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 of Financial Condition and Results of Operations” 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 and the effect of the novel coronavirus (COVID-19) on our business and operations, and those of our customers, suppliers and other third parties. 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.
Coronavirus (COVID-19)
We have been actively monitoring the coronavirus ("COVID-19") outbreak and its impact globally. Our primary focus to this point has been to ensure the health and safety of its employees. To that end, we have adopted social distancing where appropriate, implemented travel restrictions, and has taken actions to ensure that locations and facilities are cleaned and sanitized regularly. These are novel and challenging times and the magnitude of this crisis is requiring us to consider all options to promote the safety of employees, including, where appropriate, or where required to comply with foreign, national, state or local governmental authority recommendations, guidelines, and/or mandates, the temporary suspension of work at certain of our locations and production facilities to protect employees and curb the spread of the coronavirus. All of these actions may adversely impact our operating results. In particular, the aerospace sector, for which we rely on a significant part of our business, has been faced with significant reductions to its business due to lack of air travel. Due to the timing of the COVID-19 outbreak, our new order levels during the year ended December 31, 2020 and into the first quarter of 2021 have seen substantial reductions which have materially and adversely affected revenues commencing in our second quarter of 2020. While the financial results for the Company’s first quarter of 2020 reflected the initial impact of COVID-19, and the year ended December 31, 2020 and the quarter ended March 31 2021 reflected a substantial adverse effect, we are unable to predict the extent of the impact the pandemic will have on our financial position and operating results for the remainder of 2021 due to numerous uncertainties, but the impact could be material during any future period affected either directly or indirectly by this pandemic. The longer-term impacts from the outbreak are highly uncertain and cannot be predicted.
Current Developments
Historically, we have derived substantially all of our revenues through our custom equipment business and our Stainless Design Concepts (“SDC”) gas management and chemical delivery control systems segment. The marketing, sale and manufacture of our products, requires a lengthy sales cycle ranging from several months to over more than one year before we can complete production and delivery. Also, demand for our equipment and related consumable products and services may be volatile as a result of sudden changes in market conditions, competition and other factors. This can and has resulted in substantial volatility in our revenue stream.
In order to address this sales volatility, we have attempted to diversify and expand our business into providing material products and services. This strategy included the development of our capabilities to provide materials coatings and surface treatments for targeted customer / market requirements (the “Material Business”). With this objective in mind, we acquired Tantaline in December 2016 and MesoScribe in October 2017. In order to facilitate these new lines of businesses, we also purchased a building to house both operating subsidiaries for $13,850,000. This 180,000 square foot building (the “555 Building”) was to house the Material Business in the United States and provide adequate space for the anticipated growth of these businesses. In addition, we also maintain a 130,000 square foot building (the “355 Building”), which houses the equipment products portion of our business as well as our corporate headquarters.
We have invested approximately $1.6 million, $2.7 million and $2.5 million during 2020, 2019 and 2018, respectively, in building improvements, machinery, and other expenses related primarily to the Materials Business.
The projected growth of the Materials Business has not met expectations. Although we have made substantial investments in facilities, equipment and acquisitions in furtherance of our strategy, the foregoing has proven to be a significant drain on our finances and our liquidity. Since 2018 revenues for the Materials Business have been $1,700,000 in 2018, $1,600,000 in 2019 and $2,300,000 in 2020, with operating losses, exclusive of a $3.6 million impairment charge, recorded in all years for a total loss of $2.5 million. These cumulative results are due to operating losses from the Tantaline operations offset by operating profits of $.5 million from the MesoScribe operations. In the three months ended March 31, 2021 the Materials business had revenue of $.6 million and an operating loss of $.1 million. The operating loss was due to operating losses from the Tantaline operations, offset by operating profit of $.1 million from the MesoScribe operations.
Furthermore, our overall revenues have declined from $41.1 million in 2017 to $16.9 million in 2020. Cumulative operating losses, exclusive of a $3.6 million impairment charge, for the last three years (2018-2020) totaled ($14.5 million), which are comprised of 2018 ($5.3 million), 2019 ($5.0 million) and 2020 ($4.2 million). As a result of these continuing losses, and the investments in the Materials Business, our cash balances have declined from $21.7 million at December 31, 2016 to $7.7 million as of December 31, 2020 and $5.9 million at March 31, 2021, and liquidity has been strained. Contributing to and compounding this decline, is the negative effect the COVID-19 crisis has had in 2020 on the aerospace industry, which resulted from reduced travel and reduction of industry gas turbine engine sales. Aerospace sales in recent years have represented as much as 60% of our total revenue.
Our mortgage debt on the 355 Building and 555 Building, in the amount of $2.0 million and $9.2 million respectively, at March 31 2021, matures in March and December 2022, respectively.
In January 2021, our Board of Directors concluded that we needed a change in direction and new leadership to evaluate our business strategy and operations, and take timely actions to halt and reverse the declines of the past few years. As such, they appointed Emmanuel Lakios as President and Chief Executive Officer (previously our Vice-President- Sales and Marketing). We began an intensive analysis of our entire business and operations including the Materials Business. Based upon that analysis we believe our primary focus should be on the core equipment business and that the Materials Business strategy should be revised, with some of its current elements potentially minimized or ceased. Based upon this analysis, we are forecasting continued losses and negative cash flow for our Tantaline product line and as a consequence, we have implemented plans to eliminate further investment in our Tantaline product line, which will result in the avoidance of approximately $1.5-$2.0 million in additional costs. In addition, we have recorded an impairment charge of $3.6 million during the fourth quarter and year ended December 31, 2020. Based upon certain decisions and actions currently being reviewed, there may be additional costs to be incurred, inclusive of employee related and lease termination costs estimated at approximately $400,000.
In order to increase our liquidity and to provide necessary working capital to support our on-going business and operations, we have decided to sell the 555 Building in February 2021. We have determined the 555 Building is not needed for present and future business operations. We have concluded that any remaining elements of the Materials Business can be consolidated into the 355 Building, which we believe can accommodate any needs for our growth for the foreseeable future. In April 2021, the Company completed the move of its Tantaline product line to the 355 Building, while the MesoScribe consolidation into the 355 Building has been initiated. All functions of the Tantaline product line have been consolidated into the Denmark office and the United States expenses related to Tantaline have ceased.
On March 29, 2021, the Company entered into an agreement with Steel K, LLC for the sale of its 555 Building. The purchase price is $24,360,000, and the closing of the sale is subject to the satisfaction or waiver of certain conditions to closing or contingencies. A portion of the sale proceeds would be used to satisfy the existing mortgage debt on the 555 Building in the approximate amount of $9.2 million at March 31, 2021, and for various costs related to the sale closing in an amount to be determined. The excess proceeds will be used for general working capital purposes. On or about May 23, 2021, the buyer may advise the Company of any requirement to extend the closing date up to 60 days thereafter.
Statement of Operations
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Three Months Ended
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March 31,
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2021
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2020
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Revenue
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$
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3,365,860
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$
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6,036,360
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Cost of revenue
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3,047,280
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4,100,836
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Gross profit
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318,580
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1,935,524
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Operating expenses
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Research and development
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100,432
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113,828
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Selling and shipping
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135,755
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165,777
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General and administrative
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1,701,180
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1,547,758
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Total operating expenses
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1,937,367
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1,827,363
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Operating (loss) income
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(1,618,787
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)
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108,161
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Other income (expense):
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Interest income
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1,223
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24,902
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Interest expense
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(107,221
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)
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|
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(116,038
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)
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Other Income
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219,235
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110,809
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Total other income, net
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113,237
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19,673
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(Loss) income before income tax
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(1,505,550
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)
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127,834
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Income tax (benefit)
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-
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(1,530,644
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)
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Net (loss) income
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$
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(1,505,550
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)
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$
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1,658,478
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Three Months Ended March 31, 2021 vs. March 31, 2020
Revenue
Our revenue for the three months ended March 31, 2021 was $3.4 million compared to $6.0 million for the three months ended March 31, 2020, a decrease of $2.6 million or 44.3%. This sales reduction is primarily attributed to the impacts of COVID-19 which significantly reduced the Company’s orders commencing in the first quarter of 2020, for the year ended December 31, 2020 and into the first quarter of 2021, which in turn dramatically decreased our revenues in the subsequent quarters. The decrease was primarily attributable to decreased revenue of $2.1 million from our CVD Equipment segment related to spare parts and equipment sales and $.8 million decrease in our SDC segment, offset, in part by, an increase of $.3 million in our CVD Materials segment.
The revenue contributed for the three months ended March 31, 2021 by the CVD Equipment segment of $2.0 million, which totaled 59.6% of our overall revenue, was (51.0%) or ($2.1 million) lower than the segment’s $4.1 million contribution made in the three months ended March 31, 2020, which totaled 67.9% of our overall revenue. This revenue decrease is the result of decreases of $1.9 million and $.2 million, from spare parts and equipment sales, respectively.
Revenue for our SDC segment was $.8 million in three months ended March 31, 2021 as compared to $1.6 million in three months ended March 31, 2020, a decrease of $.8 million, primarily the result of the timing of one large order completed in the three months ended March 31, 2020.
Revenues for our CVD Materials segment were $.6 million in the three months ended March 31, 2021 as compared to $.3 million for the three months ended March 31, 2020. This increase of $.3 million was the result of increased MesoScribe product revenue of $.2 million and Tantaline® related revenue of $.1 million.
Gross Profit
Gross profit for the three months ended March 31, 2021 amounted to $.3 million, with a gross profit margin of 9.5%, compared to a gross profit of $1.9 million and a gross profit margin of 32.1% for the three months ended March 31, 2020. The reduction in gross profit and gross profit margin, was primarily the result of the impact of $2.7 million in decreased sales as a result of the impact of COVID-19, and the impact of fixed costs and payroll to support higher sales levels, offset in part by reduced employee payroll and related costs commencing in the last two and a half weeks of the quarter ended March 31, 2020 as a result of the Coronavirus mandates imposed.
Research and Development, Selling and General and Administrative Expenses
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, 2021 and 2020, our research and development expenses totaled $100,000 and $114,000, respectively, a decrease of $14,000.
Selling
Selling expenses were $136,000 or 4.0% of the revenue for the three months ended March 31, 2021 as compared to $166,000 or 2.8% of the revenue for the three months ended March 31, 2020. The decrease was primarily the result of reduced employee and employee related costs, during the three months ended March 31, 2021.
General and Administrative
General and administrative expenses for the three months ended March 31, 2021 were $1.7 million or 50.5% of revenue compared to $1.5 million or 25.6% of revenue for the three months ended March 31, 2020, an increase of $.2 million. As a result of the actions taken in January 2021 (noted above in the current developments) related to the change in direction and new leadership to evaluate our business strategy and operations, the increase in these expenses is primarily the result of increased legal costs of $235,000, of which $75,000 related to the preparation of the sale of the 555 Building, and the balance was related to general corporate governance, employee related matters and intellectual property, offset in part by lower employee payroll and related costs.
Operating loss
As a result of substantially lower sales and the resultant reduction in gross profit margins and increased general and administrative expenses, our operating loss was ($1.6 million) in the three months ended March 31 2021, compared with an operating income of $.1 million in the three months ended March 31, 2020.
Other income (expenses)
Other income (expenses) were $113,000 and $20,000 for the three months ended March 31, 2021 and 2020, respectively. Other income was $219,000 and $111,000 for the three months ended March 31, 2021 and 2020, respectively, from subleasing a portion of our CVD Materials facility. The decrease of $108,000 was the result of lower rent due to less occupancy in 2020. As a result of lower interest rates and lower cash balances, interest income decreased $24,000, to $1,000 for the three months ended March 31, 2021 as compared to $25,000 in 2020. In addition, Interest expense related to the Company’s mortgages decreased $9,000 to $107,000 in the three months ended March 31, 2021, as compared to $116,000 in 2020.
Income Taxes
For the three months ended March 31, 2021, there was no income tax expense as compared to an income tax benefit of $1.5 million for the three months ended March 31, 2020. On March 27, 2020, the CARES Act was enacted by the United States Congress. As a result of the enactment of the CARES Act, net operating losses (“NOL’s”) generated in 2018-2020 can now be carried back for five years and resulted in the Company recognizing approximately $1.5 million of a tax receivable. We continue to evaluate for potential utilization of our deferred tax asset, which has been fully reserved for, on a quarterly basis, reviewing our economic models, including projections and timing of orders, cost containment measures and other factors.
Net (loss) income
As a result of the foregoing factors, we reported a net loss of ($1.5 million), or ($0.23) per basic and diluted share, for the three months ended March 31, 2021, as compared to a net income of $1.7 million (which included the $1.5 million tax benefit as noted above), or $0.25 per basic and diluted share for the three months ended March 31, 2020.
Liquidity and Capital Resources
As of March 31, 2021, we had aggregate working capital of $12.3 million compared to aggregate working capital of $8.1 million at December 31, 2020. Our cash and cash equivalents at March 31, 2021 and December 31, 2020 were $5.9 million and $7.7 million, respectively.
Net cash used in operating activities was $1.6 million. This is the result of a net loss, adjusted for non-cash items, of $1.2 million, increased inventory of $.2 million, increased contract assets of $.5 million, and a $.4 million decrease accounts payable and other liabilities, offset in part by a decrease in accounts receivable of $.2 million due to timing of collections, decreased other current assets of $.2 million and increased accrued expenses of $.3 million
Long term debt decreased by $.2 million from principal payments on the mortgages related to our two facilities in Central Islip, NY.
We have a loan agreement with HSBC USA, N.A. (the “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, 2021 and December 31, 2020 were approximately $2.0 million and $2.1 million respectively. Interest accrues on the loan, at our option, at the variable rate of LIBOR plus 1.75% or Prime less 0.5% (1.86% and 1.89% at March 31, 2021 and December 31, 2020, respectively).
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 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 Note is payable in 60 consecutive equal monthly installments of $62,481, including interest. The balances as of March 31, 2021 and December 31, 2020 were approximately $9.2 million and $9.3 million respectively. The Note bears 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. As of March 31, 2021, the full amount of this Note is recorded as Liabilities Held For Sale.
On August 5, 2019, we entered into a Mortgage Modification Agreement which replaced the former covenant with a Minimum Liquid Assets (“MLC”) covenant, and on October 22, 2020, we entered into a Second Mortgage Modification Agreement modifying certain MLC balances. We are in compliance with our financial covenant under the mortgage at March 31, 2021.
We have been actively monitoring the coronavirus ("COVID-19") outbreak and its impact globally. Our primary focus to this point has been to ensure the health and safety of our employees. To that end, we have adopted social distancing where appropriate, implemented travel restrictions, and have taken actions to ensure that locations and facilities are cleaned and sanitized regularly. These are novel and challenging times and the magnitude of this crisis is requiring management to consider all options to promote the safety of our employees, including, where appropriate, or where required to comply with foreign, national, state or local governmental authority recommendations, guidelines, and/or mandates, the temporary suspension of work at certain of our locations and production facilities to protect employees and curb the spread of the Coronavirus. All of these actions may adversely impact our operating results. In particular, the aerospace sector, for which we rely on a significant part of our business, has been faced with significant reductions to its business due to lack of air travel. Due to the timing of the COVID-19 outbreak, our new order levels during the year ended December 31, 2020 and into the first quarter of 2021 have seen substantial reductions which have materially and adversely affected revenues commencing in our second quarter of 2020. While the financial results for the first quarter of 2020 reflected the initial impact of COVID-19, and year ended December 31, 2020 and the quarter ended March 31, 2021 reflected a substantial adverse effect, we are unable to predict the extent of the impact the pandemic will have on our financial position and operating results for the remainder of 2021 due to numerous uncertainties, but the impact could be material and adverse during any future period affected either directly or indirectly by this pandemic. The longer-term impacts from the outbreak are highly uncertain and cannot be predicted.
On April 21, 2020, we entered into a loan agreement (the “Loan Agreement”) with HSBC Bank USA, National Association pursuant to which we were granted a loan in the principal amount of $2,415,970, pursuant to the Paycheck Protection Program (the “PPP”) under Division A, Title I of the CARES Act, which was enacted by the United States Congress on March 27, 2020.
The PPP loan, the obligation of which is represented by a note issued by us, matures on April 21, 2022 and bears interest at a rate of 1% per annum. The note may be prepaid at any time prior to maturity with no prepayment penalties. Under the terms of the PPP, all or a portion of the Loan may be forgiven, based upon payments made in the first twenty-four weeks following receipt of the proceeds, related to payroll costs, continue group health care benefits, utilities and mortgage interest on other debt obligations incurred before February 15, 2020. We have filed an application for forgiveness in April 2021, and anticipates all or substantially all of the PPP loan to be forgiven.
As a result of the March 27, 2020 CARES Act enactment allowing the carryback of NOL’s five years, we recognized a $1.5 million tax benefit. We have collected $.8 million in the year ended December 31, 2020, and as of March 31, 2021 there remains a receivable in the amount of $.7 million.
Due to the timing of the COVID-19 outbreak, our new orders during the year ended December 31, 2020, and into the beginning of 2021 have decreased substantially which have resulted in substantial reductions in revenues resulting in operating losses commencing in our second quarter of 2020. The ongoing impact that COVID-19 has had on our business has made the conditions to operate very challenging. In particular, the aerospace sector, for which we rely on a significant part of our business, has been faced with significant reductions to its business due to lack of air travel. While we continue to monitor and take action to reduce our expenses, we have secured a $2.4 million loan under PPP and have recognized a $1.5 million tax receivable from the NOL 5 year carryback, of which $.7 million remains outstanding at March 31, 2021. In addition, we have decided to sell the 555 Building. The purchase price is $24,360,000, and the closing of the sale is subject to the satisfaction or waiver of certain conditions to closing or contingencies. A portion of the sale proceeds would be used to satisfy the existing mortgage debt on the 555 Building in the approximate amount of $9.2 million at March 31, 2021, and for various costs related to the sale closing in an amount to be determined. The excess proceeds will be used for general working capital purposes. On or about May 23, 2021, the buyer may advise the Company of any requirement to extend the closing date up to 60 days thereafter.
Based upon all of these factors, 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 of the filing of this Form 10-Q. Should the current environment continue longer or worsen, we will continue to assess our operations and take actions anticipated to maintain our operating cash to support the working capital needs, as well as compliance with our loan covenant.
Off-Balance Sheet Arrangements.
We have no off-balance sheet arrangements at this time.