Item 2. Management’s Discussion and Analysis
of Financial Condition
and Results of
Operations
.
Except for historical information contained herein, this “Management’s Discussion and Analysis o
f
Financial Condition and Results of
Opera
tion
s
” contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, as amended. These statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. These forward-looking statements were based on various factors and were derived utilizing numerous important assumptions and other important factors that could cause actual results to differ materially from those in the forward-looking statements. Important assumptions and other factors that could cause actual results to differ materially from those in the forward-looking statements, include but are not limited to: competition in the Company’s existing and potential future product lines of business; the Company’s ability to obtain financing on acceptable terms if and when needed; uncertainty as to the Company’s future profitability, uncertainty as to the future profitability of acquired businesses or product lines, uncertainty as to any future expansion of the Company. Other factors and assumptions not identified above were also involved in the derivation of these forward-looking statements and the failure of such assumptions to be realized as well as other factors may also cause actual results to differ materially from those projected. The Company assumes no obligation to update these forward looking statements to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements.
Past results are no guaranty of future performance.
You should not place undue reliance on any forward-looking statements, which speak only as of the dates they are made. When used in this Report, the words “believes,” “anticipates,” “expects,” “estimates,” “plans,” “intends,” “will” and similar expressions are intended to identify forward-looking statements.
The accompanying notes are an integral part of these consolidated financial statements
Results of Operations
Three Months Ended
March 31,
2019
vs. Three Months Ended
March 31,
2018
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2019
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2018
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Revenue
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$
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3,468,675
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$
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9,153,833
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Cost of revenue
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3,856,417
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5,392,919
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Gross profit
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(387,742
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)
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3,760,914
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Operating expenses
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Research and development
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164,080
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96,806
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Selling and shipping
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277,306
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513,475
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General and administrative
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1,735,974
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2,240,065
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Total operating expenses
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2,177,360
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2,850,346
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Operating (loss) income
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(2,565,102
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)
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910,568
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Other income (expense):
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Interest income
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46,806
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16,960
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Interest expense
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(114,651
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)
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(121,354
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)
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Total other expense, net
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(67,845
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)
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(104,394
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)
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(Loss) income before income tax
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(2,632,947
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)
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806,174
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Income tax (benefit) expense
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(456,000
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)
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247,770
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Net (loss) income
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$
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(2,176,947
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)
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$
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558,404
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Basic income (loss) per common share
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$
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(0.33
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)
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$
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0.09
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Diluted income (loss) per common share
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$
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(0.33
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)
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$
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0.09
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Weighted average common shares Outstanding-basic
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6,539,120
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6,467,252
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Weighted average common shares Outstanding-diluted
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6,539,120
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6,477,699
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The accompanying notes are an integral part of these consolidated financial statements
Revenue
Our revenue for the three months ended March 31, 2019 was $3.5 million compared to $9.2 million for the three months ended March 31, 2018, resulting in a decrease of 62.1% which was primarily attributable to the completion of orders received from our largest customer. This customer, in the aerospace industry from which we have secured multiple orders, represented $.8 million or approximately 22.2% of our revenue for the three months ended March 31, 2019 as compared to $4.4 million or approximately 47.5% of our revenue for the three months ended March 31, 2018.
The revenue contributed for the three months ended March 31, 2019, by the CVD Equipment segment, of $2.0 million, which totaled 58.2% of our overall revenue, was 69.9% or $4.7 million less than the segment’s $6.7 million contribution made in the prior year, which totaled 73.2% of our overall revenue.
Revenue for our SDC segment decreased to $1.1 million in 2019 as compared to $2.1 million in 2018, a decrease of 47.7%. The decrease is primarily attributable to a higher sales activity level from one customer in the prior year. The SDC segment represented 31.3% and 22.8% of our total revenue during the three months ended March 31, 2019 and 2018, respectively.
Revenues for our CVD Materials segment were $.4 million in the three months ended March 31, 2019 as compared to $.4 million for 2018.
Gross Profit
Gross profit for the three months ended March 31, 2019 amounted to ($.4 million), with a gross profit margin of (11.2%,) compared to a gross profit of $3.8 million and a gross profit margin of 41.1% for the three months ended March 31, 2018. The decreased gross profit and gross profit margin were the result of the reduction in sales from our largest customer and delays in receiving new orders, while costs, principally payroll, remained at levels to support our anticipated expansion of the CVD Materials segment and future growth.
Research and
D
evelopment,
S
elling
and
G
eneral and
A
dministrative
E
xpenses
Research and Development:
Due to the technical development required on our custom orders, our research and development team and their expenses are charged to costs of goods sold when they are working directly on a customer project. When they are not working on a customer project, they work in our Application Laboratory and their costs are charged to research and development. For the three months ended March 31, 2019, our research and development expenses totaled $164,000 compared to $97,000 for the three months ended March 31, 2018.
The accompanying notes are an integral part of these consolidated financial statements
Selling:
Selling expenses were $.3 million or 8.0 % of the revenue for the three months ended March 31, 2019 as compared to $.5 million or 5.6% for the three months ended March 31, 2018. The decrease was a result of lower employee related costs and commissions as a result of the reduction in overall sales.
General and Administrative:
General and administrative expenses for the three months ended March 31, 2019 were $1.7 million or 50.0% of revenue compared to $2.2 million or 24.5% for the three months ended March 31, 2018, a decrease of $.5 million. The decrease is primarily the result of reductions in employees and the related payroll and benefit costs.
Operating
Income
/(Loss)
As a result of the decreased revenues and gross margins, we recorded an operating loss of $2.6 million for the three months ended March 31, 2019 as compared to operating income of $.9 million for the three months ended March 31, 2018, which was driven primarily by the reduced revenue from our largest customer.
Other (expenses)/Income
Other expenses were $68,000 and $104,000 for the three months ended March 31, 2019 and 2018, respectively. This reduction is the result of actions taken to invest significantly more of the Company’s free cash into short-term treasury bills and certificates of deposits and thereby generating increased interest income of $30,000.
Income Taxes
For the three months ended March 31, 2019, we recorded an income tax benefit of $456,000 as compared to an income tax expense of $248,000 for the three months ended March 31, 2018. Commencing in 2018, our corporate tax rate was reduced to 21% as a result of The Tax Cuts and Jobs Act (“TCJA”) enacted December 22, 2017. For the three months ended March 31, 2019 and 2018, this rate was affected by permanent differences related to fixed and intangible assets, stock-based compensation and other items resulting in an effective tax rate of 17.3% and 30.7%, respectively.
Net (loss) / income
As a result of the foregoing factors, we reported net (loss) income of ($2.2 million), or ($0.33) per basic and diluted share, for the three months ended March 31, 2019, as compared to net income of $0.6 million, or $0.09 per basic and diluted share for the three months ended March 31, 2018.
The accompanying notes are an integral part of these consolidated financial statements
Liquidity and Capital Resources
As of March 31, 2019, we had aggregate working capital of $12.6 million compared to aggregate working capital of $15.4 million at December 31, 2018. Our cash and cash equivalents of at March 31, 2019 and December 31, 2018 were $11.3 million and $11.4 million, respectively. The decrease in working capital of $2.8 million is primarily attributable to the overall sales reductions and resulting operating loss for the year and debt service payments of approximately $.3 million, including payments on our investment in the CVD Materials building purchased on November 30, 2017. We have continued to invest in activities primarily related to preparing CVD Materials for operations which we anticipate will commence by the third quarter of 2019. Our total capital invested in the three months ended March 31, 2019 was $.4 million, primarily related to building improvements and machinery for the CVD Materials operations and we also incurred operating costs of approximately $84,000, exclusive of interest expense. Further, there were decreases in accounts receivable of $2.0 million and contract assets of $.3 million,
Accounts receivable, net of allowance for doubtful accounts, decreased by $2 million or 48.3% at March 31, 2019, to $2.1 million compared to $4.1 million at December 31, 2018. This decrease is principally due to the timing of shipments and customer payments.
Inventories as of March 31, 2019 were approximately $1.8 million representing a decrease of approximately $.1 million or a decrease of 6.2% compared to the balance of approximately $1.9 million as of December 31, 2018. The decrease was driven primarily by management’s efforts to better utilize existing inventories.
As previously reported, our Revolving Line of Credit expired on September 1, 2018. We have elected not to renew our credit line at this time because (a) renewal terms were not acceptable to us, (b) we have not borrowed on our line of credit in the past 10 years, and (c) we have sufficient cash and cash equivalents to meet our working capital and capital expenditure requirements over the next twelve months.
We have a loan agreement with HSBC which is secured by a mortgage on our Central Islip headquarters at 355 South Technology Drive. The loan is payable in 120 consecutive equal monthly installments of $25,000 in principal plus interest and a final balloon payment upon maturity in March 2022. The balances as of March 31, 2019 and December 31, 2018 were approximately $2.6 million and $2.7 million respectively. Interest accrues on the Loan, at our option, at the variable rate of LIBOR plus 1.75% or Prime less 0.5%.
On November 30, 2017, we purchased the premises located at 555 North Research Place, Central Islip, NY which is intended to house the CVD Materials segment. The purchase price of the land and the building was $13,850,000 exclusive of closing costs.
As part of the acquisition, our newly formed wholly-owned subsidiary, 555 N Research Corporation (the” Assignee”) and the Islip IDA, entered into a Fee and Leasehold Mortgage and Security Agreement (the ”Loan”) with HSBC USA, N.A. (the ”Bank”) in the amount of $10,387,500, which was used to finance a portion of the purchase price to acquire the premises located at 555 North Research Place, Central Islip, New York (the ”Premises”). The Loan was evidenced by the certain Note, dated November 30, 2017 (the ”Note”), by and between Assignee and the Bank, and secured by a certain Fee and Leasehold Mortgage and Security Agreement, dated November 30, 2017 (the “Mortgage”), as well as a collateral Assignment of Leases and Rents (“Assignment of Leases”).
The accompanying notes are an integral part of these consolidated financial statements
The Loan is payable in 60 consecutive equal monthly installments of $62,481, including interest. The balances as of March 31, 2019 and December 31, 2018 were approximately $9.9 million and $10.0 million respectively. The Loan shall bear interest for each Interest Period (as defined in the Note), at the fixed rate of 3.9148%. The maturity date for the Note is December 1, 2022. As a condition of the Bank making the Loan, we were required to guaranty Assignee’s obligations under the Loan.
At December 31, 2018, we were not in compliance with the single financial covenant (fixed charge coverage ratio) contained in the Mortgage. On March 26, 2019 the Company received a waiver from HSBC until April 1, 2020.
At December 31, 2018 we have reduced our employee headcount by 15% to 197 as compared to December 31, 2017. At March 31, 2019 we have 193 employees and we are continuing to evaluate our staffing levels to support the CVD Materials new building and related operations commencing by the third quarter of 2019, and the level of current and expected orders. We believe that our cash and cash equivalent positions and cash flow from operations will be sufficient to meet our working capital and capital expenditure requirements for the next twelve months.
The accompanying notes are an integral part of these consolidated financial statements
Off-Balance Sheet Arrangements.
We have no off-balance sheet arrangements at this time.
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Item 4
.
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Controls and Procedures
.
|
Evaluation of Disclosure
C
ontrols and Procedure
s
We maintain a system of disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). As required by Rule 13a-15(b) under the Exchange Act, management of the Company, under the direction of our Chief Executive Officer and Chief Financial Officer, reviewed and performed an evaluation of the effectiveness of design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Report”).
Based on that review and evaluation, our Chief Executive Officer and Chief Financial Officer, along with others in our management, have determined that as of the end of the period covered by this Report on Form 10-Q, while improvements have been made since our December 31, 2018 year end, the disclosure controls and procedures were not effective to provide reasonable assurance that such information is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding disclosures. Specifically, at year end December 31, 2018, we have identified the following significant deficiencies in our disclosure controls: (1) The Company lacks sufficient internal controls over monitoring the accounting activity and consolidation of its foreign subsidiary into the Company’s consolidated financial statements. (2) Also, the Company has not fully integrated its new project accounting software into its general ledger accounting system and continues to rely on manual reconciliations using electronic spreadsheets. (3) The Company has a deficiency in internal controls regarding the estimation of costs on contracts in progress.
To remediate such deficiencies, we have implemented the following changes: (1) established stricter formal procedures with respect to how and when our management will communicate to the auditors and Audit Committee on a more timely basis, (2) is adopting sufficient written policies and procedures for accounting and financial reporting, (3) we have appointed and /or designated additional qualified personnel to ensure timely filing of the reports that we file or submit under the Exchange Act, (4) added additional, multiple review levels, (5) receive from the staff of the foreign subsidiary financial information on a weekly and monthly basis in order to monitor more closely. During the year ended December 31, 2018, we integrated three more entities into its accounting software and is planning the integration of the remaining two entities shortly. In addition, we have reevaluated our internal controls regarding the estimation of costs on contracts in progress and have implemented changes as needed. We continued to monitor and improve upon our operational and financial controls during the quarter ended March 31, 2019.
The accompanying notes are an integral part of these consolidated financial statements
Changes in Internal Controls
There were no changes in our internal controls over financial reporting as defined in Rule 13a-15(f) or Rule 15d-15(f) under the Exchange Act that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the internal controls over financial reporting.
Limitations on the Effectiveness of Controls
We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control systems are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
The accompanying notes are an integral part of these consolidated financial statements
CVD EQUIPMENT CORPORATION