Cps Technologies Corp/De/ Q1 FY2024 Earnings Call

Good morning, everyone, and welcome to the CPS Technologies First Quarter Earnings Call. It is now my pleasure to turn the floor over to your host, Chuck Griffith of CPS Technologies. Chuck, the floor is yours.

Thank you, Jenny, and good morning, everyone. Today, I'm joined by Brian Mackey, our President and CEO. We look forward to discussing our first quarter results with you. But first, Chris Witty, our Investor Relations adviser, will provide a brief safe harbor statement. Chris?

Thanks, Chuck, and good morning, everyone. Before we begin the business portion of today's 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, but are not limited to, the wars in Ukraine and Israel, other geopolitical events, economic conditions, market demands and competitive factors. Such factors could cause actual results to differ materially from those in any forward-looking statements. Additional information can be found in our filings with the SEC. Now I will turn the call over to Brian to offer his perspective on the first quarter highlights. Afterwards, Chuck will review the financial results in greater detail. Brian?

Thank you, Chris. First quarter revenue was $5.9 million with an operating loss of approximately $260,000. The revenue declined year-over-year due to production constraints related to continued quality control testing as well as production inefficiencies due to labor shortages and turnover. Bottom line results were similarly negatively impacted due to non-revenue-producing spend in the first quarter, which I will discuss in more detail later. We anticipate that while demand remains strong across our product portfolio, the coming quarters, as we've discussed in the past, will also face headwinds from the anticipated drop-off in near-term ARMOR revenue. I'll now turn the call over to Chuck to provide more details about our financial results, after which I'll provide some additional detail.

Thanks, Brian. As mentioned earlier, the company's revenue totaled $5.9 million in the first quarter compared with $7.1 million last year. We've had some level of difficulty filling open manufacturing positions. Additionally, while we are cautiously optimistic that our quality issues have been resolved, we continue to run tests which occupy machine time that would otherwise be spent on production for customers. We do, however, believe that strong demand across our other offerings should lead to top line growth as the year progresses. In addition, our Navy partner Kinetic Protection remains cautiously optimistic about additional work for other Navy ship classes with contracts possible later than 2024. We gross profit in the first quarter totaled $0.9 million or approximately 15.3% of sales compared with $2.2 million or 31.6% of sales last year. This decrease was due to the lower sales volumes in Q1 2024 on consistent fixed costs as well as the aforementioned testing being done on the quality issues. That said, we anticipate gross margins to improve in the second half of 2024. Selling, general and administrative or SG&A expenses totaled $1.2 million in the first quarter versus $1.6 million in the prior year period as we remain focused on cost controls, even while investing in new business development initiatives aimed to accelerate long-term growth. The company had an operating loss of $260,000 in the first quarter compared with operating income of approximately $694,000 last year, and we posted a net loss of $143,000 or $0.01 per share versus net income of $459,000 or $0.03 per diluted share in Q1 of fiscal 2023. Turning to the balance sheet. We ended the quarter with $8.7 million of cash versus $8.8 million at the start of 2024. Trade accounts receivable as of March 30, 2024, totaled $3.8 million versus $4.4 million as of December 31, 2023. Inventories totaled $4.6 million at the end of the first quarter, essentially equivalent to the $4.6 million at the end of the fiscal year. Turning to the liability side, payables and accruals totaled $3.3 million at the end of the first quarter versus $3.6 million as of the end of December. Now Brian will provide a more in-depth discussion of the first quarter.

Thank you, Chuck. First of all, I would like to discuss CPS' vision for the future. Over the last few years, we've invested significant amounts of time, energy and dollars to the growth of CPS, and we continue to do so. Today, we have 3 more salaried engineers and material scientists than we did in Q1 of 2023, including the addition of a lead for new product introduction in the first quarter of 2024. These additions provide more depth to our technical team, enable us to be more responsive to customer requests and improve our ability to win orders. Having said that, the financial return from these new personnel will take time to develop. As a direct example, in the first quarter, we completed and shipped 8 new first articles. This 8% compares to 2 in the same period last year. These first articles are new parts, which CPS has not made in the past, but if done successfully, will lead to significant production runs in the future. Some of these would be an expansion of our portfolio with an existing customer, while others indicate a business opportunity with a new customer. Producing these first articles is engineering-intensive, and this was certainly one factor in the lower margins we saw in Q1. Nevertheless, we believe that current costs, such as these today will be a significant contributing factor to the growth of CPS in the future. Also, our manufacturing licensing agreement with Triton Systems for fiber reinforced aluminum composites, or FRA, will soon set the stage for expanded offerings to address market needs, expanding our product portfolio heading into fiscal 2025. Our relationships in the aerospace and defense markets provide insight into the market demand for strong, durable and lightweight materials. FRA composites address these needs. As a reminder, FRA composites are comprised of high-strength aluminum alloys discontinuously reinforced with short ceramic fibers. These materials have demonstrated high strength at elevated temperatures, lightweight and superior durability characteristics, which will facilitate the introduction of many new products for our military, commercial and industrial end markets. We are on track to initiate our manufacturing trials for FRA composites later this quarter, and we have already begun speaking with customers about possible relevant applications. We're very excited to have these complementary products coming to market. We also previously announced the award we recently received from the Massachusetts Manufacturing Accelerate program. In response to customer demand for products requiring 5-axis machine capability, we requested and received $200,000 to support the purchase of a 5-axis CNC machine. These funds expand our manufacturing capabilities and enable us to be more responsive to customer requirements. We have ordered the CNC machine and also expect to have this up and running later this quarter. Again, this will pave the way for higher production of hermetic packaging and other products later this year. In addition, while our current armor contract is coming to completion, we are cautiously optimistic that working with Kinetic Protection, new Navy orders may be forthcoming later in 2024. We continue to believe these ballistic solutions have a large potential market across different types of ship classes as well as other military markets. We also continue to work with another customer on providing ballistic protection against higher threat levels. At the same time, we know that further SBIR opportunities, including follow-on contracts, are possible in the weeks and months to come. At the moment, we have 6 submitted proposals awaiting funding decisions from the DOE, DOD and NASA including 4 Phase I and 2 Phase IIs. These ongoing R&D efforts are enabling us to directly address clearly defined market requirements. I'd like to share some details from our most recently completed SBIR program, which effectively demonstrates our ability to address problems identified by our customers, in this case, the Department of Energy. CPS was initially funded $200,000 by the DOE in response to our proposal entitled Modular Radiation Shielding for transportation and use of micro reactors. The problem statement focused on the ability to produce lightweight and low complexity radiation shielding that would be of paramount importance to the deployment of advanced nuclear microreactors. Lower shielding density promotes higher power density during transit for power, remote or mobile applications, including mining operations, disaster relief efforts, shipping and defense. During the 9-month Phase 1 period, which ended just last week, CPS successfully incorporated its proprietary techniques related to both injection molding and Metal Matrix composites or MMCs. We designed, fabricated and evaluated a novel MMC consisting of an aluminum matrix with both tungsten and boron carbide reinforcement particles. The resulting composite offers both neutron and gamma radiation shielding in an elegant compact solution as opposed to relying on multiple layers of dissimilar materials. Although further optimization is necessary, our baseline composite material demonstrated the capacity for new tranche shielding and was highly effective at shielding gamma radiation at much lower mass compared to traditional materials. In fact, as a barrier to gamma radiation, our composite demonstrated performance similar to lead or tungsten, but with a reduction in mass of more than 55%. Our MMC design can easily be modified to suit different protection needs with variable volumes of both gamma and neutron absorbers. Our proposed solution will greatly reduce the material mass needed while being highly customizable in size, shape and composition. The novel CPS process improves upon existing research to fabricate integrated radiation shields by achieving greater reinforcement loading with a robust, cost-effective and mature processing technology. This is a great accomplishment, especially for just a Phase I program. Our technical team was invited to present its results just last week at the National Reactor Innovation Center Program Review at Idaho National Laboratory. We're now following up on several leads developed from that event. The feedback that our presentation received also highlighted the value of our approach for stationary applications, i.e., building construction, due to the dramatically reduced weight requirements. We are also awaiting DOE's response to our Phase II proposal, which, if awarded, would provide an additional $1.1 million in funding over a 24-month period. It should come as no surprise, we're very pleased with the results to date, which has already generated meaningful dialogue related to near-term opportunities for fielding our solution. DoD initiatives like Project Pele, which is working to demonstrate a mobile nuclear reactor for U.S. military applications, again demonstrate the potential dual uses for our novel material solutions. Although we do not control the timing of when our proprietary offerings will enter the market, we continue to build our portfolio and service to our customers. Within the last few years, CPS has redoubled efforts to expand its product line to meet new technology-based requirements. One key element of this has been our participation in the SBIR programs of various federal agencies. Within the past 3 years, 5 of our 14 Phase 1 proposals have been selected for award. Historically, the government's rate of funding Phase 1 proposals for all applicants has been about 20%, and this has been even more competitive in recent years, perhaps down to 15%. So we're very pleased with our award rate so far, which is over 35%. This speaks volumes as to the capabilities of our team and our existing intellectual property. But more importantly, we see these awards as the affirmation that we are addressing the problem statements of our customers as they define them within the context of the SBIR format. We know that providing such technical solutions will provide real growth opportunities going forward, many of which have potential applications with both commercial and military customers. In the meantime, we continue to fulfill the long-term supply agreement announced last year, providing power module components and systems for a variety of rail and other applications to a multinational semiconductor manufacturer. We remain on track for the shipment of product under this contract over the course of 2024. As I said earlier, we are actively bidding on opportunities to accelerate growth in the future, while mitigating the negative impact this year due to the completion of our current Naval CAR armor contract. We continue to believe that expansion across other product lines should cover roughly half of the $2 million quarterly revenue shortfall in 2024 related to Armor, setting the stage for growth next year and beyond. We'd now like to open the call up for questions. Operator?

Your first question is coming from Wolf Check.

Based on your presentation, it sounds like you have a lot going for the company. What do you think will be the first product that you should be able to order, and what kind of revenues do you think you'd be able to generate from that in this current year?

Well, I think probably the most straightforward is the 5-axis CNC machine, particularly for hermetic packaging because that's been a request of customers over a period of time that we've been producing hermetic package products to begin with. So in the past, we've been not cost-competitive on those because we didn't have that 5-axis capability in-house. So that's a low-risk, near-term execution opportunity. Once we have that machining capability in-house, we'll be able to offer those products at a cost-competitive pricing. Now that will be first articles, and there'll be customer engagement of that, which will then turn around further down the calendar into volume orders. But that's the most direct answer to your question.

What companies do you think would be most interested in these products? Do you have a feeling for that type of distribution?

Well, on the hermetic packaging, certainly, it's customers that we're currently servicing today that are the nearest opportunity. They're very familiar with us. We're familiar with them. We know which products they are interested in getting quotes on with components that include 5-axis machining. To come back to the FRA, it's the OEMs out there that you could list that are in the business of aerial vehicles, whether it's helicopters or even drones and related aircraft, where lightweight but high strength and durability have value.

Okay. One last thing based on the comments on the conversation, it seems as though maybe you should put out some type of material to the street to help people fully understand what the company is all about and what the potential is. Not going excessively, but going within about proper constraints by making people aware of the potential.

Right. Yes, that makes sense.

And our next question is coming from Steven Fuse.

So I'm wondering if you could provide a little bit more information or color, whatever you want to call it, about the labor situation. Do you see that as kind of a temporary situation, or more of a long-term availability problem that might translate into higher costs?

Sure, Steven. So actually, I think this was more of a temporary problem during Q1. We believe that we are now currently fully staffed for purposes of our business and production that is going to be ongoing in Q2, the second half of Q2, and Q3 and on. So I think that was more temporary. If we get to the point where we have to add a whole bunch of people, that might rear its head again. But I think for now, we were just talking about it the other day that we're probably fully staffed, or we are fully staffed, and we should be in much better shape going forward.

Okay. Great. And if I could ask one more quick question. On the shielding work, you've highlighted it. So you're obviously kind of excited about that. How does that compare in terms of cost versus current solutions? I mean, do you save on costs in the assembled system versus multilayer system? Or is it more of a, this is a great elegant solution for applications that are more narrowly driven by weight?

Yes. The first application, which we initially responded to, was for the mobility of these microreactors. So you're trying to transport these things to places where either the military might have a setup or there might be disaster relief going on and that kind of thing. And obviously, the more weight that you have in the protection aspect of that truck, the less weight availability you have for the actual reactor itself. So you're able to increase the power density of the product that's being carried, which has a very real benefit for the user, the customer. And as we mentioned, it quickly became very apparent that even for non-mobile applications, the construction costs related to massive amounts of concrete have a very real cost factor to the structure of that building, the concrete pad that is built upon, and those other things in the crane that's used to move pieces around. So being able to make a less dense, more adaptable piece of material that's uniform, so you can attach to it, you can modify it to suit the shape and the needs of that construction is also more valuable. Now concrete is not particularly expensive, but when you go to a tremendous amount of it, and it's limiting your ability to build the structure that you want and move things in and out of it for testing and things like that, those are some of the conversations that we're already having. And we don't have details about that cost comparison, but we can tell from the reaction we've had to it that it's intriguing to the users. So those are the things that we're going to continue to explore further.

Great. And if you can indulge me in just one more. The deal with Triton is how much of that is an application pull versus a technology push? Is it a case of here's an application. We know we can do it, does the market reflect this is a cool thing which expands on our capabilities and opens possible markets?

The appeal of FRA to the market is fairly obvious. And one of the benefits of where we stand today is that the properties of the material were well evaluated and tested by the Triton team. So the appeal of those material performance is known to the market and is of interest. And what we're able now to do is indicate that we're a reliable, dependable element of their supply chain. If you're a helicopter OEM and you're interested in that material because of its performance benefits, you're not going to take it on unless you're sure that, that supplier is going to be around for a long time. So we're able to do that and address these market requirements by offering this material that is already of interest to them because they need lightweight and durability, and that's what this material provides. So it's driven by what these aerial applications require, but we also expect there will be other applications as we play this forward.

Your next question is coming from Davis Marcie.

Historically, you've had a 40-40-20 split between departments. Do you see that remaining consistent? And which kind of product lines are you seeing the most demand for going forward in growth capacity?

Yes. In the short term, with the completion of the Kinetic Protection Armor order for the aircraft carriers, that 20% segment might shift to a more balanced 50-50 with the other two, possibly around 48-48 with them. We are very optimistic about potential additional opportunities in the Armor sector, either with Kinetic Protection or as we explore other ARMOR applications with different customers. As for the remaining areas, hermetic packaging has significant growth potential since it represents a larger market. As Brian mentioned earlier, seven of the eight first articles we produced in the first quarter were from the hermetic packaging side of the business, indicating its capacity for near-term growth. The other aspects are likely to yield more long-term growth. Regarding the FRA shielding, we might see a little revenue before the year ends, but it won't be substantial until we reach 2025 or 2026. The armor opportunity could quickly restore historical ratios. As we finalize this order, we are engaged in ongoing discussions, though the situation can be unpredictable. However, there are real opportunities that could bring that ratio back to the original numbers you mentioned.

Got it. And then what kind of capital requirements are you expecting this year? And do you expect to reach profitability for the full year 2024?

In terms of capital requirements, we are in a strong position. The funds for the 5-axis machine have already been allocated, and our balance sheet reflects a solid cash position. If a situation arose where we needed to produce FRA at a high volume and required a new infill trader for $1 million, we could manage that without issues. Overall, we are well-prepared for our capital needs and can acquire what we need when necessary. Regarding profitability, it's a valid question. At this stage, I’m uncertain. We anticipated profitability over the last three quarters collectively, but it won't be as substantial as two years ago when we had a $2 million profit. This time, the profit margins will be much tighter. If circumstances were to deteriorate, we may face a year without profits, though we are aiming for profitability in the last three quarters, even though it will be challenging.

Your next question is coming from Greg Weaver.

Brian, Chuck, just a quick question. So the 5-axis tool, the press release has it as an award. So that money was an award, not a loan, right?

Correct. They are providing us with funding for what they are awarding us. Essentially, we are discussing a $400,000 piece of equipment, which includes installation. We receive half of that amount. Yes, it's a dollar-for-dollar requirement. Therefore, we are obtaining $200,000 for Massachusetts with the commitment to spend that amount. Some of it will be allocated to labor and other expenses. In total, it's a $400,000 investment, but it's not a loan. There is no requirement to repay it. The funds will be used to create jobs in the manufacturing sector of Massachusetts.

Okay, that's great. Regarding the testing constraints you mentioned, are you focused on ensuring the parts are good before shipping them out? Is this a temporary situation or an ongoing one to maintain quality? Are you also acquiring more equipment to help ease the bottleneck you referred to? It seems like there is a bottleneck.

Yes, it is a temporary situation. What it requires is that some of our production equipment is focused on making base plates for further testing. Instead of producing them for sale, we are making them to test. Initially, we were making only 50 pieces at a time while searching for solutions. In the first quarter, we decided that we need to move towards statistically significant runs, so we shifted from 50 pieces to 500 pieces and then an additional 500 pieces, which is a substantial amount of production that would typically be provided to a customer. We believe we are nearing the end of this process. There will be more testing done this quarter, but we feel we are close to the goal. We hope to resolve this issue soon.

Okay. Great. In the just reported quarter, the Armor revenue was around $1.7 million. And that's essentially zero in the current quarter?

No, no. We've definitely shipped some products in Q2 as well. It's down, but it's not gone yet.

Okay. We'll be gone by Q3. So what should I think about then in terms of gross margin because, as I recollect, the armor business was a nice adder, but you had tier with $1.7 million of Armor; you had a 15% gross margin, right?

I mean, we expect the margin to go up. As I said, I think there was a significant expense that goes through the testing process, and that all becomes part of our cost of sales. So that's definitely had a negative impact on margin. The other thing is Brian had mentioned that we have 3 more engineers now than we did a year ago. I think that we're viewing this as sort of an investment. Unfortunately, GAAP says, that's not an investment. You have to expense those people immediately. So I think that I don't expect we're going to be getting back to the levels that we were at a year ago when we were in the high 20s, even I think one quarter, we were at 30%. But I do think that we should be improving over what we had in the first quarter because of a number of these other expenses that we won't have going forward.

Even at a lower run rate?

Yes. Yes. I think, fingers crossed, God willing that this quarter had the lowest that it's going to be. But yes. But I think it should go up a bit more.

Okay. That will do it for me now. Hopefully, I can catch up with you next week at the Siduri. Bye.

Well, we appear to be at the end of our question-and-answer session. I will now hand back over to Brian for any closing comments.

Great. Thanks, everyone, for joining us today and for your ongoing interest in CPS Technologies. We look forward to speaking with you again after the end of the second quarter. If you have any questions in the interim, please reach out to our Investor Relations adviser. Thanks.

Thank you very much, everyone. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.