Cps Technologies Corp/De/ Q4 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to the CPS Technologies Corp. 2021 Year-End Investor Call. I would like to hand over the conference to your speaker, Mr. Chuck Griffith, sir, you may begin.

Thank you, Jeff, and good afternoon, everybody. I'm joined today by Michael McCormack, our President and Chief Executive Officer, who will offer his comments on our fourth quarter and annual results. Before we begin the business portion of the call, I would like to point out 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, the Russian invasion of Ukraine, 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 Michael to offer his perspectives on the year and fourth quarter results.

Thank you, Chuck, and good afternoon, everybody. Thank you for joining us. Today, we are pleased to announce the fourth quarter revenues of $6.2 million and an operating profit of $312,000 for the quarter ending December 25, 2021. This compares favorably with revenues of $4.2 million and an operating loss of $291,000 for the same quarter a year ago ending December 26, 2020. The financial results in the fourth quarter were anticipated based upon the proactive restructuring steps we executed in the third quarter and marked our best overall quarterly performance since the pandemic began. We believe this past quarterly performance is more indicative of our near-term outlook of the business. The nearly 50% growth in revenue as compared to the same quarter a year ago is extremely noteworthy as well as the 13% increase from the third to fourth quarter results. We are demonstrating continued incremental improvement because of the changes we are implementing to create inherent value and generate greater revenue and operating income and deliver shareholder value. For the fiscal year, we are reporting revenues of $22.5 million as compared to revenues of $20.9 million in fiscal year '20. The 7.5% annual organic growth rate over the fiscal year is consistent with our strategy. Fiscal year '21 reflects the second highest year ever in terms of revenue for the company. For the fiscal year, we are reporting $513,000 in operating income, and the company is also reporting net income of $3.2 million in 2021 versus $914,000 in fiscal year '20. This increase is due to the reversal of the company's deferred tax reserve. In addition, this also marks our second consecutive year of profitability. Our book-to-bill of 1.67 to 1 for the fiscal year 2021 continues to reaffirm our growth strategy is translating into results over a larger sample of data. We are cautiously optimistic that the increased sales of fiscal year '21 will directly translate into steadily increasing revenue in fiscal year '22. COVID is still omnipresent. We are continuing to monitor all aspects of our supply chain and remain vigilant on ensuring the availability of raw goods to create and deliver products to our customers. The variability of our entire chain has been challenged since the pandemic outbreak nearly 2 years ago. We are confident, we have multiple plans in place to control the issues we can control. I'll speak a little bit later more about the overall business progress moving forward on the call. But for now, I'll turn it over to Chuck, and he'll discuss the financial details in a little bit more detail. Chuck?

Thank you, Michael. So revenues totaled $6.2 million in Q4 2021 compared to $4.2 million generated in Q4 2020, an actual increase of 48%. This increase was due primarily to the increase in sales for armor and hermetic packages in the fourth quarter of 2021, as well as the impact of the COVID-19 pandemic on sales in the fourth quarter of 2020. Gross margin in Q4 '21 totaled $1.4 million or 22% of sales. This compares with gross margin in Q4 '20 of $0.5 million at 12% of sales. This increase in margin dollars directly correlates to the increase in revenue between the two periods. Selling, general and administrative expenses totaled $1.0 million in Q4 '21 compared with SG&A expenses of $789,000 in Q4 2020. This increase was due to the increase in sales employees, total compensation expense, and an increase in commission expense due to the higher sales volume. The company experienced operating income of $312,000 in Q4 '21 compared to an operating loss of $291,000 in Q4 2020. This increase in operating income is due primarily to the increase in revenue, as we previously discussed. For the year ended December 25, '21, revenues totaled $22.4 million compared to $20.9 million in 2020, an increase of 8%. This increase was due primarily to the increase in sales for armor and hermetic packages in 2021. Gross margin in 2021 totaled $4.8 million or 21% of sales; this compares with gross margin in 2020 of $4.2 million, which was 20% of sales. The increase in margin dollars is directly correlated to the increase in revenue. Selling, general and administrative expenses totaled $4.3 million in 2021. This compares to SG&A expenses of $3.3 million in 2020. Several factors contributed to this increase. The company incurred an expense of an excess of $300,000 for one-time restructuring costs in 2021. The company paid the salaries and benefits for both our retired CEO and our new CEO during the first half of '21; they were both here at the same time, adding about $100,000 to our SG&A expenses. And we also added three new sales positions in 2021, which contributed to our overall increase in compensation. The company experienced operating income of $513,000 in 2021 compared to operating income of $914,000 in 2020, and the decrease was due primarily to the increase in SG&A expenses as we previously discussed. The company recorded net income of $3.2 million in 2021 compared to $900,000 in 2020, and this increase is primarily due to the reversal of the company's deferred tax reserve. In December of 2018, the company set up a valuation reserve against its deferred tax asset. At that time, following a period of sustained losses, management determined that it was more likely than not that this tax asset would not be used. Management has reevaluated this decision in light of recent profitability and expected future profitability and has determined that it is more likely than not that the company will be able to fully utilize this tax asset. As such, a tax benefit of $2.7 million has been recorded on the income statement as of December 25, 2021. Turning to the balance sheet, we ended the quarter with $5 million of cash. This is an improvement to our cash position of $195,000 at the end of 2020. In May, we completed our at-the-market filing and began raising funds under that program. Through the end of the year, we raised approximately $3.4 million net under the ATM offering. These funds have enabled us to completely cease borrowing under our bank line of credit. In addition, we have 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 we've covered our short-term cash needs. We've become more selective regarding the days and market prices at which we will sell additional shares. As such, no additional cash was raised during the fourth quarter under the ATM program. Accounts receivable at December 25, 2021, totaled $4.9 million compared with $2.9 million at the end of December 26, 2020. Our days sales outstanding totaled 72 days at the end of the quarter compared to 62 days for the prior year. This increase was due to the inclusion of about $600,000 of deferred revenue in the 2021 year-end accounts receivable. If we take that amount out, then the days sales outstanding at the end of 2021 would have been 63 days, which is in line with previous years. Inventories totaled $3.9 million at the end of December 2021 compared with $3.7 million at the end of December 2020. This increase in inventory is due to increased armor materials offset by better management of inventory in other product lines. Improved inventory management is now an area of focus. The inventory turnover in the most recent 4 quarters was 4.7x compared to 4.5x for the period ended December 26, 2020. Turning to the liability side, payables and accruals totaled $2.8 million at December 25, 2021, up from $1.8 million at December 26, 2020. This is due to greater expenditures resulting from higher sales levels as well as the accrued restructuring charges, which we had previously discussed. So for further discussion, I'd like to turn the call back over to Michael. You're on.

Thank you, Chuck. This past quarter and fiscal year, we continue to make positive, measurable progress on streamlining and improving current operations, while also simultaneously addressing our long-term goal to grow to a sustained medium-sized business. As an organization, we are completely focused on increasing our ability to add sales and improve our ability to execute. We have substantially rebranded the company and improved our web, social media and digital presence. We are now able to reach more potential customers, investors and potential new employees about our ability to supply innovative, custom-made, materials-based solutions to solve our customers' most challenging issues. We have also continued to add additional staff members that will enable us to scale the size of the business without significantly adding cost as we execute. We have hired more engineers, more sales staff and shared service members to name a few positions. I would like to take a moment to discuss our approach to increasing our overall technical bandwidth, growing our approach to product innovation. We are adding technical staff to address the growing demand for our products across all three product lines: hermetic packaging, armor and the metal matrix composite business. Our engineers are working with the business development staff to develop solutions that specifically address customers' requirements while working predominantly in a funding-constrained environment. This is directly equating to the addition of new customers, especially in the RF microwave market segment. Most importantly, this is bringing about a renewed interest in our industry-only AlSiC hermetic package. I'm quite pleased with the progress we are making. We have reenergized the contract research and development services business, as evidenced by our participation in the small business innovative research and the small business technology transfer programs. The SBIR and STTR programs are the key reasons for the success of our HybridTech Armor program line with the United States Navy. These programs are highly competitive awards that encourage domestic small businesses to engage in federal research and development programs with the potential for commercialization. In addition, as these programs advance from research and development to commercialization, they are afforded additional intellectual property protections and sole source manufacturing rights within the U.S. federal government. We have recently been awarded an exciting research and development contract with the U.S. Army aviation community to address their thermal management concerns for Future Vertical Lift programs, or FVL as they call them. The FVL program is a plan to develop and replace the current utility, attack, cargo and reconnaissance helicopters in the entire U.S. armed forces. Although the program is just beginning, we are immensely proud of our engineering staff for proposing a novel solution that our military proposal has valued over several potential solutions, including numerous prestigious academic institutions to help dissipate heat over large areas for critical aviation applications. I'd like to specifically mention the magnificent work of Dr. Steve Kachur, Dr. Mark Occhionero and Mr. Bill Holmes in this endeavor. We are also awaiting notification on several other contract research and development opportunities within both the Department of Energy and the Department of Defense. As we look beyond fiscal year 2021 now, CPS is continuing to follow up on the success of the past quarters with improving production volumes. We have made a commitment to a new material resource planning tool in conjunction with our new enterprise resource planning tool to enhance the efficiency and profitability of the entire operation. We hope to have this conversion done before the end of this fiscal year. The future is extremely bright at CPS, and I'm not just saying that because I'm the CEO. We have several large-scale future opportunities in all three of our product lines: hermetic packaging, armor and metal matrix composites. These opportunities are also significant within the markets we are focusing on, aerospace and defense and commercial consumer electronics. The entire staff is working towards the growth and product offerings while improving profitability. We are quite pleased with our recent quarterly performance and expect that we will continually and incrementally improve as we move forward quarter-to-quarter and year-over-year. We are aware of the unpredictability of the COVID pandemic, but also hopefully as the year progresses, the potential impacts to the business will continue to be less and less. The impact of the unprovoked Russian invasion of Ukraine should have negligible impact on CPS as we've had almost no sales in those countries. We have lots of additional opportunities today, both small and large, that keep the entire staff focused on finding the ideal, innovative material solution for customers' needs. And with that, I'd like to take a moment so that Chuck and I are prepared to answer any questions there may be about the business, whether it be fiscal year '21 or the last quarter, and we're opening...

Open to questions.

We have a question from the line of Stephen.

Sort of a general question, can you say roughly how your business breaks out between, say, defense and national security and other applications and perhaps where you have visibility on where that's going?

Yes. So I think that we have something on that in our 10-K, which obviously we haven't published yet. But I want to say that defense is in the neighborhood of 25% of the business for 2021. And we do think it's going to continue to grow. But for last year's numbers, it's in that range.

Okay. That gives me a good sense. It seems like it's currently a general growth area.

There are no further questions at this time, please continue. We have one from Greg Weber.

Just curious, could you speak to operating leverage? I mean, you had nice, great top line and nice gross margins, but depending on earnings. So could you talk a little bit about what we should expect there on a go-forward basis?

Can you please repeat the question?

You had very good revenues, and gross margins are back up into the low 20s again. However, we earned $0.01 a share. I'm trying to understand the operating expenses situation, as it seems you're making some improvements there. Do we need more top line growth to see increased earnings, or what is the outlook?

Yes, we definitely expect an increase in earnings. The SG&A expenses for this year included significant one-time costs related to leadership changes and other adjustments we made primarily in the third quarter. These are one-time expenses, and without them, we would have likely seen an increase in earnings throughout the year. Therefore, I believe our earnings will improve moving forward, particularly compared to the first three quarters of 2021.

Okay. And maybe just a follow-on there. In terms of gross margins, what should we think about there going forward? You're obviously doing a lot to try to streamline operations, which should help, I assume, margins. But just due to product mix or whatever, any color there? Is there more gas in the tank here beyond '22 you just put up?

This is Michael. We are definitely focusing on this area. I'm proud that we are continuing to improve our gross margin despite the significant inflation we've experienced. It has been a bit challenging as we manage our costs while also ensuring customer satisfaction. The second half of the year has been particularly dynamic due to inflation's impact on the supply chain. However, I believe we've largely managed to overcome those challenges, and our earnings are showing slight improvement. We faced some obstacles along the way, but as our product mix improves, we expect to see further progress.

Okay. Great. And you're definitely not willing on that front in terms of input cost inflation. So are there any escalators in your contracts? Or you got to go back basically and start to raise prices separately?

Well, that's always a difficult issue. So some of our contracts are extremely long with our customers, and there are different provisions in each of those to address these, whether it's the annual repricing, surcharge pass-throughs, et cetera, et cetera. So each of them are kind of unique, I guess, Greg.

Next question is from the line of Patrick White.

Congratulations on a great year and quarter, and it's encouraging to see the progress being made. I wanted to ask about the hybrid armor business; it appears that the order pace is somewhat inconsistent. Do you expect this to continue for the next few years, or do you believe it will become more predictable? Additionally, you mentioned that 25% of your revenue comes from defense-related sources. Is this entirely from hybrid armor, or is there more happening in that area? Could you provide some insights on that?

Thank you for your question. This is Michael. The orders for HybridTech Armor will be irregular, which isn't ideal. However, the positive aspect is that they are quite substantial in terms of volume. Given the nature of our industry, we're still only halfway through our existing contract for HybridTech Armor with the U.S. Navy. With armor orders, you typically receive a large order, fulfill it, and then receive another large order as you approach the end. The irregularity you mentioned is indeed present. Predictability will improve once we start transitioning some of the programs we are currently executing with the Navy and others we are bidding on that fall within the Defense Authorization Act. This will provide us with better predictability and visibility for future funding. We are pleased with our armor business and its trajectory. Considering we are likely in year 2 of production after five to seven years of research and development, we see many opportunities both domestically and internationally for HybridTech Armor. Customers and nations continue to recognize the value of our product, which is relatively lightweight while providing significant protection against kinetic energy threats. Its performance in various environmental conditions is exceptional. We believe we are just beginning to tap into the potential of our armor business, and we appreciate how it is scaling right now. We are managing costs effectively as we grow. There are substantial opportunities for us in the U.S. aviation sector and foreign nations' ground vehicle sectors, and we are already making notable progress with the U.S. Navy surface fleet. While there are irregularities in the orders, we are optimistic about the future, anticipating that our mix of product lines will lead to favorable long-term results.

And in answer to the other question, Patrick, that 25% is not just the Navy contract. That Navy contract is maybe half of it, ballpark.

Got you. That helps. And I can hear the excitement in your voice regarding what it's like and I'm looking forward to maybe mid-deck and where it stands at maybe 50% of your business, but we'll see. We'll see. The other question I had, if you don't mind, is with respect to your mention of some new customers in the RF business. Can we think of that as 5G related? I mean if so, just how significant might that be in terms of maybe percentage of overall revenue out 2 or 3 years?

Well, certainly, as we continue to increase our aerospace product offerings, that has some visibility to us and some we don't have visibility into and what the applications are. I would say it's probably more likely space-related. And I don't know specifically, do you, Chuck, of 5G? I don't think so. But it's more of the aerospace side has led us into the RF microwave side.

I have other questions, but I can step aside if there are others on the queue. But if not, I'll throw a couple more at you if you don't mind.

Go ahead, Patrick. We're here.

Yes.

In the power electronics sector, I recognize that you are especially suited for the silicon carbide market, which is highly relevant to electric vehicles. I understand there is a movement toward GaN in certain areas of power electronics and in lower voltage applications like transportation, solar, and wind. Could you share your thoughts on whether your technology is compatible with more digital applications in silicon carbide? Also, does it apply to GaN as well, which I believe produces less heat and may increase the significance of your technology?

Well, yes, so let me just offer the comment that we're working with a lot of folks in the collaboration of R&D and future EV applications. And you are correct, there is a technology shift from the silicon die, and that is going on. And there are other applications other than AlSiC that we are actively working. And all of that is working together. And particularly the messaging of this week, it's extremely optimistic for us where the President and the infrastructure folks are talking about renewed interest in domestic production. So obviously, most of our concern in this market is not can we do it, it's our competition, and how can we be competitive to close most of those opportunities. And right now, we are doing well with R&D and our customers are inventing different products that are a couple of years out, if you will, Patrick, right now, and we are a viable supplier of that. And so we're interested. I think the high voltage more than low seems to be working for us. But our greatest advantage is with the AlSiC, obviously.

I'm assuming there are other technologies you are planning to introduce that haven't been announced yet beyond AlSiC?

Correct. We are a product-based business, and we have various products in production and others in research and development. The cycles with our customers and partners are often closely held, taking years for them to qualify and move a product into production. These products were studied several years ago and are moving through the necessary stages to achieve full-rate production.

Excellent. I'm going to continue with a couple more questions if that's alright. Looking ahead maybe two or three years to '24 and '25, you're aiming to transition into a midsized company, and I'm unclear about what that entails. Could you provide some insights into what you're envisioning in terms of the model for investors? Specifically, I'm interested in contribution margins moving forward and potential growth rates. When I refer to contribution margins, I'm looking to differentiate them from gross margins, which I see are in the low 20s. However, your contribution margins could potentially be higher, around 30% or more, since you have already absorbed your fixed costs. Should we anticipate 30% gross margins by mid-decade if your contribution margins indeed exceed the gross margins?

Yes, our goal is to achieve approximately a 30% gross margin. We have progressed from about 20% to 21%, then to mid-22% in the fourth quarter, and we are actively working to increase that figure even further. A 30% margin is ultimately what we are aiming for, and we hope to reach that target sooner rather than later. From a financial perspective, I believe that the ERP and MRP systems that Michael mentioned earlier will significantly assist us in achieving this objective.

And just as a quick check. Patrick, to your point is, obviously, we see there is a relationship between revenue volume, contribution margin. And as I mentioned earlier, one of the reasons we made an investment in an MRP tool is as we continue to grow, we wanted to improve our margin while we're growing. And so you can kind of see, if you will, I don't want to necessarily put a timeline on it, but we are working towards the ability to scale the business. And I guess, scale is probably a good way to understand small to medium, the different ways that we want to grow the business. We don't really quantify it in dollar terms, but we have goals, obviously, year-to-year. But we know that as we grow, we need to cut and contain and keep our costs down so that as we scale up, our margins improve. And so that is actively what we're working on, and that's what we were trying to share with you about the tools. We basically talk in terms of people, processes and tools, how we can, as we grow the business, scale the business.

Is it unreasonable to ask whether, with all these initiatives in place, it's possible to achieve 15% to 20% growth rates by the middle of the decade?

That's the goal. We've achieved 7.5% growth this year and have aspirations for even more. However, we're navigating a dynamic environment influenced by COVID and now a situation reminiscent of the Cold War. There are factors beyond our control. Nonetheless, from a business perspective, we aim to expand across all our product lines and offerings, from early technology stages to full production, and that effort is ongoing. With the addition of new tools and recent hires, we plan to integrate all these elements throughout 2022. After a quarter or two, feel free to ask me again about our progress, as that remains our objective.

Well, I think I've done my part, but thanks for letting me ask all these questions. And congrats again on the year. And Michael, you seem to be the right guy at the right time here along with Chuck, and you certainly are in a dynamic space with all that is going on, both with conflicts as well as with power electronics and movement to efficiencies. And so good luck on '22, and I'm sure you'll hear from me again.

Next question from the line of Anthony Marci.

A couple of questions. To what extent does inorganic growth play into your future? In other words, are there companies out there that you're looking at, or that can hasten your level of revenue or profitability?

This is Michael. The foundation of our plan is to maintain organic growth in the material science sector. We are open to opportunities that closely align with our growth strategy. While we are not actively pursuing them, we have made it known that we are available and receptive. We don't have fully committed resources for this, but we are open to possibilities as long as they fit our growth strategy. We need to be very selective since we are experiencing significant success right now. The history of mergers and acquisitions shows a mix of great successes and notable failures. Therefore, we want to ensure that we remain grounded as we continue to grow.

Got it. Does the new defense budget contain anything that would directly benefit you or any new programs?

Well, certainly, it's a large document. And for the most part, we have one component that's not in this year's budget, and we think it's going to be in Palm 24, which is the U.S. Navy's conversion of our HybridTech Armor to surface fleet applications. So that we're cautiously continuing to monitor. But that takes a while to get into defense budget. I think for the positive side on the defense budget would be Congress' commitment to fund that small business innovative research program, which is why one of the reasons we've returned to reenergizing our services part of our contract research and development. Congress has firmly stepped up on funding the SBIR, STTR program. We have, obviously, with a few PhDs and material scientists, we have depth and reach to the academic side. We have a few partners: Carnegie, Milligan, University of Arkansas, to name a few, that we work with, MIT. Our company is used to working with these academic institutions, and that's a well-funded program in this year's budget. So I think, if anything, you could take away that well-founded congressional research program that is based upon domestic sourcing and commercialization of products is exactly what we do.

What are your investor relations plans, especially considering you anticipate higher growth and profitability this year? To my knowledge, no sell-side firm follows the stock from a research perspective, so how do you plan to increase your visibility to the investment community?

It's definitely something that we are working on. We recognize that we can improve in that area, and we plan to address it sooner rather than later to enhance our efforts. As we move forward in 2022, I believe you will notice our progress in this regard.

Yes. To follow up on Chuck's comment, we had a shortlist of four this year. Similar to our trade shows, we want to attend more conferences, but attendance is still low due to COVID. We're uncertain about the conferences happening. However, we have identified four conferences we aim to attend and are working towards that goal. In the past, our predecessors, Grant and Chuck, had the potential to enhance visibility, and we are working to return to that level.

I was asking if you meant investment conferences or trade conferences. Investment conferences are starting to see attendance again, but many conferences are still being held virtually. I suggest hosting a virtual investor conference at least every few months to ensure that we're effectively communicating our message.

Yes, I think it's a great idea.

Okay. Are you currently employing an outside IR firm? Or is it just purely internal at this point?

At this point, it's purely internal.

Next question from the line of Lenny Dunn.

Congratulations on the way you're running the business. And I'm going to address the dilemma that we have a large investor in your firm. I completely understand that you can't disclose defense contracts that are proprietary. I also understand that you can't give a lot of guidance because a lot of the contracts you have, you're the subcontractor on and you can't antagonize the people that give you the contract. And so it leaves us kind of in a dilemma as investors because we really can't get our arms around totally on what's going on. And I understand the reasons why you can't do those things. But are there some things that you can do to give us at least some forward guidance in broad terms without being specific so that we have a little better handle on what we own? Hello?

Yes, we're here.

Well, thank you for the comments. We certainly aim to reach that point, but we aren't there yet. We're sharing what we feel comfortable with at this time. We're working on improving our communications with all our investors regarding our outlook for the future, but providing more guidance is challenging for us right now. We need to balance several factors; some customers prefer that we keep information private. We deal with competition, pandemics, and other uncontrollable events. The aspects we can control don't provide enough information to significantly alter the way we've been reporting our business for decades. However, we try to share as much as possible within those constraints. That's the best I can provide you at this moment.

Well, I was encouraged by...

We welcome you to visit anytime. We can arrange that offline and show you more.

I’ve been dealing with some health issues recently, as I've been in the hospital recovering from COVID and unable to visit. However, I am optimistic about the option exercises by insiders, which clearly indicate their confidence in the company's future. That said, I find it challenging to evaluate our position, and while I am not discouraged and remain a long-term holder who may consider adding more, I wish we had better insights into our direction moving forward. It would be helpful if you could make an effort to provide more information to give us a clearer understanding of our ownership.

Yes. I believe we will continue to announce major contracts when we have the opportunity to do so. As mentioned in December, our sales bookings for the year are double those of 2020 and 2019. We will keep doing everything we can to achieve these results.

Okay. Well, I've asked and whatever you can do to help a little, would be very much appreciated.

There are no further questions at this time. Please continue.

I think that's it.

Well, if that's it, Chuck, I think on behalf of Chuck and I, thank you, everybody, this afternoon for your time. Hopefully, you feel like we feel that the business is doing well. And obviously, Lenny pointed out that Chuck and I have showed it in. We believe it is a good business. And we look forward to talking to you guys more and welcome the feedback. Thank you very much. Have a great day.

Thank you, everybody.

That concludes today's conference. Thank you, everyone, for participating. You may now all disconnect.