CVD Equipment Corporation — Q2 2018 Form 10-Q
Business context and reporting period. This unaudited report covers the quarter and six months ended June 30, 2018. CVD designs and manufactures custom chemical vapor deposition equipment and reports three segments: CVD equipment, SDC gas-control systems, and CVD Materials coatings and related activities. The company adopted ASC 606 on January 1, 2018 using the modified retrospective method; management said adoption did not significantly affect the financial statements.
Financial performance and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue, 2018 | $6.44 million | $15.59 million |
| Revenue, 2017 | $10.83 million | $20.48 million |
| Gross profit / margin, 2018 | $1.12 million / 17.3% | $4.88 million / 31.3% |
| Gross profit / margin, 2017 | $4.41 million / 40.7% | $8.58 million / 41.9% |
| Operating income (loss), 2018 | ($1.38 million) | ($469,000) |
| Net income (loss), 2018 | ($1.33 million); ($0.21) per share | ($772,000); ($0.12) per share |
| Net income, 2017 | $1.26 million; $0.20 per share | $2.28 million; $0.36 per share |
| Operating cash flow | Not presented quarterly | $2.97 million, versus $376,000 in 2017 |
At June 30, 2018, cash and equivalents were $15.40 million, working capital was $20.9 million, and current assets and current liabilities were $26.33 million and $5.47 million, respectively. Total debt was approximately $13.03 million, including current maturities; stockholders’ equity was $40.31 million. Cash increased $1.19 million during the first half. Investing cash outflow was $1.45 million, including $1.27 million of capital expenditures; debt payments used $329,000.
Changes versus the comparable period
- Second-quarter revenue fell 40.6% year over year; first-half revenue fell 23.9%. Management attributed the decrease primarily to completion of large aviation-component production contracts.
- Gross margin declined sharply, and the company moved from operating and net income to losses. Management cited lower revenue with labor costs initially remaining at levels suited to higher activity, plus estimated losses on certain contracts.
- The large aerospace customer accounted for approximately 36.5% of Q2 revenue and 43% of first-half revenue, compared with 66% and 68%, respectively, in 2017.
- First-half CVD Materials revenue was $730,000, while the segment generated a $1.14 million operating loss. The company continued investing in the segment and its new facility.
- First-half operating cash flow improved to $2.97 million from $376,000, aided in part by a $3.08 million reduction in contract assets. Cash was lower than the prior-year June balance of $21.48 million.
Outlook, risks, and notable items
- Management provided no quantified revenue or earnings guidance. It said cash and operating cash flow should be sufficient for working capital and capital expenditures over the next 12 months, with significant investment planned for CVD Materials and its facility.
- The $7 million HSBC revolving credit facility had not been used and was due to remain available through September 1, 2018; the company expected renewal. Mortgage debt included a variable-rate loan at LIBOR plus 1.75% and a fixed-rate loan at 3.91%.
- Although compliant with debt covenants at June 30, management was uncertain it could meet the fixed-charge coverage covenant at September 30. It planned to discuss an amendment or waiver with the lender, with no assurance of obtaining one on acceptable terms; failure could materially affect financial condition.
- Management reported delays in permitting and obtaining a Certificate of Occupancy for the CVD Materials facility. It also said personnel reductions began late in the quarter; headcount had fallen by a further 20 people as of August 5.
- Contract revenue uses cost-to-cost estimates. First-half estimate changes reduced revenue by a net $495,000, primarily because of product cost overruns and cost forecasts following system redesigns; management said estimate changes can materially affect results.
- The company identified two material weaknesses in disclosure controls: insufficient monitoring and consolidation controls for its foreign subsidiary, and incomplete integration of project accounting software with the general ledger, requiring manual spreadsheet reconciliations. Management described remediation measures; controls were deemed ineffective at period end.
- Other risks include dependence on major customers and order timing, competition, uncertainty around future profitability and financing, and execution of expansion plans. Cash balances exceeded FDIC insurance limits by approximately $14.28 million. No legal proceedings or off-balance-sheet arrangements were reported.
Important facts for investors to verify
- Whether the major aerospace customer has continued or replaced the completed production orders, and how customer concentration evolves.
- Progress in restoring gross margins, including the impact of contract cost overruns, staffing adjustments, and project cost estimates.
- Whether the HSBC revolving facility was renewed and whether the company met, amended, or obtained a waiver for the September 2018 fixed-charge coverage covenant.
- Completion, permitting, occupancy, costs, and revenue contribution of the CVD Materials facility and the broader investment program.
- Whether management remediated the disclosed material weaknesses and improved project accounting and foreign-subsidiary consolidation controls.
- Cash generation and funding needs as capital expenditures continue; management’s stated 12-month liquidity expectation is not a guarantee.