CPS Technologies (NASDAQ:CPSH) Q4 2020 Earnings Call

0:00 Ladies and gentlemen, thank you for standing by, and welcome to the CPS Technologies Corp. Year-End Investor Conference Call. At this time, all participants are in the listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during this session, you will need to press star 1 on your telephone. If you require any further assistance, please press star, then 0 on your telephone. Please be advised that today's conference is being recorded. I would like to hand the conference over to your speaker today, Chuck Griffiths. Thank you. Please go ahead.

0:35 Chuck Griffiths Thank you, operator, and good afternoon, everyone. I'm joined today by Grant Bennett, our president and CEO, and Michael McCormick, our chief operating 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 Private Securities Litigation Reform Act of 1995. and should be considered as subject to the many uncertainties that exist in CPS's 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 statement. Now I'll turn the call over to Grant to offer his perspectives on the annual and fourth quarter results. Thank you, Chuck.

1:29 First, Chuck and I are delighted to be joined today by Michael McCormick, our new Chief Operating Officer. Michael began on January 4th after relocating from Florida. As mentioned in our press release, when he joined us, Michael brings deep skills in business development, new product expansion, and M&A, and has significant experience in the defense, aerospace, and armor markets. He also brings energy, focus, and drive. Eight weeks into working together, I can authoritatively say that he's delightful to work with. We'll hear from Michael later in the call, but say hello, Michael.

2:14 Hello, everyone. Thank you, Chuck, and thank you, Grant.

2:19 Great, great. Today we announced revenues of $20.9 million and an operating profit of $914,000 for the year ended December 26, 2020. This compares with revenues of $21.5 million and an operating loss of $597,000 for the previous year. For the quarter, The fourth quarter of 2020 revenues were $4.2 million with an operating loss of $291,000. This compares with the same period a year ago where revenues were $5.4 million and an operating profit of $367,000. As I indicated in the press release, 2020 was unique in so many ways as all of us understand professionally and personally.

3:14 As the year progressed, customer demand for our existing larger volume products, primarily base plates going into traction or transportation applications, declined. And in fact, they declined sequentially each quarter during the year because of COVID-19. As countries locked down due to COVID, and incidentally, I should say the About 50% of our revenues come from Europe, and as countries locked down due to COVID, train ridership declined, delivery schedules for new trains were pushed into the future, and demand for power modules declined accordingly.

4:01 In addition, some of our customers, as COVID evolved, expected problems in the supply chain, including in international transportation, and they increased their safety stock of inventory in the first half of 2020. When demand declined, they found themselves with excess inventory. We've been producing at a rate lower than our customers have been consuming product during the second half of 2020 as those customers have been drawing down their excess inventory. That's the negative news. On the other hand, the positive news is that Demand increased for other products, particularly aerospace applications, and customers largely held to development schedules for new products. As a result, new products continued to move through our pipeline.

5:01 With travel all but eliminated, we redeployed resources to accelerate internal continuous improvement projects to increase margins. We implemented planned price increases. The net result of these factors, both the negative and positive, was for the year a 2.8% decline in revenues, but a positive swing of $1.5 million in operating profits, or on a percentage basis, a 253% increase. Globally, COVID continues to be highly disruptive. and cause uncertainty in forecasting. However, we know our customers have reduced some of their excess inventories and as we take all available information into consideration including their updated forecasts, inventory levels and manufacturing schedules, we believe the fourth quarter most likely represented the bottom in terms of demand.

6:12 I'll discuss our bigger picture after Chuck reviews the financial results in detail. However, before handing the microphone over to Chuck, let me just note one or two recent developments. In addition to Michael McCormick's arrival, I note our order for hybrid tech armor panels for crew served weapons stations on aircraft carriers. We expect to begin shipping these panels towards the end of the second quarter of this year. The third quarter will be our first full quarter of production of these panels. The long lead time are the ceramic tiles that are a component in the panels.

7:01 We congratulate NASA and the Jet Propulsion Laboratory on the remarkable successful landing of the Mars Rover Perseverance. We're delighted to be a participant in that program. We produced for the JPL an ALSEC hermetic housing which houses and protects the power supply for the SHERLOCK scientific instrument on the rover. SHERLOCK is an acronym for scanning habitable environments with Raman and Luminescence for organics and chemicals. It's a deep UV spectrometer which is at the heart of the rover's mission.

7:48 Needless to say, reliability of the power supply in harsh environment is key and that's certainly what we provide. Just more broadly, we've commented several times that we've had a concerted effort to strengthen our sales, marketing, and business development efforts in the U.S. aerospace and defense electronics industries. Our revenues are approximately 70% of our revenues are exports and we're delighted at that. We're truly a worldwide supplier but we see tremendous opportunities in our own backyard and have been focusing in the US aerospace and defense electronics industries.

8:41 The results of this activity have been very meaningful in terms of new design wins, new bookings, new customers, and new products. Chuck, let me now turn the time to you to discuss the financial results in more detail.

8:59 Thank you, Grant. So revenues for the quarter totaled $4.2 million, representing a 22% decrease compared to the $5.4 million in Q4 last year. As Grant mentioned, this was primarily due to the reduced shipments of our ALSEC products. For the year, revenue was $20.9 million compared to $21.5 million for 2019, a 3% decrease. Gross margin for the quarter amounted to 12% of sales compared to 18% of sales in the fourth quarter last year. We finished the year with an annual gross margin of 20% compared to a margin of 12% in 2019. The largest factor affecting this percentage was new contracts with our three largest customers which we've discussed in the past.

9:50 Selling general and administrative costs totaled 3.2 million Thank you very much. Turning to the balance sheet, we're happy to report that we ended the quarter with $195,000 of cash and $0 of borrowing against our line of credit.

10:36 This gives us a net cash number of $195,000 and is a significant improvement over our cash position at the end of Q3 when net cash was a minus $722,000 and a further improvement from the beginning of the year when net cash was minus $1.1 million. Accounts receivable at December 26, 2020 totaled $2.9 million compared with $4.1 million at December 28, 2019. Our day sales outstanding totaled 62 days at the end of the year compared with 68 days for the year ended 2019. Several factors contributed to this reduction, not the least of which was the negotiation of better payment terms with one of our larger customers. Inventories totaled $3.7 million at December 26, 2020, compared with $3.1 million at December 28, 2019. The inventory turnover in the most recent four quarters was 4.5 times compared to 6.2 times for the four quarters ended December 28, 2019.

11:39 This decrease in turns is directly related to the decrease in purchases from our largest customers, as we previously discussed. Inventory was reduced from $4.1 million at the end of the third quarter, and we expect to continue this trend over the next few months. Turning to the liability side, you'll see the $0 drawn on our line of credit. Payables and accruals totaled $1.7 million at December 26, 2020, down from $2.3 million at December 28, 2019. You'll also see the inclusion of a note payable not in last year's liabilities. This is due to the financing of new equipment in the first and third quarters of this past year. Lastly, I'd like to point out the significant improvement in our current ratio over the course of 2020.

12:29 We started the year with a respectable 2.0 ratio, but finished the year at 3.8. And so for further discussion, let me turn the call back over to Grant. Thank you, Chuck.

12:43 As this is our first quarterly call of the new year, I thought it might be helpful to provide a higher level look at who we are and why management is very excited about the future of CPS. Let me comment on three topics essential to understanding our business. Our core competency, our product pipeline, and our primary markets. Our core competency is our technology for combining metals and ceramics to form metal matrix composites. This competency includes the intellectual property, the novel process technology developed at CPS, and very importantly, it includes the design, manufacturing, and quality capabilities to produce real products to customer specifications.

13:39 ship these products on time and do so with attractive margins. In short, the IP is the core understanding of the chemistry in the process. It's also the understanding of the execution translating that chemistry and processes into real products. The combining metals and ceramics form this category of materials called metal matrix composites, where metal is the continuous matrix and ceramic is the reinforcement. Today, our primary metal matrix composite material is a combination of the metal aluminum, the ceramic silicon carbide, known by its chemical symbol ALSIC.

14:29 Our product pipeline. Metal Matrix Composites have properties that provide compelling performance benefits in certain applications. For example, in the high voltage power module area, using an ALSIC base plate rather than a copper base plate can increase the lifetime of the module by 10 times by eliminating the mechanical stresses associated with differential coefficients of thermal expansion. In space applications, using an ALSIC housing or package can provide a 50 to 75% reduction in weight. In vehicle armor applications, a metal matrix composite armor panel can provide much longer life in harsh environments and for a given weight, better ballistic protection.

15:29 However, the benefits of metal matrix composites are usually realized only if the end product is designed from the ground up to take full advantages of the properties of metal matrix composites. For example, an ALSIC base plate enables a power module to have higher functionality and longer life in a much smaller footprint. But that benefit is only realized if the customer actually designs and builds a new module with the smaller footprint. In other words, it's rare that we directly substitute our product for an existing alternative material.

16:20 In almost every case, to fully realize the significant benefits that composites provide requires a new design of the end product. This observation is critical in understanding our product pipeline. The applications we serve are generally high reliability, high performance applications. The time between when a customer selects ALSEC for their application, we call that decision a design win, and the time when the customer has completed the development, testing, and manufacturing scale-up of their new product is generally a minimum of two years, more typically five years, and seven to eight years is not uncommon.

17:07 This means that the products that are generating revenue today result from design wins that occurred two, three, four, five, or as many as eight years in the past. However, it also means that once a product is in production, it generally stays in production for many years. A recently announced purchase order for hybrid tech armor panels for crew-served weapon stations illustrates this pipeline dynamic very, very well. CPS began development work on these kinds of panels in 2012. We achieved the crew-served weapon station design win in 2015.

17:53 By that I mean the design was set and our immediate customer had selected us. On December 8, 2017, we issued a press release indicating that the Navy had begun sea trials of our hybrid tech armor. In other words, the development of the product, the full product was completed. Between December 2017 and February 2021, a period of four years, the Navy evaluated the performance of the panels at sea installed on the USS Carl Vinson performed extensive ballistic testing, confirmed the panels, fully met the new rigorous specification developed by the Navy, obtained funding from Congress, developed a preliminary installation schedule, and finally placed a purchase order. While to many on the outside, it seemed like nothing was happening during these four years, in fact, a great deal was happening as our product was moving through the pipeline towards full adoption and production.

18:57 With that background, management is very excited about where we stand today because we are excited about what is in our current pipeline. There are design wins with tier one automotive supplier for base plates for silicon carbide based modules for automotive applications moving through our pipeline. There are design wins for power modules for use in power grids moving through our pipeline. There are design wins for ALSIC heat spreaders for application specific integrated circuits and fiber optic applications moving through our pipeline. There are design wins for the ALSIC hermetic package similar to that found on the Mars Rover for space applications that are in our pipeline.

19:54 There are design wins for complex, expensive, and enabling components for other satellite applications in our pipeline. Not all new projects our customers begin reach completion. We can have a design win and the end product in which the customer was going to use that product can be canceled along the way. In addition, development and market introduction timelines can change. For these reasons, we generally don't comment in detail on any specific design win until it is very near or has actually entered the production stage. The third area I want to comment on is the primary markets that we serve.

20:44 Many but not all of our markets could be summarized by this sentence, CPS is electrifying the green economy. One key market for us is power modules. We supply base plates and the high voltage power modules, also known as IGBT modules. As indicated, ALSEC provides a 10 times improvement in module life compared to a copper base plate above certain voltage levels. Historically, the primary market for these high voltage modules has been electric trains. That continues to be a large and growing market. However, It's been depressed by COVID this year, but the market will rebound.

21:32 However, two major long-term trends are opening up new, very significant related markets. These trends are renewable energy and the electric vehicle. Power modules connect renewable energy sources, wind turbines and solar panels to the electric grid. Likewise, power modules connect charging stations for electric cars to the grid. In fact, power modules are the very heart of an EV charging station. Obviously, electric vehicles are key. I'll come to that in a minute. But reflect for a minute on the growth in wind turbines, solar farms, and EV charging stations today. that need to be installed and connected to the grid over the next decade. It represents a very exciting opportunity.

22:29 ABB Semiconductors in Switzerland is a very important customer for us. ABB Semiconductors last year was acquired by Hitachi of Japan and moved into a new legal entity, Hitachi Power Grids. Their focus is the electrical grid on a worldwide basis. Obviously, many of the base plates we provide to Hitachi Power Grids end up in modules in the electric grid. Power modules also enable the electric vehicle. There are many, many, many different designs for power modules in EVs, and most today are not using ALSEC. However, ALSEC's properties are compelling in some designs, particularly those using silicon carbide-based rather than silicon-based power modules. We are excited about the design wins we have for silicon carbide-based automotive power modules with the Tier 1 suppliers, and we're confident that there'll be more design wins as time goes on.

23:46 I do make a distinction between a Tier 1 supplier and the automotive OEM itself. We achieve a design win at the Tier 1 supplier. The Tier 1 supplier then needs to achieve the design win at the automotive OEM. But we're very excited about all of these subsegments in the high voltage power market. Traction or trains, wind turbines, charging stations, electric grid infrastructure. and the electric vehicle. A second market for us is the aerospace and defense applications. ALSEC provides higher reliability and lighter weight for many aerospace and defense electronic applications. We're on the Mars Rover. We're in the current generation of GPS satellites.

24:36 We have parts on the F-35, the F-22. These markets tend to be very conservative and the timelines are long. But once designed in, demand lasts for many, many years. In these markets, we're earning our stripes the old-fashioned way, one design win at a time, and the pipeline gets increasingly excited. The third market is lids and heat spreaders for high-performance ASICs, graphics chips, and fiber optic applications. In the interest of time, let me defer discussion of this to a future date. and finally another market is armor. Our focus is vehicle armor, it's not body armor. Our hybrid tech panels provide advantages in two areas, severe environments such as at sea or in high temperature environments such as near the exhaust or engine of vehicles. And secondly, our hybrid tech panels we believe are the optimal solution for very high threat levels where conventional solutions just don't work.

25:50 A fairly small market today, but unfortunately growing in the troubled areas in the world where those conflicts exist. The Crew Served Weapons Station is an example of our armor in the first area, Severe Environment. We have an order for one aircraft carrier, but our partner, the prime contractor in this case, has an indefinite delivery, indefinite quantity order for the US aircraft fleet. We're confident orders to us for additional carriers will be released reasonably soon. In our February 2nd press release, we commented that the Navy has over 400 ships in total.

26:36 The Coast Guard has Well over twice that number of ships, obviously much smaller, but the same need exists on many Coast Guard vessels. We believe MMCs, as I indicated, provide the best solution to very high threats, and we are doing some joint development with some partners in this area and hope to be able to say more about that sometime later this year. Let me stop there, but I hope that's been helpful in providing an overview of who we are, how our products come to market, and what are the markets in which we're participating.

27:22 With that, operator, could we open the floor for questions? Yes, sir, and ladies and gentlemen, if you would like to ask questions, press star 1 on your telephone. Again, if you would like to ask a question, press star 1 on your telephone. We'll pause for just a moment to compile the Q&A roster. For our first question, we have Walter Schnecker. Walter, your line is open.

27:52 Thank you. Hi, Grant. How have you been?

27:54 Hi. Just fine, thank you.

27:57 Good. I have two questions. First, it was great to hear about all of the design wins. I know I haven't been up there for a number of years, but how much capacity, and I realize we'll have to talk revenues because different things use a lot more, a lot less material. How much capacity does that facility actually have in very broad terms in dollars versus the $20 million you've been doing for a number of years now if it all came in?

28:29 Very good question. Michael, you've been studying that very question a little bit, so why don't you comment on that?

28:38 Hi, Walter. Nice to meet you. Nice meeting you. So I think it's safe to assume that without any significant investment in additional capital equipment, we could probably handle a volume 2 to 3X, our current, and a combination of shift work and more utilization of the force space we have. but from a capacity standpoint of capital investments made, we could easily handle a number twice our revenue.

29:08 Let me just amplify on that slightly which is we are operating three shifts a day but the second shift is much smaller than the first and the third shift is really a skeletal shift only operating those specific operations where It's not economical to turn the equipment on and off. You want it running 24 hours a day. And so we could essentially double the employment base in the factory. And again, in real broad terms, at least double the revenue.

29:55 And product mix is important. The aerospace and defense kinds of products that we've been booking tend to be higher revenue and lower volume, so that product mix is also important. But in broad strokes, two to three times.

30:19 Good. Second speech question. The stock market guards have been very kind to your shareholders recently. You personally and anyone else who's had the patience to stay with the company a long time. Having said that, if we look at your December 31st balance sheet, you've got $200,000 of cash, $200,000 of liability, $6 million of equity. You talked about if it all came in, you might need some more capital equipment. How can you not sell, making up a number, 2 to 3 million shares, put Thank you for joining us.

31:27 Chuck, do you want to comment? And then I'll comment as well.

31:29 Yeah, so obviously we're exploring opportunities. We really don't want to comment too much other than that at this point in time. But we're certainly aware that the situation you have described exists for us.

31:47 Do you want to add to that? Yeah, let me just say, to do what you described, involves some FCC filings and it involves engagements with the appropriate banking individuals. So it isn't done overnight, but the board and management is absolutely brightly aware of the additional opportunities that become available for the reasons you describe.

32:32 So let me leave that there. You're correct in stating that it hasn't been done as of February 24th, meaning But I would not draw a conclusion that it is not going to be done.

32:55 Good. Okay. I mean, because we ought to beat it to death. It's something that's obvious. As you know, I do a lot of microcap companies, and they have been very, as a group, have been very active where their stocks have gone up multipold, changing the dynamics of their financial balance sheets by a lot. So, you know, but just one last question. Out of the 20 million, aerospace broadly defined is roughly what percent of revenues and attractions biggest?

33:31 Today, aerospace, aerospace, I'm thinking out loud here. Frankly, the percentage has changed significantly. for the dynamics we just described. But aerospace has moved from 20% to probably 35% in the last quarter or two.

34:10 Good. And just lastly, just a comment. I suspect Ralph is on the call today I just want to wish him well in retirement.

34:21 You are wonderful. You are wonderful.

34:24 Okay, thanks a lot, guys.

34:26 Thanks very much. I appreciate your comments. Yeah, bye. Bye-bye. For our next question, we have Thomas Barnes. Thomas, your line is open.

34:39 Thank you, thank you. I have a very simple and basic question as it relates to Your company's public view. When you guys were awarded that Hypertech Armor contract and you guys went public with the news, there was a substantial surge as it relates to your shares. My question is, as other design wins come to fruition, would you guys be having the same approach as it relates to letting the public know about these design wins and contracts?

35:11 Sure. What I tried to describe, well, the short answer is we would like to do for other design wins what we have done with kinetic protection and these hybrid tech panels. And again, by that, we released press releases, one in 2017, that the customer had spent the money to install the product for extensive evaluation, and then they placed the order. So the answer is yes, and we anticipate certainly in the next several months that you'll see One or more of what you described.

36:16 Well said. It sounds like you're holding some cards close to the chest. I appreciate that. And thank you for the time.

36:23 Thank you. Thank you. For our next question, we have Tim O'Connell. Tim, your line's open.

36:34 Hi. Good afternoon, gentlemen. My question actually was also around Thank you very much.

37:04 and without describing exact timing or amount, we're moving forward on that front.

37:10 All right, thank you. For the next question, we have Warren Silver. Warren, your line's open.

37:21 Good afternoon, gentlemen. Grant, I want to thank you for keeping our company in a survival mode for the last 36 years of incubation. and hopefully we could break out now. One question I'd like to address to the aerospace. I saw last year Cessna Aircraft had an electric engine in their plane. And then I see now United Aircraft in the vertical takeoff mode. They're backing Archer V2OL. and then I saw the other day there's a company called Joby that's having a SPAC and that's backed by Reid Hoffman.

38:06 And you mentioned that the industry is making a transition from silicon to silicon carbide. And I know, speaking to people, if I'm flying in an airplane or a vertical takeoff operation, I would like to have a base plate that's aluminum-silicate carb, you know, IGBT. Because if it has a copper base plate, the plane could obviously not function correctly. And like these other gentlemen are saying, in the past, we always had to have our own cash flow. I think we ought to raise up some money and make these investments here, specifically on the vertical take-off business, Deloitte, recently in the Aerospace Industries Association, predicted the U.S. air mobility market will begin deployment in 2025 and expected to hit $115 billion in revenue 10 years after. Do you have any comment on that?

39:08 You are exactly on the market. The market is not tomorrow, but that application is Thank you very much. are working today.

39:55 We have orders for product that a major player that you would recognize in that space is doing development on the power module for aviation applications. So in short, We want to be in every single electric plane of any type. And we are, on a worldwide basis, we're seeking out, calling on, and in several cases working with the Tier 1 suppliers that will be serving those applications.

40:48 You commented on, this actually is my 36th year here, and time's gone by quickly. And the fascinating applications that we work on is one of the reasons that I love this company. But in many cases, I've said to myself, we're a little too far ahead of the market. and as we look at this electrification, you talk about electric planes, but look at the electric car, look at the displacement of hydraulic systems, bioelectric systems in industrial applications.

41:33 We believe our time has come and we're very excited about it.

41:37 Well, thank you. And I'm also very excited because of retiring after 58 years at Wells Fargo. and in February, the first week, I thought it was Christmas time because I was able to sell some of the shares that I've held for many years and pay for my granddaughter's education, hopefully, at Berkeley up in Boston. So again, you never know when you're going to be surprised, but I just want to congratulate everyone for their dedication and hopefully the next three to five years will be very beneficial to all of the shareholders who stood with us all of these years. Thank you.

42:16 Fantastic. Thank you, and congratulations on your retirement. By the way, Berkeley is a wonderful school. I know the president there, Roger Brown, well.

42:27 Thank you. For our next question, we have Greg Weaver. Greg, your line is open.

42:37 Hi. Good afternoon, gentlemen. On the armor order you got, or the Kinetic got for $28.7 million. What does that translate to for CPSH?

42:48 Let me turn that over to Michael. Hi, Greg. How are you?

42:53 Hi. So, you know, each order to Kinetic Protection on an order of magnitude, about half of that order comes to CPS.

43:03 Okay. Thanks. That's helpful. And now it's an IDIQ, right? You indicated that you're expecting revenue beginning in Q2. Now, what should we think about there? There was some kind of draw against the IDIQ, but obviously it's not the full amount that's been ordered, right?

43:22 The contract that Kinetic Protection has is a five-year IDIQ for up to 10 shipsets. The initial order was for the first shipset.

43:35 Gotcha. Okay. That's helpful. Thank you. And just the second question was on the Q4 gross margins. Do those reflect all the price increases that we talked about before in terms of your customers for the modules?

43:50 Yes, they do.

43:53 So I guess what should we think about go forward here? This is all a function of top line. That's 12%, I believe I calculated for the quarter. I mean, we were on our way to 20% before.

44:08 Yeah, you're correct. I think it is the top line that we need to focus on and are. Right.

44:21 We are fixed costs. We are confident in the return of higher demand in the base plate business as COVID subsides. And for that reason, we have kept fixed costs where they were a year ago, more or less. And so part of what's going on is, yes, it's a top line fixed cost dynamic.

45:02 Yeah. Okay. And just lastly, kind of tying into that with the first question, Should we think that Armour is one of your better margin opportunities?

45:16 Michael or Chuck, do you want to comment on that? Yeah, I think that's fair to say. I think we expect that to be the case, yes.

45:23 Okay, great. Thank you very much. Good luck.

45:28 Thank you. and presenters. We don't have any further questions at this time. Please continue.

45:40 Okay. We thank each of you for joining the call. As you probably all know, we're located just south of Boston. I realize no one's traveling currently, but we invite any of you to visit us and see what we do if you would like. We Look forward to our next quarterly call and we certainly will have some press releases between now and then. We always appreciate hearing from you. Many of you send material that's helpful to us and we thank you for that. But we thank you for your interest in the company and Hope you remain safe. Get your vaccinations when it becomes available. And we'll look forward to speaking with you in a quarter.

46:40 Thanks very much. And we'll end there. Thank you. And ladies and gentlemen, this concludes today's conference call. Thank you all for participating. You may now disconnect.