CVD Equipment Corp: Form 10-Q for the period ended Jun 30, 2023

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 Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. Readers are cautioned not to place undue reliance on forward-looking statements, as there can be no assurance that the plans, intentions or expectations upon which they are based will occur. These statements involve known and unknown risks and uncertainties that may cause our actual results or outcomes to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements are based on various factors and are 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 our existing and potential future product lines of business, including our PVT150 system;
• our ability to attract and retain key personnel and employees;
• our ability to obtain financing on acceptable terms if and when needed;
• uncertainty as to our ability to develop new products for the high power electronics market including our plan to develop a PVT200 to grow silicon carbide crystals for 200mm wafters and epitaxy equipment for silicon carbide waters;
• uncertainty as to our future profitability;
• uncertainty as to any future expansion of the Company;
• uncertainty as to our ability to adequately obtain raw materials and components from foreign markets in light of geopolitical developments, and
• uncertainty as to our ability to timely acquire raw materials for production due to supply chain disruptions.

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. We assume 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 performance is no guaranty of future results.

You should not place undue reliance on any forward-looking statements, which speak only as of the dates they are made. When used with this Report, the words “believes” “anticipates”, “expects”, “estimates”, “plans”, “intends”, “will” and similar expressions are intended to identify forward-looking statements.

Executive Summary

We have served the advanced materials markets with chemical vapor and thermal process equipment for over 40 years. CVD designs, develops, and manufactures a broad range of chemical vapor deposition, thermal process, gas control, and other state-of-the-art equipment and process solutions used to develop and manufacture materials and coatings for industrial applications and research. To learn more about CVD’s systems and offerings, visit www.cvdequipment.com (http://www.cvdequipment.com).

Business Update

Our core strategy is to focus on growth market applications in end-user markets related to the “electrification of everything” and aerospace. The phrase “electrification of everything” refers to the shift from fossil fuels to the use of electricity to power devices, buildings, electric vehicles or EVs, and many other applications. With respect to aerospace, our systems are being used by our customers to produce ceramic matrix composite materials or CMCs that will be used in next generation jet engines with the objective of reducing jet fuel consumption and contributing to the decarbonization of that industry.

During 2021, we received the first six (6) orders for our PVT150 system that is used by our customer to grow silicon carbide crystals. These crystals are then further processed into silicon carbide wafters by our customer and later processed into integrated circuits and other devices. Devices based on silicon carbide have been shown to reduce energy consumption in EVs and reduce the need for additional cooling elements. During 2022, we received an additional 24 orders from the same customer. We also launched our marketing campaign for the PVT150 in the first quarter of 2023 as we seek orders from other potential customers.

During 2022, we completed the production of a system for a customer that deposits coatings onto powders used in silicon-graphite anodes that has the objective of increasing EV battery performance while lowering cost.

We believe recent orders we received from a major aerospace company for the production of chemical vapor infiltration system reflects the beginnings of a recovery in aircraft manufacturing. In prior years, we had sold Tow-Coating Systems to manufacture CMCs to another major jet engine manufacturer and have an installed base of such systems at that customer.

During the six months ended June 30, 2023, new order bookings approximated $15.8 million, representing a decrease of approximately $1.0 million or 6% as compared to bookings of $16.7 million in six months ended June 30, 2022. CVD Equipment’s orders in the first half of 2023 were driven by demand in two of our three strategic markets. Aerospace attributed approximately $8.7 million of multiple systems orders during the six months ended June 30, 2023 that will ship over the next 12 months. Also contributing to the order bookings in 2023 was a battery nanomaterial production system of approximately $1.8 million.

Our PVT150 system which was launched in 2022 with an initial 20 systems shipped in 2022, and a follow-on order of 10 systems to the same customer of which 8 units shipped in the second quarter of 2023 and the balance will be shipped in the second half of 2023. In the first quarter of 2023, the PVT150 system was launched to the broader customer market and we are engaged in discussions with several potential customers. There were no PVT150 orders received in the first six months of 2023. The uncertainty as to the receipt and timing of orders for our PVT150 system contributes to the overall quarter to quarter fluctuation in orders.

Our backlog increased from $17.8 million at December 31, 2022 to $18.8 million at June 30, 2023 as orders were in excess of revenues by approximately $2.0 million. In addition, the backlog was reduced by $0.5 million related to the sale of Tantaline and $0.6 million related to the planned wind down of MesoScribe.

Historically, our orders have fluctuated based on end user market conditions, adoption of our new products and acceptance of our products. The order rate as well as other factors in our manufacturing process ultimately impacts the timing of revenue recognition whether accounted for over time or at a point in time. In addition, system revenue that will be recognized based on point in time will result in fluctuations in revenue recognized at the point in time when control of the promised products or services is transferred to the Company’s customers.

Accordingly, orders received from customers and the corresponding revenue recognized may fluctuate from quarter to quarter. The sales cycle for our equipment is typically six months, but can range up to twelve to eighteen months, depending on the application and product stage of the equipment. The order cycle to manufacture and test a system also will vary from six to eighteen months for our CVD Equipment segment and two to twelve months for our SDC segment, depending on system complexity and magnitude of the system.

Results of Operations

Three Months Ended June 30, 2023 and 2022

The following table presents revenue and expense line items reported in our Consolidated Statements of Operations for the three months ended June 30, 2023 and 2022 and the period-over-period dollar and percentage changes for those line items (in thousands, except percentages).

* Not meaningful

Revenue

Our revenue for the three months ended June 30, 2023 was $5.1 million compared to $5.8 million for the three months ended June 30, 2022, a decrease of 12.7%.

The decrease in revenue versus the prior year period was primarily attributable to lower revenue of $0.7 million from the CVD Equipment segment related to lower equipment revenue, a $0.4 million increase in revenue from our SDC segment and a $0.5 million decrease from the CVD Materials segment. The decrease in revenue in the period was principally the result of lower PVT equipment revenues at CVD Equipment and the sale of the Tantaline subsidiary that is part of the CVD Materials segment.

Our order backlog at June 30, 2023 was approximately $18.8 million as compared to $17.8 million at December 31, 2022. Our backlog at June 30, 2023 consists of $4.5 million related to remaining performance obligations of contracts in progress and not yet started, $12.1 million of system sales that will be recognized based on point in time and $2.2 million represents non-system orders received from customers. Historically, our revenues and orders have fluctuated based on changes in order rate as well as other factors in our manufacturing process that impacts the timing of revenue recognition. In addition, system revenue that will be recognized based on point in time will result in fluctuations in revenue recognized at the point in time when control of the promised products or services is transferred to the Company’s customers. Accordingly, orders received from customers and revenue recognized may fluctuate from quarter to quarter.

The revenue contributed by the CVD Equipment segment for the three months ended June 30, 2023 of $3.1 million represented 60.5% of overall revenue as compared to $3.8 million or 65.1% of overall revenue for the three months ended June 30, 2022. The decrease in revenues of $0.7 million or 18.9% resulted principally from less PVT150 revenues in the current quarter as compared to the prior year quarter.

The revenue contributed by the SDC segment for the three months ended June 30, 2023 of $1.7 million represented 32.7% of overall revenue as compared to $1.2 million or 20.8% of overall revenue for the three months ended June 30, 2022. Revenue for our SDC segment increased $0.4 million or 36.9% due to increased orders and strong demand for the SDC’s gas and chemical delivery system products as compared to the prior year. The demand and related bookings for SDC’s products are subject to fluctuation depending on changes in market demand.

The revenue contributed by the CVD Materials segment for the three months ended June 30, 2023 of $0.3 million represented 6.7% of our overall revenue as compared to $0.8 million or 14.0% of overall revenue for the three months ended June 30, 2022. The decline was principally due to the sale of the Tantaline subsidiary during the quarter.

Gross Profit

Gross profit for the three months ended June 30, 2023 was $1.4 million, with a gross profit margin of 27.4%, compared to a gross profit of $1.4 million and a gross profit margin of 24.8% for the three months ended June 30, 2022. The decrease in gross profit of $53,000 was primarily due to lower revenues that was offset by an improved product mix as compared to the prior period.

Research and Development

For the three months ended June 30, 2023, research and development expenses were $0.6 million, or 11.0% of revenue as compared to $0.6 million, or 9.8% for the three months ended June 30, 2022. The small decrease in 2023 was the result of lower bonus accruals that were partially offset by increased personnel and employee-related costs to develop new products for key growth markets and lower production volumes.

General engineering support and expenses related to the development of more standardized products and value-added development of existing products are reflected as part of research and development expense. General engineering support and expenses are charged to costs of goods sold when work is performed directly on a customer order.

Selling

Selling expenses were $0.4 million or 8.4% of the revenue for the three months ended June 30, 2023 as compared to $0.3 million or 5.7% for the three months ended June 30, 2022. The increase in 2023 was primarily the result of increased personnel and employee-related costs to support increased marketing efforts.

General and Administrative

General and administrative expenses for the three months ended June 30, 2023 were $1.4 million or 26.8% of revenue compared to $1.3 million or 22.2% of revenue for the three months ended June 30, 2022, an increase of $0.1 million. The increase in expenses was principally due increases in personnel and employee-related costs and professional fees offset by lower bonus accruals.

During the three months ended June 30, 2023, the Company revised its estimated bonus accrual as of June 30, 2023. This resulted in an adjustment of $0.2 million to reverse a portion of the 2023 bonus that was accrued as of March 31, 2023. The impact of this reversal on general administrative expense was a reduction of $0.1 million. The impact of this reversal also resulted in reductions of expenses for cost of revenue of $41,000, research and development of $56,000 and selling expenses of $24,000 during the three months ended June 30, 2023.

Loss on Disposition of Tantaline

This item represents the net loss on the sale of our Tantaline subsidiary including professional fees.

Impairment Charge

This item represents the loss on the impairment of certain assets of MesoScribe based on the decision at June 30, 2023 to dispose of the subsidiary in the second half of 2023.

Other Income (Expense), Net

Other income (expense), net was $129,000 for the three months ended June 30, 2023 as compared to other income (expense), net of ($91,000) for the three months ended June 30, 2022. The change was principally due to an increase in interest income due to higher interest rates and increased amounts invested in U.S. treasury bills and a reduction in the foreign exchange loss.

Income Taxes

We continue to evaluate the potential utilization of our deferred tax asset, which has been fully reserved for, on a quarterly basis, by reviewing our economic models, including projections of future operating results.

Six Months Ended June 30, 2023 versus June 30, 2022

The following table presents revenue and expense line items reported in our Consolidated Statements of Operations for the six months ended June 30, 2023 and 2022 and the period-over-period dollar and percentage changes for those line items (in thousands, except percentages).

* Not meaningful

Revenue

Our revenue for the six months ended June 30, 2023 was $13.8 million compared to $10.5 million for the six months ended June 30, 2022, an increase of 31.6%.

The increase in revenue versus the prior year period was primarily attributable to increased revenue of $2.3 million from the CVD Equipment segment related to equipment sales and spare parts, a $1.3 million increase in revenue from our SDC segment and a $0.3 million decrease from the CVD Materials segment. The increase in revenue in the period was principally the result of the recognition of revenue associated with additional equipment contracts and from higher PVT150 revenues. Revenue related to PVT150 systems sold to one customer represented 21.0% of our total revenues and 32.4% of CVD Equipment segment revenues during the six months ended June 30, 2023. We recognized revenue on this contract as we construct the equipment for our customer.

The revenue contributed by the CVD Equipment segment for the six months ended June 30, 2023 of $8.9 million represented 64.8% of overall revenue as compared to $6.6 million or 63.2% of overall revenue for the six months ended June 30, 2022. The increase in revenues of $2.3 million or 34.9% resulted principally related revenue associated additional equipment contracts and higher revenues from our PVT150 system contract.

The revenue contributed by the SDC segment for the six months ended June 30, 2023 of $3.8 million represented 27.9% of overall revenue as compared to $2.6 million or 24.7% of overall revenue for the six months ended June 30, 2022. Revenue for our SDC segment increased $1.3 million or 48.8% due to increased orders and strong demand for the SDC’s gas and chemical delivery system products as compared to the prior year. The demand and related bookings for SDC’s products are subject to fluctuation depending on market demand.

The revenue contributed by the CVD Materials segment for the six months ended June 30, 2023 of $1.0 million represented 7.3% of our overall revenue as compared to $1.3 million or 12.2% of overall revenue for the six months ended June 30, 2022. The decrease in revenue was principally due to the sale of Tantaline in May 2023.

Gross Profit

Gross profit for the six months ended June 30, 2023 was $3.8 million, with a gross profit margin of 27.8%, compared to a gross profit of $2.2 million and a gross profit margin of 21.1% for the six months ended June 30, 2022. The increase in gross profit of $1.6 million was primarily the result of leveraging fixed costs on higher sales levels and an improved product mix offset by certain component cost increases and higher compensation costs.

Research and Development

For the six months ended June 30, 2023, research and development expenses were $1.2 million, or 8.4% of revenue as compared to $0.9 million, or 8.4% for the six months ended June 30, 2022. The increase in 2023 was the result of increased personnel and employee-related costs to develop new products for key growth markets offset by lower bonus expense.

General engineering support and expenses related to the development of more standardized products and value-added development of existing products are reflected as part of research and development expense. General engineering support and expenses are charged to costs of goods sold when work is performed directly on a customer order.

Selling

Selling expenses were $0.8 million or 6.2% of the revenue for the six months ended June 30, 2023 as compared to $0.6 million or 5.8% for the six months ended June 30, 2022. The increase in 2023 was primarily the result of increased personnel and employee-related costs to support increased marketing efforts as well as increase in trade shows and other marketing expenses.

General and Administrative

General and administrative expenses for the six months ended June 30, 2023 were $3.0 million or 21.5% of revenue compared to $2.4 million or 23.4% of revenue for the six months ended June 30, 2022, an increase of $0.5 million. The increase in expenses was principally due to increases in personnel and employee-related costs to support the growth of our business and higher professional fees of $0.2 million offset by lower bonus expense.

Loss on disposition of Tantaline

This item represents the net loss on the sale of our Tantaline subsidiary including professional fees.

Impairment Charge

This item represents the loss on the impairment of certain assets of MesoScribe based on the decision to dispose of the subsidiary in the second half of 2023.

Other Income (Expense), Net

Other income, net was $278,000 for the six months ended June 30, 2023 as compared to other (expense), net of ($116,000) for the six months ended June 30, 2022. The change was principally due to an increase in interest income due to higher interest rates and increased amounts invested in U.S. treasury bills and a reduction in the foreign exchange loss.

Income Taxes

We continue to evaluate the potential utilization of our deferred tax asset, which has been fully reserved for, on a quarterly basis, by reviewing our economic models, including projections of future operating results.

Liquidity and Capital Resources

As of June 30, 2023, aggregate working capital was $16.6 million as compared to aggregate working capital of $15.5 million at December 31, 2022. Working capital increased due to the classification of our employee retention credit receivable as a current asset at June 30, 2023 as the receivable was fully collected in July 2023. Cash and cash equivalents at June 30, 2023 and December 31, 2022 were $13.0 million and $14.4 million, respectively.

Net cash used in operating activities for the six months ended June 30, 2023 was $0.8 million. This decrease was principally due to increases in contract assets of $0.8 million, increase in inventories of $1.6 million, decrease in accrued expenses of $0.8 million (primarily due to payment of 2022 bonus) offset by reduction in accounts receivable of $1.6 million, an increase in contract liabilities of $0.7 million and non-cash items of $1.1 million. The increase in inventory was related to the production of PVT150 equipment in anticipation of potential future orders and inventory associated with a system order that will be recognized at the point in time the equipment is transferred to the Company’s customer.

Capital expenditures for the six months ended June 30, 2023 were $0.2 million related to purchases of manufacturing equipment and building improvements. The disposition of Tantaline resulted in a cash outflow of $0.3 million based on the terms of the agreement.

Cash flows from financing activities for the six months ended June 30, 2023 included $0.1 million of proceeds from the exercise of employee stock options.

During the three months ended June 30, 2023, the Company entered into negotiations with a third party to sell certain assets and license certain propriety information of MesoScribe. On August 4, 2023, the Company entered into a Purchase and License Agreement (the “Agreement”) with the third-party. Pursuant to the Agreement, the Company will sell certain proprietary assets relating to its plasma spray technology and material deposition system and grant a non-exclusive license to use certain of the Company’s related intellectual property as more fully described in the Agreement, for an aggregate purchase price of $0.9 million. The purchase price is payable in several installments and contingent upon certain performance metrics and other milestones.

The Company will continue to fulfill remaining orders for MesoScribe products through the end of 2023 at which time it plans to cease the remaining operations of MesoScribe and dispose of any remaining equipment.

We believe that our cash and cash equivalent positions and our projected cash flow from operations will be sufficient to meet our working capital and capital expenditure requirements for the next twelve months from the filing of this Form 10-Q. We will continue to assess our operations and take actions anticipated to maintain our operating cash to support the working capital needs.

Critical Accounting Policies and Estimates

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Our critical estimates include accounting for certain items such as revenues on long-term contracts recognized on the input method; and the recoverable value of our long-lived assets.

We consider the following significant accounting policies to be critical because of their complexity and the high degree of judgment involved in maintaining them.

Revenue Recognition

We design, manufacture, and sell custom chemical vapor deposition equipment through contractual agreements. These system sales require us to deliver functioning equipment that is generally completed within two to eighteen months from commencement of order acceptance. For systems sales that meet the criteria to recognize revenue over time, we recognize revenue over time by using an input method based on costs incurred as it depicts our progress toward satisfaction of the performance obligation. Under this method, revenue arising from fixed price contracts is recognized as work is performed based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligations. For system sales that to not meet the criteria to recognize revenue over time based on the contract provisions, the Company recognize revenue based on point in time.

Incurred costs include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation costs. Contract material costs are included in incurred costs when the project materials have been purchased or moved to work in process as required by the project’s engineering design. Cost based input methods of revenue recognition require us to make estimates of costs to complete the projects. In making such estimates, significant judgment is required to evaluate assumptions related to the costs to complete the projects, including materials, labor, and other system costs. If the estimated total costs on any contract are greater than the net contract revenues, we recognize the entire estimated loss in the period the loss becomes known and can be reasonably estimated.

We have been engaged in the production and delivery of goods on a continual basis under contractual arrangements for many years. Historically, we have demonstrated an ability to accurately estimate total revenues and total expenses relating to our long-term contracts. However, there are many inherent risks and uncertainties in estimating revenues, expenses and progress toward completion, particularly on larger or longer-term contracts. If we do not estimate the total sales, related costs, and progress toward completion on such contracts, the estimated gross margins may be significantly impacted, or losses may need to be recognized in future periods. Any such resulting changes in margins or contract losses could be material to our results of operations and financial condition.

Long-Lived Assets

Long-lived assets consist primarily of property, plant and equipment. Long-lived assets are reviewed for impairment whenever events or circumstances indicate their carrying value may not be recoverable. When such events or circumstances arise, an estimate of the future undiscounted cash flows produced by the asset, or the appropriate grouping of assets, is compared to the asset’s carrying value to determine if impairment exists pursuant to the requirements of ASC 360-10-35, “Impairment or Disposal of Long-Lived Assets.” If the asset is determined to be impaired, the impairment loss is measured on the excess of its carrying value over its fair value. Assets to be disposed of are reported at the lower of their carrying value or net realizable value.

Evaluation of Disclosure Controls and Procedures

We maintain a system of disclosure controls and procedures (as defined in Rule 13a-15(e) and 13d-15(e) under the Exchange Act of 1934, as amended, (the “Exchange Act”)). As required by Rule 13a-15(b) under the Exchange Act, our management, 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 our 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 the disclosure controls and procedures were 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.

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.

CVD EQUIPMENT CORPORATION

PART II

OTHER INFORMATION