CPS TECHNOLOGIES CORP/DE/ - Quarter Report: 2022 October (Form 10-Q)

PART I FINANCIAL INFORMATION

ITEM 1 FINANCIAL STATEMENTS (Unaudited)

CPS TECHNOLOGIES CORP.
Balance Sheets (Unaudited)
(continued on next page)

See accompanying notes to financial statements.

CPS TECHNOLOGIES CORP.
Balance Sheets (Unaudited)
(concluded)

See accompanying notes to financial statements.

CPS TECHNOLOGIES CORP.
Statements of Operations (Unaudited)

See accompanying notes to financial statements.

CPS TECHNOLOGIES CORP.
STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED October 1, 2022 AND SEPTEMBER 25, 2021

See accompanying notes to financial statements.

CPS TECHNOLOGIES CORP.
Statements of Cash Flows (Unaudited)

See accompanying notes to financial statements.

CPS TECHNOLOGIES CORP.
Notes to Financial Statements
(Unaudited)

(1)          Nature of Business

CPS Technologies Corp. (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.

Using its proprietary MMC technology, the Company also produces light-weight armor, particularly for extreme environments and heavy ballistic threat levels.

The Company sells into several end markets including the aerospace & defense markets, wireless communications infrastructure market, high-performance microprocessor market, motor controller market, and other microelectronic 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 25, 2021 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 25, 2021 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.cpstechnologysolutions.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 one real estate lease expiring in February 2026. CPS also has a few other leases for equipment which are minor in nature and are generally short-term in duration. None of these equipment leases have been capitalized as the Company elected an accounting policy for short-term leases, which allows lessees to avoid recognizing right-of-use assets and liabilities for leases with terms of 12 months or fewer.

The real estate lease expiring in 2026 (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 based on the present value of lease payments over the lease term using the Company’s incremental borrowing rate at commencement date. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.

Operating Leases

The Norton facility lease comprises approximately 38 thousand square feet. The lease is triple net lease wherein the Company is responsible for payment of all real estate taxes, operating costs and utilities. The Company also has an option to renew the lease starting in March 2026 through February 2032. Annual rental payments range from $152 thousand to $165 thousand through maturity.

The following table presents information about the amount, timing and uncertainty of cash flows arising from the Company’s capitalized operating leases as of October 1, 2022

Operating Lease Costs and Cash Flows

Operating lease cost and cash paid was $41 thousand during the third quarter of 2022 and $120 thousand for the nine months ended October 1, 2022. These costs are related to its long-term operating lease. All other short-term leases were immaterial.

Finance Leases

The company does not have any finance leases.

(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.

During the quarter ended October 1, 2022 there were 25,000 stock options granted under the Plan. There were 5,000 stock options granted under the Plan during quarter ended September 25, 2021.

During the quarter ended October 1, 2022, no options were exercised. During the quarter ended October 1, 2022, 10,000 options were forfeited and none expired. During the quarter ended September 25, 2021, 500 options were exercised at a weighted average price of $1.49, 32,500 options were forfeited and none expired.

During the quarter ended October 1, 2022, the Company did not repurchase any shares for employees to facilitate their exercise of stock options. During the quarter ended September 25, 2021 the Company repurchased 112 shares for employees to facilitate their exercise of stock options.

There were also 983,100 shares outstanding at a weighted average price of $2.44 with a weighted average remaining term of 6.3 years as of October 1, 2022, and there were 518,800 shares exercisable at a weighted average price of $2.03 with a weighted average remaining term of 4.3 years as of October 1, 2022. The Plan, as amended, is authorized to issue 1,500,000 shares of common stock. As of October 1, 2022, there were 915,800 shares available for future grants.

During the three and nine months ended October 1, 2022 the Company recognized approximately $43 thousand and $207 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 25, 2021 the Company recognized approximately $28 thousand and $148 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.

(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 a revolving line of credit (LOC) with Massachusetts Business Development Corporation (BDC) in the amount of $2.5 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. In May of 2020 this credit line was increased to $3.0 million. The LOC is secured by the accounts receivable and other assets of the Company and had an interest rate of LIBOR plus 650 basis points. In May of 2021 the interest rate was reduced to LIBOR plus 550 basis points. On October 1, 2022, the Company had $0 of borrowings under this LOC and its borrowing base at the time would have permitted an additional $3.0 million to have been borrowed.

The line of credit is subject to certain financial covenants, all of which have been met or waived.

(9)   Note Payable         

In March 2020, the company acquired inspection equipment for a price of $208 thousand. The full amount was financed through a 5 year note payable with a third party equipment finance company. The note is collateralized by the equipment 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 was paid in full during the quarter ended October 1, 2022.

The aggregate maturities of the notes payable based on the payment terms of the agreement are as follows: 

Total interest expense on notes payable during 2022 was $6,243.

(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.

In September 2021, this decision was reevaluated in light of the Company’s recent profitability and its forecasts for future profitability. The Company concluded that it is “more likely than not” that the Company will be able to fully utilize the deferred tax asset. This reversal of the valuation allowance was made net of the expected tax liability for 2021 in the amount of $2,790,201. For the third quarter of 2022 a charge against the tax asset of $364,497 for the estimated tax liability on Q3 income was made. For the 9 months ended October 1, 2022, a charge against the tax asset of $705,755 was made for the estimated tax liability on year-to-date income.  The Company has calculated its tax liability using a 21% rate for federal taxes and an 8.6% rate for state taxes.

(11)   Other Taxes

In Q3 the Company determined that it was eligible for the Employee Retention Tax Credit (“ERTC”). This amount was determined to be $641,086 and is included in Accounts Receivable and Other Income. The Company has filed its tax returns to reflect this income and has included its impact in the Q3 tax calculation.

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 25, 2021.

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 25, 2021, 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 25, 2021.

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 Silicon Carbide (“SiC”) and Gallium Nitride (“GaN”), collectively Metal Matrix Composites (“MMC”). 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, cold rolled steel and Kovar. Using its proprietary MMC technology, the Company also produces lightweight armor, particularly for extreme environments and heavy threat levels. 

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.

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 such as engineering, tooling design and fabrication, process engineering, and others. 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 MMC, housings for hybrid circuits and our proprietary armor solution 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. 

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 Corp.

Results of Operations for the Third Fiscal Quarter of 2022 (Q3 2022) Compared to the Third Fiscal Quarter of 2021 (Q3 2021); (all $ in 000s)

Total revenue was $6,748 in Q3 2022, a 22% increase compared with total revenue of $5,515 in Q3 2021. This increase was due primarily to increases in the Company’s armor production as well as increases in sales to other customers in the aerospace and defense markets.

Gross margin in Q3 2022 totaled $1,883 or 28% of sales. In Q3 2021, gross margin was $1,139 or 21% of sales. This increase in margin directly correlates to the increased revenue and the impact increased revenue has on fixed manufacturing costs.

Selling, general and administrative expenses (SG&A) were $1,175 in Q3 2022, down 4% when compared with SG&A expenses of $1,227 in Q3 2021. This decrease was primarily due to non-recurring restructuring costs of $327 incurred in 2021, partially offset by an increase in variable compensation in 2022 incurred as a result of the Company’s increased revenue.

In Q3, 2022, the Company incurred interest expense of $2 due to equipment financing. This compares with interest expense of $3 in Q3 of 2021.

The Company generated operating income of $709 compared with an operating loss of $88 in the same quarter last year. This increase in operating income is due to the non-recurring restructuring costs, discussed above, as well as the impact of higher revenue on the absorption of fixed costs. The net income for Q3 2022 totaled $988 versus net income of $2,728 in Q3 2021. This differential in net income is due to the reversal of the deferred tax asset valuation allowance in Q3 2021, discussed in footnote 10 above, partially offset by the ERTC in 2022, discussed in footnote 11 above.  The pre-tax net in 2021 loss was $72.

Results of Operations for the First Nine Months of 2022 Compared to the First Nine Months of 2021 (all $ in 000s)

Total revenue was $20,472 in the first nine months of 2022, a 26% increase compared with total revenue of $16,243 in the first nine months of 2021. This increase was due to the growth of our armor and hermetic package product lines.

Gross margin in the first nine months of 2022 totaled $5,675 or 28% of sales. In the first nine months of 2021 gross margin totaled $3,435 or 21% of sales. This increase was due to higher sales volumes and the impact those higher volumes have on our fixed costs.

Selling, general and administrative (SG&A) expenses were $3,750 during the first nine months of 2022, up 16% compared with SG&A expenses of $3,234 in the first nine months of 2021. The hiring of our new CDO, increased variable compensation accruals due to higher 2022 operating profitability and increased costs associated commissions on armor product shipments were the primary reasons for this increase. 

During the first nine months of 2022, the Company incurred interest expense of $6 on its notes payable. This compares with interest expense of $33 incurred during the first nine months of 2021 which included the notes payable as well as bank borrowings in Q1 and Q2 of 2021.

In the first nine months of 2022 the Company generated operating income of $1,925 compared with operating income of $201 in the same period last year. Similar to revenue, the difference between the first quarter of 2022 compared to the Covid impacted first quarter of 2021, plus the non-recurring restructuring costs account for this difference. The net income for the first nine months of 2022 totaled $1,862 versus net income of $2,998 in the first nine months of 2021. This difference is due to the tax impact on Q3 2021 described in note 10 above offset by the ERTC in 2022 described in note 11 above.

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

The Company’s cash and cash equivalents at October 1, 2022 totaled $5,599. This compares to cash and cash equivalents at December 25, 2021 of $5,050. The increase in cash was primarily due to our net profit, offset by increased accounts receivable and inventory to support higher sales.

Accounts receivable at October 1, 2022 totaled $5,836 compared with $4,870 at December 25, 2021. The Q3 2022 total includes $641 receivable for the ERTC.

Days Sales Outstanding (DSO) decreased from 72 days at the end of 2021 to 69 days at the end of Q3 2022, based on trade receivables. This decrease was due to deferred revenue included in accounts receivable at the end of 2021 not yet reflected in revenue. The accounts receivable balances at December 25, 2021, and October 1, 202 were both net of an allowance for doubtful accounts of $10.

Inventories totaled $4,869 at October 1, 2022 compared with inventory totaling $3,912 at December 25, 2021. The increase in inventory was necessary to support rising sales and due to product mix, as some products are more labor intensive, while others are more materials intensive. The inventory turnover in the most recent four quarters ending Q3 2022 was 4.5 times, slightly down from 4.6 times averaged during the four quarters of 2021 (based on a 5 point average).

The Company financed its working capital during the first nine months of 2022 from its net profit during the period. The Company expects it will continue to be able to fund its working capital requirements for the remainder of 2022 from existing cash balances.

Although the Company’s customer base is expanding, 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 550 basis points. The Company was in compliance with all debt covenants as of October 1, 2022, had $0 borrowings under this LOC and its borrowing base at the time would have permitted $3.0 million to have been borrowed.

In March 2020, the company acquired a scanning acoustic microscope for a price of $208 thousand. 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 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 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 October 1, 2022, the Company had $46 of construction in progress and no outstanding commitments to purchase production equipment.

The Company has one real estate lease expiring in February 2026. 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 2020 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

101.INS Inline XBRL Instance Document

101.SCH Inline XBRL Taxonomy Extension Schema Document

101.CAL Inline XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF Inline XBRL Taxonomy Extension Definition Linkbase Document

101.LAB Inline XBRL Taxonomy Extension Label Linkbase Document

101.PRE Inline XBRL Taxonomy Extension Presentation Linkbase Document

104 Cover Page Interactive Data File (embedded within the Inline XBRL and contained in Exhibit 101)

(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 CORP.
(Registrant)

Michael E. McCormack
Chief Executive Officer

Charles K. Griffith Jr.

Chief Financial Officer