard from some of our customers that they are having some issues with other suppliers so that supply chains could be disruptive. But in our case, our major suppliers remain open. Fortunately, demand through the first quarter was very strong and remained strong. We do see 2 things going on, one primarily in the past and one in the future. As it relates to the past, at least some customers towards the end of Q1, sensing all of the uncertainty related to COVID-19 sought to increase their own safety stock. In some cases, customers pulled the business in; this definitely occurred but was fairly modest. In our own case, we also foresaw uncertainties, in particular, we were looking at uncertainties relating to international shipment. We increased our own safety stock of inventories, and that has been helpful for us. As we look forward, again, demand fundamentally remained strong. In some cases, we see some evidence that customers are not canceling, but stretching out their demand as they do their own planning. But in short, we don't see, as of today, these items having a significant impact. We are experiencing some cost increases. The freight cost to Europe has at least doubled, and depending on where you're shipping to, it's tripled. We have implemented many actions inside CPS to create a very safe workplace so that the costs associated with cleaning the facility several times a day with supplies to do that have increased. We also have had much higher levels of absenteeism than we normally have. Our first and primary interest is the safety of our employees. In the current environment, there have been many employees who have elected to take a leave of absence in order to attend to family concerns, in some cases because school has been canceled, and they have children at home. In other cases, because they might have individuals at home who are in a high-risk category. So that absenteeism has been a factor. Internally, I'm pleased that with the full cooperation and commitment really of every employee, we have put a great deal of effort into creating the safest possible workplace. We have scrupulously followed the CDC guidance, OSHA guidance, and World Health Organization guidance. We have rearranged work locations to ensure social distancing. We have adjusted the shifts, where we continue to operate 3 shifts, but we've adjusted the shifts to eliminate overlap and minimize interactions as employees come and go. All employees have been issued face masks and other PPE as appropriate. We take the temperature of every employee as they begin their shift within 15 minutes of beginning the shift. We also have a short questionnaire for every contractor or visitor to the facility, and we take their temperature before they're allowed in the facility as well. As I sit here in our conference room, I'm actually looking at just an example of the unusual times we're in: a bottle of hand sanitizer, I'll call it homebrew hand sanitizer, put together by our facilities department, 70% isopropyl alcohol, 30% aloe vera, Vitamin E and scents that's a CDC recipe. Since it's not available in the stores, we produce it ourselves, and it's in essentially every dispenser at every door and in every conference room in the company. So what will the impact be of COVID-19 on our operating results? In short, the impact will, without a question, be negative, but we believe as of today, it will be modest. We believe that some revenues may be stretched out. We believe that some costs will be higher in the short term until absenteeism returns to a normal level, and until, in particular, commercial airlines resume flying, our freight costs will be higher. But nonetheless, as of today, we remain very optimistic about our prospects for 2020. We believe that the items we've mentioned relating to volume and pricing and new business will continue to be seen in the upcoming quarters through the end of this year.

Your first question comes from the line of Danny Arnett.

Congrats on the good quarter. My question relates to the motor controller market for EVs. To the extent that you can comment, do you guys provide anything to Tesla in any of their current or upcoming platforms? I was looking at prior transcripts. In prior years, I think you mentioned that you had visited them at their facility and sort of a related question. I know you have mentioned applications in space and satellite. Do you have anything ongoing with SpaceX?

Okay. I can answer those 2 questions. We, of course, abide by all nondisclosure agreements. So there are some customer developments that I can't comment on, but I can comment on the 2 that you asked. Today, we do not have any business with Tesla. Tesla, in general, I don't pretend to have a complete understanding of their future plans, but their current models don't use IGBT modules. They use discrete components. This is an architecture where they're using individual die as opposed to IGBT die being mounted in a module. The vast majority of the hybrid and other EVs around the world have chosen to use modules, but Tesla has not. We have called on them and would love to be doing business with them in the future. But today, we're not. We also are not doing any direct business with SpaceX. We do make a number of products, which we sell into Tier 2 companies. Those companies are suppliers to SpaceX. My own opinion is that it's highly likely that somewhere in SpaceX, those are used, but we do not have any direct business with SpaceX.

Our next question comes from the line of Lenny Dunn.

I don't have any problem with the company, but I do want to address one thing. I was on hold for 15 minutes before the operator finally came in to ask for my ID number. Your call was well underway. I called the company, talked to the operator, and she was trying to figure out how to get me in when they finally answered. I'm going to guess that not everybody persevered, or you'd have a lot more people on the call. So I want to bring that to your attention.

Lenny, thank you for making the effort to call in. The person you spoke to here did come in, and we attempted to contact the operator there. We apologize, and we'll follow up with the service. But I apologize that...

I'm a patient person and I've been around for a while. I believe many are concerned about the uncertainty surrounding COVID, and we all hope for a quick resolution, though it's unpredictable. At my age, I tend to keep to myself. I go home, come to work, and spend time alone in my car. I mostly avoid stores, and I know there are many others my age living in a similar way, which is unfortunate. And even as the country is starting to open up some, it really won't for me. I'm not going to take a chance. I mean, I don't even see my grandkids. I'm glad to hear everything you've said and that you're operating properly. And it's very clear you're going to do very well, and we actually bought another 60,000 shares a few weeks ago, which we hadn't bought shares in a long time and probably not going to buy anymore right now only because we have a disproportionate amount. But it got so compelling when it started trading around $1 flat that we stepped back in and bought some more. Part of the problem is that no one is paying attention, and it's even harder to get anyone's attention now because everybody's holding on for dear life with what they have in small caps. Because of the clear illiquidity that small caps have, people are afraid to step in. You just have to get the story out there a little better. But as far as the execution of what you're doing, everything is falling into place. And I'm very happy to see that.

Lenny, thank you for your comment. Our thoughts and prayers are with you and everyone in this environment. It's ironic, but from my perspective, we're in a position today where all of the fundamentals are where they should be. There are no unusual dislocations in the marketplace, except for COVID-19. We're fortunate that all of our major customers are still operating and have continued to do so. I am very grateful for the employees here who are understandably concerned about their health. By working together, we believe we've created a safe workplace. We also think it's unlikely that COVID-19 will disappear anytime soon, so creating the safest workplace is crucial.

We have our next question from the line of David Barney.

I have a couple of things. Over the last couple of years, Grant, I know you've discussed the 5-year plan. Could you provide an update on its current progress and whether you feel you're on target? My other question is regarding the armor program. I know you've seemed optimistic about it, which surprised me since you haven't mentioned it much in the past year or so. Can you share your thoughts on its future for the company?

Thank you, David. The two questions you asked are closely connected: our five-year plan and armor. We do not disclose the five-year plan, but I can say that it outlines our company as having three main product lines: AlSiC components, hermetic packages, and armor. Regarding our progress on the five-year plan, I must honestly say that we are considerably behind our initial expectations for armor. However, we are pleased with the progress we are making in hermetic packaging and AlSiC components. From a planning perspective, we had hoped to have more clarity on opportunities in the automotive sector than we currently do. To be quite candid, I don't speak too much about armor, and I don't speak too much about the automotive market. We believe we do have significant potential and opportunity in both of those markets. The challenge is not technical development; the challenge is primarily business development and technical selling. We are continuing to invest in sales and marketing. In particular, we have our sights on one government application and one commercial application and things are simply moving much slower than we would hope. In the government application, the issue is the appropriation of funds. In the commercial application, frankly, the issue currently appears to be that people are distracted by COVID-19. In short, the market development, the speed with which customers are willing to adopt a new approach has been disappointing to us in the armor area. But again, we believe that the potential is significant. Our first real order is the most difficult. Once we have that order, you may recall we have shipped parts into an amphibious vehicle application for the Marines. It was a retrofit application and fairly early on in the program. The Marine Corps decided to cancel the rest of retrofitting the fleet to focus their attention on a new vehicle. That new vehicle is not yet being produced, and that demand went away. But I’m going on at too great a length here. In short, yes, we believe there is opportunity.

It sounds like you're well positioned to take advantage of the opportunity should it come around.

That's a much more concise summary than I can come up with. So thank you. Yes. That's a great summary.

Anyway, congratulations on a great quarter under difficult situations. Hopefully, things will improve as the year goes on.

We have our next question from the line of Lenny Dunn.

Just a simple question. Are you preparing for a late-summer conference because it's likely that people will attend by then? The worst-case scenario is that if things don't work out, you might just have to cancel like anyone else would. However, it's important to get on the list of attendees because we need to share our story; the more people who are prepared, the better.

Lenny, thank you. I agree with you. Chuck and I have been looking at conferences. We're conservative by nature. I’m much more comfortable presenting at a conference when we have a couple of very solid quarters and a clear trend. Although today, that's 2 data points, Q4 and Q1, by the fall, that would be at least 3. We discussed this briefly at our most recent Board meeting, concluding that sometime this year, if they open up, or at the latest, the first quarter of next year, we definitely needed to be out in front of one or more of these conferences. If they open up in the second half of this year, we'd like to be at least one of them.

Make sure to get on the list. They will cancel if things go wrong, so there’s no need to worry about that. However, you should get on the list before it closes.

Good point. Yes.

We have our next question from the line of Frank Litewski.

Great quarter. I was curious. In the last fiscal year, your top 3 customers accounted for about 70% of your revenues. How do you see that coming in this year? More importantly, what do you see over the next five years for concentration of customers?

Excellent question. Our strategic objective is to reduce customer concentration. To do that, we obviously need to grow additional customers, and we're, of course, working on that. Having said that, all 3 of our largest customers, their business is growing, and we are growing with them. Over the past year, we've increased our market share. So my answer is, as we look forward, I think most likely, those 3 customers will continue to be our largest customers for a few more years. Our objective is to grow other customers. We have more than one customer that is below the $1 million level. As they use AlSiC for more and more applications, they're definitely going to be bumping above that, at least in one case this year and in some additional cases next year. So in short, the 3 continue to grow. They're deeply capable long-term worldwide leaders in their markets. We're going to stick with them. We're working in all 3 cases to identify additional opportunities even outside of the current product line in which we're working. Nonetheless, our objective is to further diversify our customer base.

One other question, if I could. At least in the past, your armor operations had a remote facility. Is that costing you much money since you're obviously not getting much out of it? Is that something you're looking at? Or is it costing you much to keep that capability there?

The short answer is, it's not. We have a wonderful landlord and a very good relationship. We have significantly reduced the square footage that we're leasing and have consolidated the armor-specific production equipment in an efficient way. There's some cost involved, but it's minor. We're now in a position where we think what we're doing is completely sustainable, and we can afford the space we have. It's primarily related to armor. We use some of the equipment for other products. We're now at a very sustainable level that we feel comfortable with, so that's not a drag on earnings.

Okay. One final question if I could. In past years, I haven't seen it mentioned. There was a contract that you were working on with, I believe it was Raytheon, and it was a shipboard missile application. What has happened to that?

You're referring to a very large program called Air Missile Defense Radar, AMDR. Yes. AMDR is a next-generation radar system for the Navy. We had a component in the phased array radar. It's a very complex system. We provided benefits in that subassembly, completed the qualification process, and with Raytheon's permission, announced that we were down selected as the vendor of this component. Raytheon had teams of folks working with us on detailed planning. Then they decided to use a different subsystem. They didn't replace our component; they replaced the whole subsystem. It had nothing to do with our component, but to our disappointment, that opportunity went away.

Our next question comes from the line of Michael Hague.

Just about liquidity, financing, working capital and any big bump or big boost that you might need? I'm not saying that your credit line arrangements might not be sufficient, but I could also imagine things happening either with your 3 customers or the 30% that hopefully at least grows as fast as the big 3 do. Would you consider joint venture partnering customer financing, other arrangements should occasion call for it?

Do you want to comment, Chuck, on our liquidity?

Yes. I think the quick answer to your question is we haven't really looked at that at this point. I'm not that concerned about our current liquidity. We hit a peak at the end of the quarter due to low January sales translating into low collections in March. We've seen borrowings come down since then, and I'm not concerned certainly for the short term and probably for the immediate foreseeable future.

We have a good relationship with our lender. If there were any issues, we could resolve them quickly. We're in pretty good shape from a liquidity standpoint for the rest of the year.

If I comment from an operational point of view, our main area of working capital is accounts receivable. We could go back to giving a discount to reduce our receivable balance. Our line of credit is paying for itself as we have stopped discounts. We think we were at our peak borrowings at the end of Q1, and that the borrowings under the line have already come down and will continue to do so.

What I was thinking about is if something happened, if armor or anything else occurred in the next year or 2. You could handle that with existing credit lines if it was slow enough. If the need was more immediate, you might need other financing.

Yes, that's definitely true. We do have a good relationship. Based on our borrowings, we're limited by our limit, not by our receivable balances. If something like that came along, we could borrow more than the $2.5 million limit.

We have our next question from the line of Warren Silver.

It's nice to hear that your company's returning to profitability. Grant, you mentioned the power transmission business, and there was an article in the Wall Street Journal last week about the United States wanting to bring back the drug manufacturing from China to America. Is there any program that CPSH is adopting to supply American manufacturers? We deal with GE in the wind business and with ABB overseas. Is there potential here for us to grow in this market?

Yes, thank you for that question. Power modules are increasingly utilized in the electrical grid. The U.S. has historically played a minor role in power modules but is experiencing a resurgence. One reason is that the U.S. leads in the production of silicon carbide-integrated circuits. While silicon carbide remains significantly more expensive than silicon, it is expected that as performance improves, the high voltage segment will become the dominant technology. In the U.S., Cree and its subsidiary Wolfspeed are key players, and we maintain a strong relationship with them. International Rectifier, acquired by Infineon, also has extensive operations in the U.S. Additionally, Powerex, a joint venture between General Electric and Mitsubishi Electric, plays an important role in the U.S. power module market. Our U.S. business is growing, especially as silicon carbide die presents an opportunity for the U.S. to regain market share. Again, I'm happy to see that we're in a profitable mode, and everyone up there, please be safe.

We don't have further questions at this time. Presenters, please continue.

Let me thank you for joining us. Thank you to those of you who joined us in our annual meeting. I want to leave on a positive and optimistic note. We are fortunate that COVID-19 has not affected our fundamental markets, has not significantly impacted our primary customers. The fundamentals are strong, and we're looking forward to a positive 2020, a period of growth on both the top and bottom line compared to last year, while acknowledging that COVID-19 creates many uncertainties. We remain optimistic and invite you to come see us. We hope that as life returns to normal, those who are in the Boston area will stop by and see what we're doing. We look forward to speaking with you in a quarter. With that, we'll sign off. Thanks very much.

Thanks, everybody.

That concludes today's conference call. Thank you for your participation, and you may now disconnect. Stay safe, everyone.

Thank you.