CPSH

CPS Technologies Corp. 10-Q Summary (Period Ended June 30, 2012)

Business Context and Reporting Period

CPS Technologies Corporation (CPS) provides advanced material solutions, primarily metal-matrix composites, to the electronics, power generation, automotive, and defense industries. The company also assembles housings for hybrid circuits and maintains a cooperative agreement with the U.S. Army for armor development. This report covers the second fiscal quarter and the first six months ended June 30, 2012.

Key Financial Metrics

Liquidity: Cash decreased by $768,101 during the six-month period. The company maintains a $2 million revolving line of credit (LOC) with a borrowing base of $836,000 as of June 30, 2012. No borrowings were outstanding under the LOC at period end.

Material Changes vs. Prior Period

• Revenue Decline: Revenues dropped 25% in Q2 2012 and 33% for the six-month period compared to 2011. Drivers included weak orders for traction products, end-of-life declines in heatspreaders/lids, reduced revenue from the U.S. Army cooperative agreement, and lower sales of hermetic packages.
• Margin Compression: Gross margin collapsed from 20% to 5% in Q2 and from 17% to less than 2% for the six months. This was caused by lower sales volumes spreading fixed costs over fewer dollars, $95,000 in obsolescence charges in Q2, and additional costs from an outside finishing operation.
• Profitability: The company swung from a net profit in 2011 to a net loss of $373,000 in Q2 2012 and $907,000 for the six months. Operating losses were driven by the gross margin decline, partially offset by an 8% reduction in SG&A expenses due to lower compensation and the suspension of the 401K match program.
• Balance Sheet: Accounts receivable decreased significantly to $1.75 million (from $3.11 million), improving Days Sales Outstanding to 43 days. Inventories increased to $3.36 million, with a significant portion ($1.46 million) held at customer locations under consignment agreements.

Outlook, Risks, and Management Commentary

• Outlook: Management expects to fund working capital for the remainder of 2012 using existing cash and the LOC. Growth is anticipated in hybrid/electric vehicle baseplates, though the company remains sensitive to weak European economies and slowed traction spending in China.
• Capital Resources: In May 2012, the LOC was increased to $2 million and the equipment finance facility renewed to $1.25 million, both maturing in May 2013. The company is in compliance with financial covenants.
• Risks: The company relies on a limited number of customers; the loss of any single customer could necessitate additional external financing. Failure to generate sufficient revenue or reduce discretionary spending could materially adversely affect business objectives.
• Unusual Items: The filing notes $95,000 in obsolescence charges in Q2 2012 and significant tax benefits recorded due to net operating loss carryforwards ($227,000 federal and $58,000 state in Q2).

Investor Verification Checklist

• Verify the sustainability of the 401K match suspension and its impact on future SG&A expenses.
• Confirm the status of the U.S. Army cooperative agreement and the timeline for potential armor revenue.
• Assess the collectability of the remaining accounts receivable given the sharp decline in balance and the allowance for doubtful accounts increase to $40,000.
• Monitor the utilization of the $2 million line of credit, as cash burn continues at approximately $768,000 per six months.
• Review the specific end-of-life product mix to determine if the margin compression is temporary or structural.