CPS TECHNOLOGIES CORP/DE/ - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
FORM 10-Q

(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the period ended September 26, 2020
or

[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from          to

Commission file number          0-16088

CPS TECHNOLOGIES CORPORATION

(Exact Name of Registrant as Specified in its Charter)

(508) 222-0614
Registrants Telephone Number, including Area Code:

CPS Technologies Corporation

111 South Worcester Street

Norton, MA 02766-2102

Former Name, Former Address and Former Fiscal Year if Changed since Last Report

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period than the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days.  [X] Yes   [ ]  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). [X] Yes [ ] No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [ ]   Accelerated filer [ ]   Non-accelerated filer [X]   Smaller reporting company [X] Emerging growth company[ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act):
[ ] Yes       [X] No

Securities registered pursuant to Section 12(b) of the Act:

Title of each class                         Trading Symbol(s)       Name of each exchange on which registered

Common Stock, $0.01 par value                        CPSH                           NASDAQ Capital Markets

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.  Number of shares of common stock outstanding as of October 30, 2020: 13,296,168. 

PART I  FINANCIAL INFORMATION

ITEM 1  FINANCIAL STATEMENTS (Unaudited)

CPS TECHNOLOGIES CORPORATION
Balance Sheets (Unaudited)
(continued on next page)

See accompanying notes to financial statements.

CPS TECHNOLOGIES CORPORATION
Balance Sheets (Unaudited)
(concluded)

See accompanying notes to financial statements.

CPS TECHNOLOGIES CORPORATION
Statements of Operations (Unaudited)

See accompanying notes to financial statements.

CPS TECHNOLOGIES CORPORATION
STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 26, 2020 AND SEPTEMBER 28, 2019

See accompanying notes to financial statements.

CPS TECHNOLOGIES CORPORATION
Statements of Cash Flows (Unaudited)

See accompanying notes to financial statements.

CPS TECHNOLOGIES CORPORATION
Notes to Financial Statements
(Unaudited)

(1)  Nature of Business

CPS Technologies Corporation (the “Company” or “CPS”) provides advanced material solutions to the electronics, power generation, automotive and other industries.   The Company’s primary advanced material solution is metal-matrix composites (MMC’s) which are a combination of metal and ceramic. 

CPS also assembles housings and packages for hybrid circuits. These housings and packages may include components made of metal-matrix composites or they may include components made of more traditional materials such as aluminum, copper-tungsten, etc.

The Company sells into several end markets including the wireless communications infrastructure market, high-performance microprocessor market, motor controller market, and other microelectronic and structural markets.

(2)  Summary of Significant Accounting Policies

As permitted by the rules of the Securities and Exchange Commission applicable to quarterly reports on Form 10-Q, these notes are condensed and do not contain all disclosures required by generally accepted accounting principles.

The accompanying financial statements are unaudited. In the opinion of management, the unaudited financial statements of CPS reflect all normal recurring adjustments which are necessary to present fairly the financial position and results of operations for such periods.

The Company’s balance sheet at December 28, 2019 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

For further information, refer to the financial statements and footnotes thereto included in the Registrant’s Annual Report on Form 10-K for the year ended December 28, 2019 and in CPS’s other SEC reports, which are accessible on the SEC’s website at www.sec.gov and the Company’s website at www.alsic.com.

The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.

(3)  Net Income (loss) Per Common and Common Equivalent Share

Basic net income (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period.  Diluted net income (loss)  per common share is calculated by dividing net income (loss) by the sum of the weighted average number of common shares plus additional common shares that would have been outstanding if potential dilutive common shares had been issued for granted stock options and stock purchase rights.  Common stock equivalents are excluded from the diluted calculations when a net loss is incurred as they would be anti-dilutive.

The following table presents the calculation of both basic and diluted EPS:

(4)  Commitments & Contingencies

Commitments

Leases

The Company has two real estate leases—one expiring in February 2021 and one with an 11 month duration expiring December 2020. The latter is not expected to be renewed and has not been recorded on the balance sheet in accordance with Accounting Standards Codification (ASC) 842 for leases. CPS also has a few other leases for equipment which are minor in nature and are generally short-term in duration. None of these have been capitalized.

The lease expiring in 2021 (the “Norton facility lease’) is included as a right-of-use lease asset and corresponding lease liability on the balance sheet. This asset and liability was recognized on December 30, 2018 based on the present value of remaining lease payments over the remaining lease term using the Company’s incremental borrowing rate at date of adoption. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.

Operating Leases

Lease expense for operating leases is recognized on a straight-line basis over the lease term. Lease expense is allocated between Cost of Product Sales and Selling, General and Administrative Expense in the income statement

The following table presents information about the amount, timing and uncertainty of cash flows arising from the Company’s capitalized operating leases as of September 26, 2020

Cash Flows

An initial right-of-use asset of $310 thousand was recognized as a non-cash asset addition with the adoption of the new lease accounting standard on December 30, 2018. Cash paid for the amounts included in the present value of operating lease liabilities was $114 thousand during the first nine months of 2020 and is included in operating cash flows.

Operating Lease Costs

Operating lease cost was $114 thousand during the first nine months of 2020. This cost is related to its long-term operating lease. All other short-term leases were immaterial.

(5)  Share-Based Payments

The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. That cost is recognized over the period during which an employee is required to provide services in exchange for the award, the requisite service period (usually the vesting period). The Company provides an estimate of forfeitures at initial grant date. Reductions in compensation expense associated with the forfeited options are estimated at the date of grant, and this estimated forfeiture rate is adjusted periodically based on actual forfeiture experience. The company uses the Black-Scholes option pricing model to determine the fair value of the stock options granted.

There were no stock options granted or issued under the Plan during the quarters ended September 26, 2020 and September 28, 2019.

During the quarter ended September 26, 2020, 288,250 options were exercised at a weighted average price of $1.53, and 261,355 options expired at a weighted average price of $1.53.  Also, during the quarter 500 shares were gifted to an employee for completing 20 years of service to the company. During the quarter ended September 28, 2019, 24,000 options were forfeited and 16,000 options expired.

During the quarter ended September 26, 2020 the Company repurchased 200,018 shares for employees to facilitate their exercise of stock options. During the quarter ended September 28, 2019 there were no shares repurchased.

During the three and nine months ended September 26, 2020 the Company recognized approximately $17 thousand and $100 thousand, respectively as share-based compensation expense related to share and option grants. These amounts are included as a component of selling, general and administrative expenses in the statement of operations.

During the three and nine months ended September 28, 2019 the Company recognized approximately $28 thousand and $113 thousand, respectively as share-based compensation expense related to share and option grants. These amounts are included as a component of selling, general and administrative expenses in the statement of operations.

As of September 26, 2020, there was $163 thousand of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan; that cost is expected to be recognized over a weighted average period of 1.79 years. There were also 1,286,500 shares outstanding at a weighted average price of $1.81 with a weighted average remaining term of 5.35 years, and there were 1,022,400 shares exercisable at a weighted average price of $1.88 with a weighted average remaining term of 4.66 years. The Plan, as amended, is authorized to issue 3,000,000 shares of common stock. As of September 26, 2020, there were 1,392,350 shares available for future grants

(6)  Inventories

Inventories consist of the following:

(7)  Accrued Expenses

Accrued expenses consist of the following:

(8)  Line of Credit 

In September 2019, the Company entered into revolving line of credit with The Massachusetts Business Development Corporation (BDC) in the amount of $2.5 million.  In May of 2020 this credit line was increased to $3.0 million.  The agreement includes a demand note allowing the Lender to call the loan at any time.  CPS may terminate the agreement without a termination fee after 3 years.  The LOC is secured by the accounts receivable and other assets of the Company and has an interest rate of LIBOR plus 650 basis points. At September 26, 2020 the Company had $835 thousand of borrowings under this LOC and its borrowing base at the time would have permitted an additional $1.835 million to have been borrowed. 

The line of credit is subject to certain financial covenants.

(9)        Note Payable 

In March 2020, the company acquired a Sonoscan ultrasound microscope for a price of $208 thousand.  The full amount was financed through a 5 year note payable with Crest Capital Corporation.  The note is collateralized by the microscope and is being paid in monthly installments of $4 thousand, consisting of principal plus interest at a rate of 6.47%.

In July 2020 CPS placed into service a piece of manufacturing equipment which it financed with the machine’s vendor.  The equipment cost of $40 thousand will be paid at the rate of $2 thousand per month over 2 years, resulting in an implied interest rate of 1.90%. 

The Company’s obligations including interest at September 26, 2020 consist of the following:

(10)  Income Taxes

A valuation allowance against deferred tax assets is required to be established or maintained when it is "more likely than not" that all or a portion of deferred tax assets will not be realized. In December 2018, the Company established a valuation allowance reserve, as it is judged more likely than not that all or a portion of its deferred tax assets will not be utilized before they expire. This decision was reached after giving greater weight to the Company’s losses in recent years as compared to its forecasts.

No provision for income taxes was provided during the quarter and nine months ended September 26, 2020, as the Company continues to maintain a full valuation allowance against the majority of its deferred tax assets and no current tax is forecasted for the year.

ITEM 2       MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of financial condition and results of operations is based upon and should be read in conjunction with the financial statements of the Company and notes thereto included in this report and the Company’s Annual Report on Form 10-K for the year ended December 28, 2019.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements that involve a number of risks and uncertainties. There are a number of factors that could cause the Company’s actual results to differ materially from those forecasted or projected in such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof.  The Company undertakes no obligation to publicly release the results of any revisions to these forward-looking statements which may be made to reflect events or changed circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Critical Accounting Policies

The critical accounting policies utilized by the Company in preparation of the accompanying financial statements are set forth in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 28, 2019, under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.  There have been no material changes to these policies since December 28, 2019.

Overview

Products we provide include baseplates for motor controllers used in high-speed electric trains, subway cars, wind turbines, and hybrid and electric vehicles.  We provide baseplates and housings used in radar, satellite and avionics applications.  We provide lids and heat spreaders used with high performance integrated circuits for use in internet switches and routers.   We provide baseplates and housings used in modules built with Wide Band Gap Semiconductors like SiC and GaN. CPS also assembles housings and packages for hybrid circuits. These housings and packages may include MMC components; they may include components made of more traditional materials such as aluminum, copper-tungsten, etc.

CPS’s products are custom rather than catalog items. They are made to customers’ designs and are used as components in systems built and sold by our customers. At any point in time our product mix will consist of some products with on-going production demand, and some products which are in the prototyping or evaluation stages at our customers. The Company seeks to have a portfolio of products which include products in every stage of the technology adoption lifecycle at our customers. CPS’ growth is dependent upon the level of demand for those products already in production, as well as its success in achieving new "design wins" for future products.

The manufacturing process for MMCs (infusing ceramic materials with molten metals) is complicated and results in varying yields, which poses challenges to profitability for less developed manufacturers.

As a manufacturer of highly technical and custom products, the Company incurs fixed costs needed to support the business, but which do not vary significantly with changes in sales volume. These costs include the fixed costs of applications engineering, tooling design and fabrication, process engineering, etc. Accordingly, particularly given our current size, changes in sales volume generally result in even greater changes in financial performance on a percentage basis as fixed costs are spread over a larger or smaller base. Sales volume is therefore a key financial metric used by management.

The Company believes the underlying demand for metal matrix composites is growing as the electronics and other industries seek higher performance, higher reliability, and reduced costs. CPS believes that the Company is well positioned to offer our solutions to current and new customers as these demands grow.

Our products are manufactured by proprietary processes we have developed including the QuicksetTM Injection Molding Process (‘Quickset Process’) and the QuickCastTM Pressure Infiltration Process (‘QuickCast Process’).

CPS was incorporated in Massachusetts in 1984 as Ceramics Process Systems Corporation and reincorporated in Delaware in April 1987 through a merger into a wholly-owned Delaware subsidiary organized for purposes of the reincorporation. In July 1987, CPS completed our initial public offering of 1.5 million shares of our Common Stock. In March 2007, we changed our name from Ceramics Process Systems Corporation to CPS Technologies Corporation.

COVID-19 Pandemic

 As a provider of “essential services”, CPS continues to be open and operating during the novel coronavirus pandemic. To date most of our customers remain open and operational. In Q3 we saw a significant increased volatility on the part of some of our customers, while for others it has been business as usual. We expect that this volatility will continue for at least the next several quarters. Unexpected reductions in demand on the part of two of our major customers led to a reduction in third quarter revenue. As these reductions were unexpected, by both CPS and our customers, inventory built to meet expected Q3 demand remains in inventory. We expect this inventory will be reduced over time, but will probably remain somewhat inflated over the next quarter or two.

CPS continues to follow CDC and OSHA guidance in our workplace. Employees’ temperatures are taken at the beginning of each shift, shift have been staggered to reduce employee overlap, workstations have been rearranged to ensure social distancing, all employees are using facemasks, et. The pandemic has had very little impact on our ability to produce and ship customer orders.

Results of Operations for the Third Fiscal Quarter of 2020 (Q3 2020) Compared to the Third Fiscal Quarter of 2019 (Q3 2019); (all $ in 000s)

Total revenue was $4,452 in Q3 2020, a 1% increase compared with total revenue of $4,387 in Q3 2019. This increase was due primarily to price increases of 6% offset by a reduction in sales volume of 5%. These price changes were implemented in Q4 2019 and Q1 2020.  In addition, the company was able to offset a $120 thousand reserve, increasing revenue, set up for potential quality issues at one customer.  This was a negotiated settlement against that customer’s reduction in purchases below the amount of their contractual obligation.

Gross margin in Q3 2020 totaled $938 or 21% of sales.  In Q3 2019, gross margin was $223 or 5% of sales.   This increase in margin was due to product mix, the aforementioned price increases, and increased operating efficiencies.

Selling, general and administrative expenses (SG&A) were $684 in Q3 2020, down 3% when compared with SG&A expenses of $702 in Q3 2019.  This decrease was primarily due to reduced travel as a result of the Covid-19 pandemic.

In Q3, 2020, the Company incurred interest expense of $21 due primarily to bank borrowings.  This compares with interest expense of $17 in Q3 of 2019.

The Company generated operating income of $253 compared with an operating loss of $479 in the same quarter last year. This increase in operating income is due primarily to the increase in pricing, discussed above. The net income for Q3 2020 totaled $231 versus a net loss of $496 in Q3 2019.

Results of Operations for the First Nine Months of 2020 Compared to the First Nine Months of 2019 (all $ in 000s)

Total revenue was $16,722 in the first nine months of 2020, a 4% increase compared with total revenue of $16,024 in the first nine months of 2019. This increase was due primarily to a 10% increase in pricing during the first nine months of 2020 compared with the first nine months of 2019.

Gross margin in the first nine months of 2020 totaled $3,671 or 22% of sales.  In the first nine months of 2019 gross margin totaled $1,557 or 10% of sales.  This increase was due to price increases, a change in product mix and increased operating efficiencies. 

Selling, general and administrative (SG&A) expenses were $2,466 during the first nine months of 2020, down 2% compared with SG&A expenses of $2,523 in the first nine months of 2019.  This small decrease was primarily due to reduced travel as a result of the Covid-19 pandemic.

During the first nine months of 2020, the Company incurred interest expense of $87 due primarily to bank borrowings.  This compares with interest expense of $24 incurred during the first nine months of 2019.

In the first nine months of 2020 the Company generated operating income of $1,205 compared with an operating loss of $966 in the same period last year.  The net income for the first nine months of 2020 totaled $1,132 versus a net loss of $990 in the first nine months of 2019. 

Liquidity and Capital Resources (all $ in 000s unless noted)

The Company’s cash and cash equivalents at September 26, 2020 totaled $113.  The Company’s net cash, which considers the $835 of bank borrowings, totaled a negative $722 at the end of the third quarter. This compares to cash and cash equivalents at December 28, 2019 of $134 and a net cash of negative $1,116. The increase in net cash was due to the income from operations offset by an increase in working capital.

Accounts receivable at September 26, 2020 totaled $3,962 compared with $4,087 at December 28, 2019.

Days Sales Outstanding (DSO) increased from 67 days at the end of 2019 to 80 days at the end of Q3 2020.  DSO’s at the end of 2019 were due to low sales during Q4 2019 to our European customers having extended payment terms compared to higher sales in Q3 2020. The accounts receivable balances at December 28, 2019, and September 26, 2020 were both net of an allowance for doubtful accounts of $10.

Inventories totaled $4,187 at September 26, 2020 compared with inventory totaling $3,100 at December 28, 2019. This increase was a result of an inventory build up due to expected increase in customer sales volume in Q3. Unexpectedly reduced demand by their customers caused them to reduce their buying from CPS.  The inventory turnover in the most recent four quarters ending Q3 2020 was 4.9 times, down from 6.2 times averaged during the four quarters of 2019 (based on a 5 point average).

The Company financed its working capital during the first nine months of 2020 from a combination of its net profit during the period and bank borrowings.  The Company expects it will continue to be able to fund its working capital requirements for the remainder of 2020 from existing cash balances and bank borrowings.

The Company continues to sell to a limited number of customers and the loss of any one of these customers could cause the Company to require additional external financing. Failure to generate sufficient revenues, raise additional capital or reduce certain discretionary spending could have a material adverse effect on the Company’s ability to achieve its business objectives.

Contractual Obligations

In September 2019, the Company entered into revolving line of credit (LOC) with Massachusetts Business Development Corporation (BDC) in the amount of $2.5 million.  This agreement was amended in May 2020 to increase the line to $3.0 million.  The agreement includes a demand note allowing the Lender to call the loan at any time.  The Company may terminate the agreement without a termination fee after 3 years.  The LOC is secured by the accounts receivable and other assets of the Company and has an interest rate of LIBOR plus 650 basis points.  At September 26, 2020 the Company had $835 thousand of borrowings under this LOC and its borrowing base at the time would have permitted an additional $1.835 million to have been borrowed.  The increased availability has allowed the Company to end its policy of allowing prompt pay discounts to certain customers. This has and should continue to have a positive effect on the Company’s earnings going forward.

In March 2020, the company acquired an ultrasound microscope for a price of $208.  The full amount was financed through a 5 year note payable with a financing company.  The note is collateralized by the microscope and is being paid in monthly installments of $4, consisting of principal plus interest at a rate of 6.47%

In July 2020 CPS placed into service a piece of manufacturing equipment which it financed through a capital lease with the machine’s vendor.  The original lease amount was $40 thousand and will be paid at the rate of $2 thousand per month over 2 years with an interest rate of 1.9%. 

As of September 26, 2020, the Company had $127 of construction in progress and no outstanding commitments to purchase production equipment.

The Company has two real estate leases—one expiring in February 2021 and one expiring December 31, 2020. Since the latter is not expected to be renewed, it has not been recorded on the balance sheet. CPS also has a few other leases for equipment which are minor in nature and are generally short-term in duration. None of these have been capitalized. (Note 4, Leases)

Management believes that a combination of existing cash balances and borrowings, if necessary, will be sufficient to fund our cash requirements for the foreseeable future. However, there is no assurance that we will be able to generate sufficient revenues or reduce certain discretionary spending in the event that planned operational goals are not met such that we will be able to meet our obligations as they become due.

ITEM 3             QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is not significantly exposed to the impact of interest rate changes or foreign currency fluctuations.  The Company has not used derivative financial instruments.

ITEM 4             CONTROLS AND PROCEDURES

(a)        The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d - 14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Form 10-Q (the “Evaluation Date”).  Based on such evaluation, such officers have concluded that, as of the Evaluation Date,  1) the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports the Company files under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and 2) the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure.

(b)        Changes in Internal Controls. There has been no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

PART II OTHER INFORMATION

ITEM 1             LEGAL PROCEEDINGS
            None.

ITEM 1A           RISK FACTORS
            There have been no material changes to the risk factors as discussed in our 2019 Form 10-K

ITEM 2             UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
            None.

ITEM 3             DEFAULTS UPON SENIOR SECURITIES
            None.

ITEM 4             MINE SAFETY DISCLOSURES
            Not applicable.

ITEM 5             OTHER INFORMATION
            Not applicable.

ITEM 6             EXHIBITS
(a)        Exhibits:

Exhibit 31.1 Certification of Chief Executive Officer Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 302 of The Sarbanes-Oxley Act Of 2002

Exhibit 31.2 Certification of Chief Financial Officer Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 302 of The Sarbanes-Oxley Act Of 2002

Exhibit 32.1 Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act of 2002

(b)        Reports on Form 8-K

            None

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

CPS TECHNOLOGIES CORPORATION
(Registrant)

Date:    November 10, 2020
/s/        Grant C. Bennett
Grant C. Bennett
Chief Executive Officer

Date:    November 10, 2020

/s/        Charles K. Griffith Jr.

Charles K. Griffith Jr.