Cps Technologies Corp/De/ Q2 FY2021 Earnings Call

Good day, and thank you for standing by. Welcome to the CPS Technologies Corporation Second Quarter Investor Call. I would now like to hand the conference over to your speaker today, Mr. Chuck Griffith, Chief Financial Officer. Sir, please go ahead.

Thank you, operator. Good afternoon. I'm joined today by Michael McCormack, our new President and Chief Executive Officer. 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 will turn the call over to Michael to offer his perspective on the annual and second quarter results.

Thank you, Chuck. Good afternoon, everyone. Today, we announced revenues of $5.9 million and operating income of $253,000 for the quarter ending June 26, 2021. This compares with revenues of $5.8 million and operating income of $331,000 for the quarter ended June 27, 2020. The financial results in the second quarter were profitable and growing as compared to the first quarter of FY '21. Shipments are increasing to customers as are increased revenues. And more importantly, our book-to-bill ratio is increasing. Over the first half of FY '21, our book-to-bill was approximately 2:1, confirming that our strategy for growth is beginning to show success with a larger sample of data. A key to our growth plan is to have all of our business lines performing well. This internal diversification of revenue sources reduces our customer concentration while utilizing existing resources more efficiently to satisfy the requirements of a wide array of customers. These customers have shown significant growth in 2021. To put this into perspective, revenue for the second quarter was 2% higher than the second quarter of 2020. In 2020, our top 3 customers in Q2 made up 80% of our revenue. In this past quarter of 2021, our top 6 customers equated to 80% of our sales in the quarter. We believe this broadening of our customer base will increase the likelihood of planned, sustained growth in both revenues and earnings moving forward. We are continuing to see a slow recovery from the pandemic to the base slate business and expect it to remain steady throughout 2021 as spending on high-speed rail and mass transit systems continues to lag. We are confident that demand in the sector will return in FY '22. I'll speak more later about our growth plans moving forward later in the call, but for now, Chuck will discuss the financial results in more detail.

Thanks, Michael. Revenues totaled $5.9 million in quarter 2 2021 compared to $5.8 million generated in quarter 2 2020, an increase of 2%. As Michael mentioned, the additional movement of new customers into our top accounts more than offset the reduction in sales from certain other customers. Gross margin in quarter 2 2021 totaled $1.4 million or 23% of sales. This compares with gross margin in Q2 2020 of $1.2 million or 21% of sales. This increase in margin was primarily due to moderate price increases and product mix. Selling, general, and administrative expenses totaled $1.1 million in quarter 2 2021 compared with SG&A expenses of $853,000 in quarter 2 2020. This increase in SG&A expense was due to increased compensation expenses as a result of the addition of our new COO and a delay in certain directors' compensation from quarter 1 to quarter 2. The company experienced an operating profit of $253,000 in Q2 2021 compared with an operating profit of $331,000 in Q2 2020. This decrease in operating income is primarily due to the increase in SG&A expenses previously discussed. Turning to the balance sheet, we ended the quarter with $3.0 million of cash. This is an improvement to our cash position of $195,000 at the end of 2020. In May, we completed our aftermarket filing and began raising funds under that program. Through the end of the second quarter, we raised approximately $3.1 million under the ATM offering. These funds have enabled us to completely eliminate borrowing under our line of credit even as our daily cash balance fluctuates. In addition, we've been able to absorb the increases in accounts receivable as our sales grow and in inventory as we develop our armor line. Our raise under this offering is being managed such that while we've covered our short-term cash needs, we are becoming more selective regarding the days and market prices at which we sell additional shares. Accounts receivable at June 25, 2021, totaled $4.4 million compared with $2.9 million at December 26, 2020. Our days sales outstanding totaled 69 days at the end of the quarter compared to 62 days at the end of the year 2020. The increase in days sales outstanding was due to higher sales to large customers to whom we gave longer payment terms. Inventories totaled $4.0 million at June 26, 2021, compared to $3.7 million at December 26, 2020. This increase was due to the buildup of inventory for our armor order. The inventory turnover in the most recent 4 quarters was 4.0x compared to 4.5x for the 4 quarters ended December 26, 2020. Again, this decrease is related to the raw materials we purchased for our armor contract. Turning to the liability side, payables and accruals totaled $2.6 million at June 26, up from $1.8 million at December 26, 2020. This is due to greater expenditures from higher sales and inventory levels. And so for further discussion, I'd like to turn the call back over to Michael.

Thank you, Chuck. First of all, I'd like to take a moment to recognize the significant long-term contributions of Grant Bennett to CPS. Grant recently retired from his day-to-day CEO position, but he remains an active and contributing member of the Board of Directors. Grant's compassion, leadership, and tireless dedication to the company over his 35 years of selfless service to CPS have built a solid foundation that moving forward will serve the company well. I'm sure Grant's listening, too. So Grant, thank you. You were a great CEO for CPS, and for us who know you personally as well as professionally, you are an outstanding human being who inspires us all to be considerate of the human condition in all our endeavors. Thank you, Grant. I think this is an ideal time for me to share with those on the call and investors why I joined the company and the exciting opportunities for growth I see as the business moves forward from today through the second half of fiscal '21 into '22 and beyond, and well into '23. Growth and growth potential are the reasons the Board of Directors asked me to join CPS. After graduating from West Point, I began my career as an officer in the U.S. Army before transitioning to industry. The military provided me with numerous opportunities, particularly in developing my leadership skills and commitment to a greater goal. In industry, I have extensive experience in a product-centric business environment. CPS has a rich history of creating unique products and their related manufacturing processes to solve customer needs in various markets. The center of this activity is product development. We are making several internal resource investments in this area, ranging from staff, including engineers and scientists, to facilities. The vision for CPS is to be the premier provider of high-performance material solutions for mission-sensitive applications in the United States, connecting and protecting customers around the world. Our vision is informed by our core values and beliefs, purpose, and mission. The fundamental reason CPS was founded and continues to operate is to provide performance-enhancing innovative solutions through the application of advanced materials into end products to improve the quality of life. I have set the mission for CPS to grow and graduate from a small business to a sustained medium-sized business over the next 5 years. We are well on our way to accomplish this mission by building on our 35-plus years of success. Specifically, in addition to our consistent ongoing and long-standing commercial business, we see potential for great growth in the aerospace and defense sector. We have recently shared some of CPS' successes in the aerospace arena with the products we provided for the Mars Rover and GPS satellites. We also continue to have success in the defense sector. As you're aware, we have begun to make product deliveries to our customers in support of the U.S. Navy. There is a high likelihood of additional orders to protect naval forces on this program, as well as other branches of the service, both domestically and with our allies. We are continuing to make measured investments in product development, sales and marketing, and our digital strategy to ensure we increase our reach to potential new customers with product solutions. We are actively reallocating and realigning internal resources to streamline and prepare for growth. Based upon our success to date, we recognize that in order to achieve our mission, we will need further investments for growth. This is the primary reason we initiated the aftermarket or ATM offering that Chuck just reviewed. Our intention is to use the capital from this activity to help fund and accelerate our growth, specifically to hire additional staff members, acquire capital equipment that will enable us to increase our capabilities, efficiencies, and growing capacities, and provide the necessary working capital to accelerate the plan. To provide specific examples of how our strategy is beginning to translate into operational results, I would like to talk about our hermetic products business line for a moment. With our continued increase in product development efforts, we are currently exceeding our growth goals and appear to be on pace to have a new record year of growth. In addition, we already have visibility into further growth in fiscal '22. The booked orders year-to-date for the first half of the fiscal year already exceed the entire year last year. Our revenue for this business line is already approaching last year's revenue with 2 additional quarters of execution to come. The primary growth in this area is the aerospace and defense market, specifically in the United States. This is a very attractive sector for CPS because it places a premium on the advantages of our products. A majority of our customers operate within an intellectual property protection envelope or a regulatory restricted environment, which prevents or significantly adds barriers to entry for foreign competitors. Specifically, our lightweight and unmatched thermal management properties, combined with high specific stiffness, enable superior performance for our customers' end products. Most of these programs are also very long-running. In addition, our success with our hermetic package business has brought about renewed interest in our market-only source of an AlSiC hermetic package, combining the best in class from our two business lines. We see prime and Tier 1 contractors, as well as original equipment manufacturers, continuing their product development activities, relying on the advantages offered by our AlSiC properties. This is the base building block for a lighter release weight and highly reliable end product, which directly translates into operational availability for their customers in integrated designs, such as airborne laser weapon systems which CPS is involved in developing. CPS AlSiC is the base composite material of choice. As the success of our previous product developments become more widely known and accepted, they are being adopted on the GPS3, MethaneSAT, and countless restricted programs. All our AlSiC products, AlSiC hermetic packages, and our large portfolio of robust hermetic packages illustrate a strong growth path in 2022 and beyond. I could talk about the exciting business opportunities at CPS all day long, but I want to be respectful of our time and leave some time for questions since this is my first quarterly results call with you all, and I suspect there may be some follow-up questions to my remarks. In closing, during the second half of fiscal '21, both Q3 and Q4, we expect our performance to continue improving over the second quarter, assuming that the latest variant of the coronavirus or some unforeseen event does not significantly impact the global economy as it did in 2020. I'm extremely optimistic that '22 and '23 will firmly place CPS on the path forward to achieve our goals for customers and investors. Thank you for your time. Chuck?

So operator, we can open up for questions.

Speakers, your first question is from Kenneth Pounce.

Yes, it sounds very encouraging. Maybe a few more details, you said markets in aerospace and defense, there was a contract, I guess, for protection for aircraft carriers. Maybe you could elaborate on that if there are some other ship classes that you might be able to get contracts soon?

Kenneth, this is Michael. Thank you for the thought. Yes, we are actively executing on our program right now for the U.S. Navy on the CVN carrier class of programs. We are developing alternative solutions and other integrated solutions with our partner Kinetic Protection to address other vessels in the U.S. Navy as well as the Coast Guard. And those are just the near-term opportunities we have, Kenneth. We are working on some longer-term opportunities in both U.S. rotary wing applications and foreign navies. I hope that helps.

How is the solid metal that you're producing? Are you experiencing any cost pressures given the rising prices of steel and other alloys?

Well, excellent question. Our HybridTech Armor Panels, our proprietary panels, are metal matrix composites. So there are components of steel and aluminum in the mixture. We're able to contain costs. We've been able to buy and have those materials on the shelf to execute our contracts today. And we're well aware of the pressures within the global supply chain as the potential for inflation exists.

Speakers, your next question from Patrick White.

I wanted to congratulate you and appreciate the enthusiasm you bring. We will certainly miss Grant Bennett. If you don't mind, could you provide any context regarding your thoughts on a 5-year execution plan to become a medium-sized business? Would that suggest a 15% internal growth rate, or could you elaborate on any parameters?

Thank you, Patrick, for the kind words regarding the opportunity to lead CPS. We have developed a plan that offers numerous chances for success. It is centered on a combined compound annual growth rate of our existing business along with new opportunities from additional products, and that is our main focus at the moment. We recognize the importance of reaching and engaging more customers to expand our presence. As we grow, we aim to do so in a sustainable and predictable manner, with reliable revenue and earnings.

Can I ask a follow-up question?

Sure. Go ahead, Patrick.

So obviously, the silicon carbide market for EVs and high-voltage applications in EVs, including with the larger vehicles, is one that is getting a lot of attention these days. And there have been hints that maybe CPSH might be able to be involved and establish some partnerships. Can you add any context today or share any thoughts on whether, in fact, you are working with one or more providers like STMicro or Infineon towards maybe adapting an AlSiC solution to those applications?

Yes. We certainly work with many major players who supply the automotive industry. We are extremely excited about some of the recent new programs as well as some of the past design wins as they begin to mature within those companies to offer solutions. Yes, the answer is yes. We are participating with these companies. Some of it, I'd prefer not to reveal because it is competition-sensitive, but yes, Patrick, we are participating with them. We believe that the hybrid electric vehicle market and the use of our AlSiC metal matrix composite will be an enabler to help them achieve some of their goals.

Sure. Do you see that expanding into solar and other applications?

Well, certainly, we're already involved in wind power and wind turbines. Any high-voltage application would be something that the OEMs and their engineers would certainly be looking at AlSiC as a potential solution for solving some thermal management problems.

Okay. Last couple of questions, and I'll put them together, and I'll excuse myself on this call. You're hinting at potential increases in efficiency, I assume that is hopefully to enhance margins, particularly as you get more involved in the military side. Can you comment on that? And then finally, the airborne laser systems is probably a long-term application but certainly a large application. Can you comment on that? It's not evident to me at least how AlSiC would play a role there or maybe on a hermetic packaging or something else. Anyway, congratulations. Welcome aboard, and thank you for your efforts towards establishing CPSH as a growing company.

Thank you. The airborne laser program, in particular, is, to your point, a longer-term effort. However, we are involved early with large OEMs who provide that in the defense sector. It is an AlSiC solution, not a hermetic package solution, and we're extremely confident. It presents new challenges for us on the design side, and we have just begun that process. So more to be determined. But to your point, it is a long design cycle. However, the positive side is that once designed in, it can lead to a design win and subsequently production win for our customers, which would mean a long-term revenue stream for us. To your first question, our goal of streamlining activities is aimed at improving earnings.

Speakers, we don't have any questions in the queue. You may proceed.

What percentage of the military contract of the $32 million in contracts has been fulfilled and invoiced?

That's the prime contracted value. I think we shared earlier that our portion represents about half of that value. I would say we haven't even billed the first 10% yet.

Correct. Yes, we have not.

Makes sense.

Yes. So we're actively shipping and creating. We're still on the first ship set.

Okay. Once you do ship these out, is this a paid if paid, paid when paid? Is this something that's a very long process to finally get paid?

No. One of the attractive aspects of the defense market and the U.S. government is that they are very good payers. So once we invoice it, we get paid according to the terms of the agreement with our partner Kinetic Protection, and they have been outstanding to date.

Okay. So you guys are only in, you said, the first 10% of the contract. Is that what I heard?

Less than that.

Less than that.

I assume it took some time to get started with this. As you continue to refine this process, I expect you will accelerate progress. I believe there is a certain timeline for this product as well. When can we expect it to be fully completed?

So, Thomas, we certainly shared with our partner Kinetic Protection and the U.S. Navy that we have additional capacity to do more. The current delivery cadence depends on the Navy's ability to receive. Right now, we have about 4 to 5 ship sets currently scheduled all the way through to fiscal '23, about H2 to quarter 2 of '23 today and based on the orders we have. This is due to the availability of the aircraft carriers.

Sure. It depends on when they are in port, yes. Of this, let's say, $15 million or $17 million potential revenue, this is spread out through 2023, is what I'm hearing.

Today, yes.

That makes sense. Given the context, we're really expecting an increase in revenue and profit based on these contracts. It sounds like it's a very long process.

Yes. We agree with you, Thomas. That is going to significantly contribute to both revenue and earnings. It is a long delivery, long process. The U.S. naval fleet determines the scheduling, but we could go faster. We have asked for that and we have the capacity to do more. The delivery schedule is dictated by the Navy's operational tempo.

You guys are getting some interest in this armor from other sectors, right? I mean, I assume there are private security interests, and many would want this on their vehicles, correct?

Yes. The applications are virtually endless, right? Finding those applications where our product makes the most sense and conducting sales engagement to close deals is ongoing. But just like the sales cycle, the revenue cycle is also long. We are actively engaged and have many potential clients.

I think it's fair to say that we've probably seen an increase in our sales contacts from companies as a result of this Navy order. There's much more interest from these armor sectors.

Okay. I have one more question for you guys. On the marketing and PR, I think you spoke in the last conference call about polishing things up a bit. What kind of progress has been made regarding that?

I would say, Thomas, we are probably a little past halfway. We've selected a firm and have a digital strategy for reaching out to people, combined with our social media presence and web presence. We have a review scheduled this week or next week to get an update. We aim to be finalized around the first of October.

Yes, I see that there have been some increased posts. A couple of my colleagues are actively trying to keep people informed, which has been helpful. I believe that some overall polish in investor relations would go a long way.

We are extremely excited about the product and its development. We conduct regular reviews of our content weekly, and we are pleased with how the message is taking shape. It just takes a bit of time. We are trying to maintain ongoing dialogue and improve communication not just with you, but with all our customers, shareholders, and the entire investment community. We are excited about our progress and hope to start sharing some information as part of our build to launch.

Are you continuously reinvesting in your sales team and putting back significantly into the company for future growth? Is that something that's part of the earnings release?

Absolutely. Growth requires some timing, and we have made some measured investments that we have shared. Our goal is to increase revenue and market share to be the solution provider our customers are looking for. We need to attract more employees, and it's very competitive right now to hire talented individuals, but we are doing well. We recently had a couple more hires this week, and there is more positive news ahead.

We hired Tim Davis in May, and he is already looking like a great addition.

Good. Can we expect a lot from you, Michael, as far as leveraging some of your older contacts and relationships in this new business?

Absolutely. When the Board hired me, they knew I had a strong background of contacts, particularly in the aerospace and defense markets. We have been in communication with them and have started some contract research and development activities. They are at lower levels and longer-term, but our goal is to fill the product pipeline with all sorts of products at various stages of development and keep pushing for solutions with customers. It is a dynamic environment with competitors, and we are focused on doing our best.

Sure. Well, good deal because I know Michael McCormack had quite the resume in refining and polishing companies, and he also graduated from West Point. I was thinking that many of those contacts will come with him and some of those relationships.

Yes. Business is fundamentally about relationships. You have to build and also maintain them. Thank you, Thomas, for your time. Those were great questions.

I appreciate your answers. I plan to hold on for the long term and the ride here. I hope everyone else is on the same page. I look forward to the next 20% or 30% of these contracts being fulfilled and seeing those results.

Thank you, Thomas, for your confidence.

Sir, you have a follow-up question from Patrick White.

I'm just following up to Tom's question and probing just a little further because if I think I heard some hesitance to say exactly what the cadence of these sales would be over the next 2 years. But if it was on a level basis at maybe $16 million of the existing contracts, we would be talking about roughly $2 million additive to your base business each year. Assuming these are rather unique technologies, unlike AlSiC, where you may have competitors, the contribution margins might be 25% or higher. Can you confirm that? Is that a sound way of thinking about this going forward over the next couple of years?

Certainly, we have over half of the ship sets that are available to us ordered already, and we are executing. We agree with you, Patrick, that we believe our margin on this product line moving forward will increase. We have just finished ship set 1, and we have some additional requests from the Navy. It is going extremely well. If you do the math, we essentially have with this point on, 2 more years of delivery already scheduled, and that only represents half of the order’s value. It is indeed a protective and productive piece of our business.

That sounds promising.

It's absolutely promising.

I'm assuming you're counting this existing Navy program with the carriers to be one program.

Correct. We currently have 4 other active programs, but they are not at the production award stage yet.

Right, right.

I understand, but would they be at the same relative magnitude or much smaller?

It’s uncertain. It could be similar, it could be more, or it could be less. The data shared with us by the OEMs we work with shows potential that is on par, if not better, than the existing Navy order. We will see, right? They have competitors too, and they need to win those contracts.

Is the tank side of the Army tanks something that is off the radar, no longer viable? Or is that a prospect as well?

Depending on the platform, it is applicable. It combines the threat, the platform, ballistic protection, and kinetic energy threats. All elements vary whether it’s a truck, tank, or aircraft carrier. Protecting service members deployed forward is essential and has a significant place in the budget. It's not just a luxury; it's a necessity. Our HybridTech Armor Panel offers advantages and excels at low weight and high kinetic energy threats.

That's quite helpful. Implicit in the math is that the higher the volume, the higher contribution margins might be assumed.

We have been in high-volume manufacturing for a long time and understand that in order to achieve that high volume, certain trade-offs at the lower side must be considered. It is very lucrative at the high side.

Speakers, we don't have any questions on queue. You may proceed.

Alright. Thank you, Catherine. We appreciate everyone who called and listened in. Chuck, do you want to take us out?

Thank you to everyone for calling. We hope to have plenty of good news in the coming quarter to share as we move forward, but we'll see. We’ll certainly talk to you at the end of the quarter. Thank you very much.

Thank you, everyone.

This concludes today's conference call. Thank you all for joining. You may now disconnect.