The following discussion and analysis of financial condition and results of operations is based upon and should be read in conjunction with the financial statements of the Company and notes thereto included in this report and the Company's Annual Report on Form 10-K for the year ended December 28, 2019 and in CPS's other SEC reports, which are accessible on the SEC's website at www.sec.gov and the Company's website at www.alsic.com.







Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements that involve a number of risks and uncertainties. There are a number of factors that could cause the Company's actual results to differ materially from those forecasted or projected in such forward-looking statements. This includes the impact of the COVID-19 pandemic, which is discussed in Item 3 of this report. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to publicly release the results of any revisions to these forward-looking statements which may be made to reflect events or changed circumstances after the date hereof or to reflect the occurrence of unanticipated events.





Critical Accounting Policies

The critical accounting policies utilized by the Company in preparation of the accompanying financial statements are set forth in Part II, Item 7 of the Company's Annual Report on Form 10-K for the year ended December 28, 2019, under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations". There have been no material changes to these policies since December 28, 2019.







Overview

Products we provide include baseplates for motor controllers used in high-speed electric trains, subway cars, wind turbines, and hybrid and electric vehicles. We provide baseplates and housings used in radar, satellite and avionics applications. We provide lids and heat spreaders used with high performance integrated circuits for use in internet switches and routers. We provide baseplates and housings used in modules built with Wide Band Gap Semiconductors like SiC and GaN. CPS also assembles housings and packages for hybrid circuits. These housings and packages may include MMC components; they may include components made of more traditional materials such as aluminum, copper-tungsten, etc.

CPS's products are custom rather than catalog items. They are made to customers' designs and are used as components in systems built and sold by our customers. At any point in time our product mix will consist of some products with on-going production demand, and some products which are in the prototyping or evaluation stages at our customers. The Company seeks to have a portfolio of products which include products in every stage of the technology adoption lifecycle at our customers. CPS' growth is dependent upon the level of demand for those products already in production, as well as its success in achieving new "design wins" for future products.

As a manufacturer of highly technical and custom products, the Company incurs fixed costs needed to support the business, but which do not vary significantly with changes in sales volume. These costs include the fixed costs of applications engineering, tooling design and fabrication, process engineering, etc. Accordingly, particularly given our current size, changes in sales volume generally result in even greater changes in financial performance on a percentage basis as fixed costs are spread over a larger or smaller base. Sales volume is therefore a key financial metric used by management.

The Company believes the underlying demand for metal matrix composites is growing as the electronics and other industries seek higher performance, higher reliability, and reduced costs. CPS believes that the Company is well positioned to offer our solutions to current and new customers as these demands grow.

Our products are manufactured by proprietary processes we have developed including the QuicksetTM Injection Molding Process ('Quickset Process') and the QuickCastTM Pressure Infiltration Process ('QuickCast Process').

CPS was incorporated in Massachusetts in 1984 as Ceramics Process Systems Corporation and reincorporated in Delaware in April 1987 through a merger into a wholly-owned Delaware subsidiary organized for purposes of the reincorporation. In July 1987, CPS completed our initial public offering of 1.5 million shares of our Common Stock. In March 2007, we changed our name from Ceramics Process Systems Corporation to CPS Technologies Corporation.

Results of Operations for the First Fiscal Quarter of 2020 (Q1 2020) Compared to the First Fiscal Quarter of 2019 (Q1 2019); (all $ in 000's)

Revenues totaled $6,512 in Q1 2020 compared with $5,270 generated in Q1 2019, an increase of 24%. About one third of this increase was due to increased unit volume with the balance due to price changes in Q1 2020 compared with Q1 2019.

Gross margin in Q1 2020 totaled $1,550 or 24% of sales. This compares with gross margin in Q1 2019 of $159 or 3% of sales. Increases in sales volume as well as a reduction in manufacturing expenses of $202 predominantly account for this change. As stated above, the sales increase was the result of increases in both unit sales volume and price. The increase of unit sales volume was more than offset by increased efficiencies in manufacturing resulting in the reduction in manufacturing expenses.

Selling, general and administrative (SG&A) expenses totaled $929 in Q1 2020 compared with SG&A expenses of $904 in Q1 2019. Although the Company has been able to reduce sales commission rates where appropriate, this increase was due almost entirely to increased sales commissions as a result of increased sales.

The Company experienced an operating profit of $622 in Q1 2020 compared with an operating loss of $744 in Q1 2019 as a result of the improved gross margin.

The Company is part of the Defense Industrial Base and thus has been open and operating throughout the COVID-19 pandemic. The COVID-19 pandemic did not affect financial results for the quarter ended March 28, 2020. The Company believes the pandemic will negatively affect financial results, at least modestly, in upcoming quarters.

Since the outbreak of the pandemic, the Company has aggressively implemented CDC guidelines in the workplace to prevent the spread of COVID-19. For example, the Company has staggered shifts to eliminate overlap at shift changes, reorganized workstations to ensure social distancing, implemented daily screening of all employees by taking employees' temperatures, etc. Where possible, employees are working from home.

Demand from customers remains strong as of today, but this demand may be reduced due to COVID-19 related factors such as government-mandated business closings, inability of our customers to obtain components from other suppliers, etc.

We are now seeing certain operating costs increasing such as freight costs. Employee absenteeism has increased due to school closings, employees caring for sick family members, etc. Increased absenteeism is causing labor inefficiencies and increased use of overtime.

Because demand has remained strong, no employees have been furloughed and employee hours have not been reduced. The Company does not currently need and is not participating in the Payroll Protection Program of the CARES Act. The Families First Coronavirus Response Act requires the Company to pay employees who are absent due to specific COVID-19 reasons, but allows the Company to recover this cost via a reduction in the Company's portion of payroll taxes.

All of these factors combine to create a higher degree of uncertainty regarding future financial performance, however, as of today the Company believes the effect of the COVID-19 pandemic on future financial performance will be negative, but modest.

Liquidity and Capital Resources (all $ in 000's unless noted)

The Company's net cash and cash equivalents at March 28, 2020 totaled ($1,455). (Net cash is defined as cash and cash equivalents less bank borrowings.) This compares to cash and cash equivalents at December 28, 2019 of ($1,116). Payment terms for customers range from payment in advance to 90 days from shipment and are based on factors such as credit worthiness, volume of business, etc. The decrease in net cash was due primarily to longer terms for our large customers, including the elimination of the prompt pay discount, resulting in an increase in working capital (i.e. receivables and inventory less payables and accruals).

Accounts receivable at March 28, 2020 totaled $5,959 compared with $4,087 at December 28, 2019. Days Sales Outstanding (DSO) increased from 67 days at the end of 2019 to 77 days at the end of Q1 2020. The increase in DSO was due to higher sales at the end of the quarter compared to the beginning of the quarter, as well as higher sales to one customer with longer payment terms. The accounts receivable balances at December 28, 2019, and March 28, 2020 were both net of an allowance for doubtful accounts of $10.

Inventories totaled $3,595 at March 28, 2020 compared with inventory totaling $3,100 at December 28, 2019. The inventory turnover in the most recent four quarters ending Q1 2020 was 6.0 times (based on a 5 point average) compared with 6.2 times averaged during the four quarters of 2019.

The Company financed its increase in working capital in Q1 2020 from its profit and increased borrowings of $328 from its line of credit with BDC Capital. The Company expects it will continue to be able to fund its operations for the remainder of 2020 from existing cash balances and bank borrowings.

The Company continues to sell to a limited number of customers and the loss of any one of these customers could cause the Company to require additional external financing. Failure to generate sufficient revenues, raise additional capital or reduce certain discretionary spending could have a material adverse effect on the Company's ability to achieve its business objectives.

Contractual Obligations (all $ in 000's unless otherwise noted)

In September 2019, the Company entered into revolving line of credit (LOC) with Massachusetts Business Development Corporation (BDC) in the amount of $2.5 million. This agreement replaces the $1.25 million line of credit with Santander Bank. The agreement includes a demand note allowing the Lender to call the loan at any time. The Company may terminate the agreement without a termination fee after 3 years. The LOC is secured by the accounts receivable and other assets of the Company and has an interest rate of LIBOR plus 650 basis points. At March 28, 2020 the Company had $1.58 million of borrowings under this LOC and its borrowing base at the time would have permitted an additional $922 thousand to have been borrowed. The increased availability has allowed the Company to end its policy of allowing prompt pay discounts to certain customers. This has and should continue to have a positive effect on the Company's earnings going forward.

In March 2020, the company acquired a Sonoscan ultrasound microscope for a price of $208. The full amount was financed through a 5 year note payable with Crest Capital Corporation. The note is collateralized by the microscope and is being paid in monthly installments of $4, consisting of principal plus interest at a rate of 6.47%

As of March, 28 2020 the Company had $287 of construction in progress and no outstanding commitments to purchase production equipment.

The Company has two real estate leases-one expiring in February 2021 and one with an 11 month duration with options to extend additional years. Since the latter is not reasonably certain that any options will be exercised, it has not been recorded on the balance sheet. CPS also has a few other leases for equipment which are minor in nature and are generally short-term in duration. None of these have been capitalized. (Note 4, Leases)

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