CVD Equipment Corporation — Q3 2018 Form 10-Q
Business context and period: Unaudited results cover the three and nine months ended September 30, 2018. The company designs and manufactures specialized equipment and reports CVD equipment, SDC gas-control systems, and Materials businesses. Comparisons are with the same 2017 periods; the company adopted ASC 606 in 2018 and said adoption did not significantly affect results.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $4.03 million | $10.83 million | $19.62 million | $31.31 million |
| Gross profit (loss) | $(0.06) million | $4.60 million | $4.82 million | $13.18 million |
| Gross margin | (1.4)% | 42.5% | 24.6% | 42.1% |
| Operating income (loss) | $(2.85) million | $1.89 million | $(3.32) million | $5.44 million |
| Net income (loss) | $(2.50) million | $1.40 million | $(3.27) million | $3.68 million |
| Diluted EPS | $(0.39) | $0.22 | $(0.51) | $0.58 |
Revenue declined 62.8% in Q3 and 37.3% year to date. Management attributed the deterioration primarily to completion of large aerospace production contracts, fewer new orders, prior-period revenue recognition related to higher-than-expected contract costs, and contract cost overruns and underutilized production labor. Q3 cost revisions reduced revenue by a net $1.10 million; the nine-month reduction was $1.59 million. Operating expenses were $2.80 million in Q3 and $8.14 million year to date.
Cash flow and liquidity: Nine-month operating cash flow was positive $2.73 million, compared with cash used of $3.67 million in 2017. The improvement included a $5.85 million reduction in contract assets, primarily as project milestones allowed additional customer billing. Investing cash outflow was $2.27 million, including $2.26 million of capital expenditures; financing cash outflow was $0.48 million, primarily debt principal payments. Cash was $14.19 million at September 30, versus $14.21 million at year-end 2017. Working capital was $17.7 million, down from $22.4 million.
Total debt was approximately $12.9 million, comprising $0.66 million of current maturities and $12.21 million of long-term debt. The $14.19 million cash balance exceeded reported debt, but the revolving credit facility expired September 1, 2018 and was not renewed; the company was discussing a possible new facility with HSBC and gave no assurance an agreement would be reached. Two mortgage-loan financial covenants were not met; HSBC waived them through October 1, 2019. Management said available cash and operating cash flow would meet working-capital and capital-expenditure needs for the next 12 months.
Outlook, risks, and notable items
- Management expected Q4 2018 revenue to approximate Q3 levels and anticipated operating losses in Q4 2018 and Q1 2019. Return to profitability depends partly on new orders, permits, and ramp-up of the Materials business; the company was reviewing costs.
- Permitting delays pushed the expected start of operations at the new CVD Materials facility to the latter part of Q2 2019. Management said the delay would add expenses and carrying costs. Site-plan approval had been received, with building permits and a certificate of occupancy still pending.
- Customer and order concentration are material risks. One aerospace customer generated 26% of Q3 revenue and 40% of nine-month revenue, versus 59% and 65%, respectively, in 2017. Management reported that requests for quotations remained high but new orders were below expectations.
- Management cited ongoing investment in Materials, research and development, and new applications. It reported a provisional patent application for Fluid Reactor technology and said Mesoscribe had been selected for three government-sponsored awards expected in Q1 2019.
- Disclosure controls and procedures were reported ineffective. Identified material weaknesses included monitoring and consolidation of the foreign subsidiary, incomplete integration of project-accounting software with the general ledger and reliance on spreadsheet reconciliations, and controls over contract-cost estimates.
- Other exposures include significant judgment in estimating costs to complete contracts, unanticipated cost overruns, and cash balances exceeding FDIC insurance limits by approximately $12.6 million. The filing reported no legal proceedings or off-balance-sheet arrangements.
Important facts for investors to verify
- Whether new orders recover and customer concentration declines, particularly after the large aerospace contracts ended.
- Whether estimated contract costs, loss recognition, and gross margins stabilize; contract-estimate changes materially affected reported revenue.
- Timing and total cost of the Materials facility permitting, construction, and operating ramp-up, including the additional carrying costs.
- Whether the company obtains a replacement credit facility and remains compliant with mortgage covenants after the waiver expires.
- Progress in remediating the disclosed material weaknesses and improving project-cost estimates and financial reporting controls.