CVD EQUIPMENT CORP 10-Q

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 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 / PVT 200 systems; ● 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 launch a PVT200 system to grow silicon carbide crystals for 200mm wafers and our plan to develop epitaxy equipment for silicon carbide wafers; ● uncertainty as to our future growth and profitability; and ● uncertainty as to our ability to adequately obtain raw materials and components for production from foreign markets in light of geopolitical developments and 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. 22 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 . 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 could 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 and 2022, we received the 30 initial 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 wafers by our customer. Integrated circuits and devices based on silicon carbide have been shown to reduce energy consumption in EVs and reduce the need for additional cooling elements. We also launched our marketing campaign for the PVT150 system to the broader customer market in the first quarter of 2023 as we seek orders from other potential customers. We have been engaged in discussions with several potential customers. There were no PVT150 system orders received in the first nine months of 2023. The uncertainty as to the receipt and timing of orders for our PVT product line contributes to the overall quarter to quarter fluctuation in such orders. During 2022, we completed the production of a PowderCoat 1100 system for a customer that grows silicon nanowires onto powders used in silicon-graphite anodes that has the objective of increasing EV battery performance while lowering cost. During 2022 and 2023, we received orders from a major aerospace company for the production of chemical vapor infiltration systems to be used to manufacture CMCs. 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. 23 During the nine months ended September 30, 2023, new order bookings approximated $19.9 million, representing a decrease of approximately $4.1 million or 17.1% as compared to bookings of $24.0 million in the nine months ended September 30, 2022. CVD Equipment segment’s orders in the first nine months of 2023 reflected demand in two of our three strategic markets. Aerospace orders were approximately $10.6 million consisting of multiple systems orders that expect to ship over the next 12 months. Order bookings in 2023 included a battery nanomaterial production system of approximately $1.8 million that is expected to be completed in 2023. Our backlog decreased from $17.8 million at December 31, 2022 to $16.6 million at September 30, 2023 as orders were less than revenues by approximately $0.1 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, acceptance of our products and our customers’ ability to raise capital financing. 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, any system revenue that will be recognized based on point in time will result in fluctuations as revenue is recognized at the point in time when control of the promised products or services is transferred to our 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. 24 Results of Operations Three Months Ended September 30, 2023 and 2022 The following table presents revenue and expense line items reported in our condensed consolidated statements of operations for the three and nine months ended September 30, 2023 and 2022 and the period-over-period dollar and percentage changes for those line items (in thousands, except percentages). Three months ended September 30 2023 2022 Change Percent Revenue $ 6,234 $ 8,119 $ (1,885 ) (23.2 )% Cost of revenue 4,636 5,699 (1,063 ) (18.7 )% Gross profit 1,598 2,420 (822 ) (34.0 )% Gross profit percentage 25.6 % 29.8 % Operating expenses: Research and development 704 518 186 35.9 % Selling 434 290 144 49.7 % General and administrative 1,450 1,490 (40 ) (2.7 )% Total operating expenses 2,588 2,298 290 12.6 % Operating income (loss) (990 ) 122 (1,112 ) * Other income (expense): Interest income 173 43 130 * Interest expense (6 ) - (6 ) * Foreign exchange income (expense) - (107 ) 107 * Other income 70 5 65 * Total other income (expense), net 237 (59 ) 296 * Income (loss) before income taxes (753 ) 63 (816 ) * Income tax expense - - - * Net income (loss) $ (753 ) $ 63 $ (816 ) * * Not meaningful Revenue (net of intersegment sales) CVD Equipment $ 4,756 $ 5,718 $ (962 ) (16.8 )% SDC 1,388 1,592 (204 ) (12.8 )% CVD Materials 90 809 (719 ) (88.9 )% Total $ 6,234 $ 8,119 $ (1,885 ) (23.2 )% 25 Revenue Our revenue for the three months ended September 30, 2023 was $6.2 million compared to $8.1 million for the three months ended September 30, 2022, a decrease of 23.2%. The decrease in our revenue versus the prior year period was primarily attributable to lower revenue of $1.0 million from the CVD Equipment segment related to lower equipment revenue, a $0.2 million decrease in revenue from our SDC segment and a $0.7 million decrease from the CVD Materials segment. The decrease in revenue in the period was principally the result of lower PVT150 system revenues at CVD Equipment partially offset by an increase in aerospace revenues in the CVD Equipment segment and lower revenues in the CVD Materials segment due to the sale of our Tantaline subsidiary and the wind down of our MesoScribe subsidiary. One customer represented 40.3% of our revenue for the three months ended September 30, 2023 and this customer is expected to continue to represent a significant portion of our revenue through June 30, 2024. There were certain customer contracts in 2023 where the revenue was to be recognized at the point in time when the equipment is transferred to the customer based on contract terms. These contracts were modified during the three months ended September 30, 2023 such that the revenue under these contracts is now being recognized over time using the input method. Company and CVD Equipment segment revenues for the three months ended September 30, 2023 include $0.8 million of revenue that was deferred as of June 30, 2023 and recognized on the date of the contract modification. Our order backlog at September 30, 2023 was approximately $16.6 million as compared to $17.8 million at December 31, 2022. Our backlog at September 30, 2023 consists of $15.5 million related to remaining performance obligations of contracts in progress and not yet started, and $1.1 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, any 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 our customers. Accordingly, orders received from customers and revenue recognized may fluctuate from quarter to quarter. Revenue contributed by the CVD Equipment segment for the three months ended September 30, 2023 of $4.8 million represented 76.3% of overall revenue as compared to $5.7 million or 70.4% of overall revenue for the three months ended September 30, 2022. The decrease in revenues of $1.0 million or 16.8% resulted principally from less PVT150 system revenues in the current quarter as compared to the prior year quarter that was offset by an increase in aerospace revenues. Revenue contributed by the SDC segment for the three months ended September 30, 2023 of $1.4 million represented 22.3% of overall revenue as compared to $1.6 million or 19.6% ended September 30, 2022. Revenue for our SDC segment decreased $0.2 million or 12.8% due to lower bookings 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. Revenue contributed by the CVD Materials segment for the three months ended September 30, 2023 of $90,000 represented 1.4% of our overall revenue as compared to $0.8 million or 9.7% of overall revenue for the three months ended September 30, 2022. The decline was principally due to the sale of our Tantaline subsidiary in May 2023 and the wind down of MesoScribe’s operations. 26 Gross Profit Gross profit for the three months ended September 30, 2023 was $1.6 million, with a gross profit margin of 25.6%, compared to a gross profit of $2.4 million and a gross profit margin of 29.8% for the three months ended September 30, 2022. The decrease in gross profit of $0.8 million was primarily due to changes in contract mix, increases in certain component costs and higher compensation costs and lower gross profit due to the sale of our Tantaline subsidiary and the wind down of MesoScribe’s operations. Research and Development For the three months ended September 30, 2023, research and development expenses were $0.7 million, or 11.3% of revenue as compared to $0.5 million, or 6.4% for the three months ended September 30, 2022. The increase in 2023 was the result of increased personnel and employee related costs to develop new products for key growth markets partially offset by a decrease in bonus expenses. 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 7.0% of the revenue for the three months ended September 30, 2023 as compared to $0.3 million or 3.6% for the three months ended September 30, 2022. The increase in 2023 was primarily the result of increased personnel and employee-related costs and an increase in trade shows as well as other marketing expenses to support increased marketing efforts. New personnel included a director of marketing and a sales director dedicated to the silicon carbide market. General and Administrative General and administrative expenses for the three months ended September 30, 2023 were $1.5 million or 23.3% of revenue compared to $1.5 million or 18.4% of revenue for the three months ended September 30, 2022. Increase in professional fees were offset by lower compensation costs. In addition, the prior period included a severance charge of $0.1 million. Other Income (Expense), Net Other income (expense), net was $0.2 million for the three months ended September 30, 2023 as compared to other income (expense), net of ($59,000) for the three months ended September 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, additional amounts received for employee retention credits and a reduction in the foreign exchange loss. Income Taxes Our provision for income taxes consists solely of state income taxes. Our deferred tax asset has been fully reserved. 27 Nine Months Ended September 30, 2023 versus September 30, 2022 The following table presents revenue and expense line items reported in our condensed consolidated statements of operations for the nine months ended September 30, 2023 and 2022 and the period-over-period dollar and percentage changes for those line items (in thousands, except percentages). Nine months ended September 30 2023 2022 Change Percent Revenue $ 19,998 $ 18,579 $ 1,419 7.6 % Cost of revenue 14,579 13,952 627 4.5 % Gross profit 5,419 4,627 792 17.1 % Gross profit percentage 27.1 % 24.9 % Operating expenses: Research and development 1,865 1,397 468 33.5 % Selling 1,281 895 386 43.1 % General and administrative 4,410 3,937 473 12.0 % Loss on disposition of Tantaline 162 - 162 * Impairment charge 111 - 111 * Total operating expenses 7,829 6,229 1,600 25.7 % Operating loss (2,410 ) (1,602 ) (808 ) (50.4 )% Other income (expense): Interest income 400 74 326 * Interest expense (18 ) (5 ) (13 ) * Foreign exchange income (expense) 42 (250 ) 292 * Other income 91 11 80 * Total other income (expense), net 515 (170 ) 685 * Loss before income taxes (1,895 ) (1,772 ) (123 ) (6.9 )% Income tax expense 11 1 10 * Net loss $ (1,906 ) $ (1,773 ) $ (133 ) (7.5 )% * Not meaningful Revenue (net of intersegment sales) CVD Equipment $ 13,670 $ 12,324 $ 1,346 10.9 % SDC 5,229 4,172 1,057 25.3 % CVD Materials 1,099 2,083 (984 ) (47.2 )% Total $ 19,998 $ 18,579 $ 1,419 7.6 % 28 Revenue Our revenue for the nine months ended September 30, 2023 was $20.0 million compared to $18.6 million for the nine months ended September 30, 2022, an increase of 7.6%. The increase in revenue versus the prior year period was primarily attributable to increased revenue of $1.3 million from the CVD Equipment segment related to equipment sales and spare parts, a $1.1 million increase in revenue from our SDC segment and a $1.0 million decrease from the CVD Materials segment. The increase in revenue in the period was principally the result higher aerospace revenues in the CVD Equipment segment, higher revenues in our SDC segment due to increased orders, and lower revenues in the CVD Materials segment due to the sale of the Tantaline subsidiary and the wind down of our MesoScribe subsidiary. Revenue contributed by the CVD Equipment segment for the nine months ended September 30, 2023 of $13.7 million represented 68.4% of overall revenue as compared to $12.3 million or 66.3% of overall revenue for the nine months ended September 30, 2022. The increase in revenues of $1.3 million or 10.9% represents increase in equipment orders in our aerospace, industrial and research markets offset by lower PVT150 system revenues. Revenue related to PVT150 systems sold to one customer represented 15.9% of our total revenues and 23.1% of CVD Equipment segment revenues during the nine months ended September 30, 2023. We recognized revenue on this contract as we construct the equipment for our customer. Revenue contributed by the SDC segment for the nine months ended September 30, 2023 of $5.2 million represented 26.1% of overall revenue as compared to $4.2 million or 22.5% of overall revenue for the nine months ended September 30, 2022. Revenue for our SDC segment increased $1.1 million or 25.3% 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. Revenue contributed by the CVD Materials segment for the nine months ended September 30, 2023 of $1.1 million represented 5.5% of our overall revenue as compared to $2.1 million or 11.2% of overall revenue for the nine months ended September 30, 2022. The decrease in revenue was principally due to the sale of Tantaline in May 2023 and the wind down of our MesoScribe subsidiary. Gross Profit Gross profit for the nine months ended September 30, 2023 was $5.4 million, with a gross profit margin of 27.1%, compared to a gross profit of $4.6 million and a gross profit margin of 24.9% for the nine months ended September 30, 2022. The increase in gross profit of $0.8 million was primarily the result of leveraging fixed costs on higher sales levels and an improved contract mix offset by certain component cost increases and higher compensation costs and lower gross profit due to the sale of our Tantaline subsidiary and the wind down of MesoScribe’s operations. 29 Research and Development For the nine months ended September 30, 2023, research and development expenses were $1.9 million, or 9.3% of revenue as compared to $1.4 million, or 7.5% for the nine months ended September 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 $1.3 million or 6.4% of the revenue for the nine months ended September 30, 2023 as compared to $0.9 million or 4.8% for the nine months ended September 30, 2022. The increase in 2023 was the result of increased personnel and employee-related costs and an increase in trade shows and other marketing expenses to support increased marketing efforts. General and Administrative General and administrative expenses for the nine months ended September 30, 2023 were $4.4 million or 22.1% of revenue compared to $3.9 million or 21.2% of revenue for the nine months ended September 30, 2022, an increase of $0.5 million. The increase in expenses was principally due to increases in personnel and employee-related costs of $0.5 million to support the growth of our business, higher professional fees of $0.3 million partially offset by lower consulting expenses of $0.1 million. In addition, the prior period included a severance charge of $0.1 million. 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 wind down its operations. Other Income (Expense), Net Other income, net was $0.5 million for the nine months ended September 30, 2023 as compared to other (expense), net of ($0.2 million) for the nine months ended September 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, additional amounts received for employee retention credits and a reduction in the foreign exchange loss. Income Taxes Our provision for income taxes consists solely of state income taxes. Our deferred tax asset has been fully reserved. 30 Liquidity and Capital Resources As of September 30, 2023, aggregate working capital was $16.2 million as compared to aggregate working capital of $15.5 million at December 31, 2022. Cash and cash equivalents at September 30, 2023 and December 31, 2022 were $14.3 million and $14.4 million, respectively. Net cash used in operating activities for the nine months ended September 30, 2023 was $0.1 million. This decrease was principally due to a net loss of $1.9 million, increases in contract assets of $0.7 million, increase in inventories of $1.8 million, decrease in accrued expenses of $0.7 million (primarily due to payment of 2022 bonus) offset by a decrease in accounts receivable of $1.2 million, collection of employee retention credit receivable of $1.5 million, an increase in contract liabilities of $0.8 million and non-cash items of $1.5 million. The increase in inventory was related to the production of PVT150 systems in anticipation of potential future orders. Capital expenditures for the nine months ended September 30, 2023 were $0.3 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. We received $0.6 million of deposits from the purchaser of certain MesoScribe equipment as described below. Cash flows from financing activities for the nine months ended September 30, 2023 included $0.1 million of proceeds from the exercise of employee stock options. On August 4, 2023, we entered into a Purchase and License Agreement (the “Agreement”) with the third-party. Pursuant to the Agreement, we 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 our 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. During the three months ended September 30, 2023, we received payments under the Agreement in the amount of $0.6 million which is reflected as deposits from purchaser in the accompanying condensed consolidated balance sheet as of September 30, 2023. We expect the transaction to be completed during the next three months with the shipment of the equipment to the purchaser. We expect to continue to fulfill remaining backorders for MesoScribe products through the end of 2024 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. 31 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, we 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. 32 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. Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable.