Notes to Condensed Consolidated Financial Statements

(unaudited)

NOTE 1:         

BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements for CVD Equipment Corporation and Subsidiaries (collectively “the Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. They do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary in order to make the interim financials not misleading have been included and all such adjustments are of a normal recurring nature. The operating results for the three and six months ended June 30, 2021 are not necessarily indicative of the results that can be expected for the year ending December 31, 2021.

The condensed consolidated balance sheet as of December 31, 2020 has been derived from the audited consolidated financial statements at such date, as filed on Form 10-K with the SEC on March 31, 2021, but does not contain all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with that report.

All material intercompany balances and transactions have been eliminated in consolidation. In addition, certain reclassifications have been made to prior period consolidated financial statements to conform to the current period presentation.

BUSINESS DEVELOPMENTS

In January 2021, the Company’s Board of Directors concluded that a change in the Company’s business strategy and direction was necessary and appointed Emmanuel Lakios as President and Chief Executive Officer (previously our Vice-President- Sales and Marketing) to, among other things, evaluate the Company’s business strategy and operations. Based on this evaluation, due to the continuing losses and significant investments required to continue in the Materials business, the Board concluded that our primary focus should be on the core equipment business and that the Materials Business strategy should be revised, with some of its current element’s potentially minimized or ceased.  Based upon an analysis, including forecasted continued losses and negative cash flows for the Tantaline product line, the Company has implemented plans to eliminate further investment in our Tantaline product line. In addition, we recorded an impairment charge of $3.6 million during the fourth quarter and year ended December 31, 2020, related to Tantaline Long lived assets. In addition, the Company continues to monitor its costs and will take actions to mitigate expenses in the future to align them with anticipated revenue levels.

NOTE 1: (continued)

During February 2021, in order to increase the Company’s liquidity and to provide necessary working capital to support the Company’s on-going business and operations, the Board decided to sell its facility located at 555 North Research Place, Central Islip, NY (the “555 Building”). Management determined the 555 Building is not needed for present and future business operations and concluded that any remaining elements of the Materials Business can be consolidated into its remaining facility in Central Islip (the “355 Building”), which it believes can accommodate any needs for our growth for the foreseeable future. In April 2021, the Company completed the move of its Tantaline product line to the 355 Building, while the MesoScribe consolidation into the 355 Building has been initiated. All functions of the Tantaline product line have been consolidated into the Denmark office and the United States expenses related to Tantaline have ceased. On March 29, 2021, the Company entered into an agreement with Steel K, LLC for the sale of the 555 Building, and on July 26, 2021 the Company closed on the sale of the 555 Building. The sale price was $24,360,000, subject to adjustment for apportionments, adjustments and credits. A portion of the sale proceeds were used to satisfy the existing mortgage debt on the 555 Building, including interest and fees, in the amount of $9,352,719, as well as various costs related to the closing of the transaction. The net proceeds to the Company were approximately $14,000,000 (see Note 14).

NOTE 2:         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition

The Company designs, manufactures and sells custom chemical vapor deposition equipment through contractual agreements. These system sales require the Company to deliver functioning equipment that is generally completed within three to eighteen months from commencement of order acceptance. The Company recognizes revenue over time by using an input method based on costs incurred as it depicts the Company’s 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, typically within three months to eighteen months.

Incurred costs include all direct material and labor costs and those indirect costs related to contract performance, such as 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, and installed, as required by the project’s engineering design. Cost based input methods of revenue recognition require the Company 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, the Company recognizes the entire estimated loss in the period the loss becomes known and can be reasonably estimated.

NOTE 2:         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Revenue Recognition (continued)

“Contract assets,” include unbilled amounts typically resulting from system sales under contracts and revenue recognized exceeds the amount billed to the customer. The amount may not exceed their estimated net realizable value. Contract assets are classified as current based on our contract operating cycle.

“Contract liabilities,” include advance payments and billings in excess of revenue recognized. The Company typically receives down payments upon receipt of order and progress payments during the manufacturing cycle. Contract liabilities are classified as current based on our contract operating cycle and reported on a contract-by-contract basis, net of revenue recognized, at the end of each reporting period.

For outright sales of products, revenue is recognized when control of the promised products or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those products or services (the transaction price). A performance obligation is a promise in a contract to transfer a distinct product or service to a customer and is the unit of account under ASC 606, “Revenue from Contracts with Customers”.

Recent Accounting Standards

In June 2016, the FASB issued Accounting Standard Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326), which require that financial assets measured at amortized cost be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset to present the net carrying value at the amount expected to be collected. The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the increase or decreases of expected credit losses that have taken place during the period. The measurement of expected credit losses is based upon historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. On November 15, 2019, the FASB delayed the effective date for smaller reporting companies. The amendments in this update are now effective for fiscal years beginning after December 15, 2022 and interim periods within those annual periods. We are currently evaluating the effect of this update on our consolidated financial statements.

We believe there is no additional new accounting guidance adopted, but not yet effective that is relevant to the readers of our financial statements. However, there are numerous new proposals under development which, if and when enacted, may have a significant impact on our financial reporting.

NOTE 3:         CONCENTRATION OF CREDIT RISK

Cash and cash equivalents

The Company had cash and cash equivalents of $5.4 million and $7.7 million at June 30, 2021 and December 31, 2020, respectively. The Company invests excess cash in U.S. treasury bills, certificates of deposit or money market accounts, all with original maturities of less than three months. Cash equivalents were $1.0 million at June 30, 2021 and December 31, 2020, respectively.

The Company places most of its temporary cash investments with financial institutions, which from time to time may exceed the Federal Deposit Insurance Corporation limit. The amount at risk at June 30, 2021 and December 31, 2020 was $3,203,000 and $5,822,000, respectively.

Sales concentration

Revenue from a single customer in any one period can exceed 10% of our total revenues. During the three months ended June 30, 2021, three customers exceeded 10%, and represented 17.3%, 12.9% and 11.2% of revenues, and during the six months ended June 30, 2021 one customer exceeded 10%, and represented 18.0% of revenues. During the three months ended June 30, 2020, two customers exceeded 10%, and represented 42.2% and 10.0% of revenues, and during the six months ended June 30, 2020, one customer represented 37.0% of revenues.

Accounts receivable

The Company sells products and services to various companies across several industries in the ordinary course of business. The Company performs ongoing credit evaluations to assess the probability of accounts receivable collection based on a number of factors, including past transaction experience, evaluation of their credit history and review of the invoicing terms of the contract to determine the financial strength of its customers. The Company also maintains allowances for anticipated losses. At June 30, 2021, two customers exceeded 10% of the accounts receivable balance, representing 20.2% in total, and at December 31, 2020 two customers represented 35.0% of the accounts receivable balance.

NOTE 4:         REVENUE DISAGGREGATION

The following table represents a disaggregation of revenue for the three and six months ended June 30, 2021 and 2020 (in thousands):

NOTE 4:         REVENUE DISAGGREGATION (continued)

The Company has unrecognized contract revenue of approximately $3.2 million at June 30, 2021, which it expects to recognize as revenue within the next twelve months.

Judgment is required to evaluate assumptions including the amount of net contract revenues and the total estimated costs to determine our progress towards contract completion and to calculate the corresponding amount of revenue to recognize.

Changes in estimates for sales of systems occur for a variety of reasons, including but not limited to (i) build accelerations or delays, (ii) product cost forecast changes, (iii) cost related change orders or add-ons, or (iv) changes in other information used to estimate costs. Changes in estimates may have a material effect on the Company’s consolidated statements of operations.

Contract Assets and Liabilities

Contract assets consist of (i) retainage which represent the earned, but unbilled, portion for which payment is deferred by the customer until certain contractual milestones are met; and (ii) unbilled receivables which represent revenue that has been recognized in advance of billing the customer, which is common for long-term contracts. Contract liabilities consist of customer advances and billings in excess of revenue recognized.

During the six months ended June 30, 2021 and 2020, the increase in contract assets of approximately $.6 million and $.4 million, respectively, was the result of work performed in excess of billings which are based upon project milestones.

Contract assets and contract liabilities on input method type contracts in progress are summarized as follows:

NOTE 6:         ACCOUNTS RECEIVABLE, NET

Accounts receivable are presented net of an allowance for doubtful accounts of approximately $59,000 and $164,000 as of June 30, 2021 and December 31, 2020, respectively. The allowance is based on prior experience and management’s evaluation of the collectability of accounts receivable. Management believes the allowance is adequate. However, future estimates may change based on changes in future economic conditions.

NOTE 7:         LONG-TERM DEBT

The Company has a loan agreement with HSBC which is secured by a mortgage against our Central Islip, NY headquarters. The loan is payable in 120 consecutive equal monthly installments of $25,000 in principal plus interest and a final balloon payment upon maturity in March 2022. The balances as of June 30, 2021 and December 31, 2020 were approximately $1.9 million and $2.1 million respectively. Interest accrues on the loan, at our option, at the variable rate of LIBOR plus 1.75% or Prime less 0.5% (1.82% and 1.89% at June 30, 2021 and December 31, 2020, respectively).

On November 30, 2017, the Company purchased the premises located at 555 North Research Place, Central Islip, NY (the “555 Building”). The purchase price of the building was $13,850,000 exclusive of closing costs. The Company’s wholly-owned subsidiary, 555 N Research Corporation (the “Assignee”) and the Islip IDA, entered into a Fee and Leasehold Mortgage and Security Agreement (the “Loan”) with HSBC in the amount of $10,387,500, which was used to finance a portion of the purchase price to acquire the premises located at 555 North Research Place, Central Islip, New York. The Loan was evidenced by the certain note, dated November 30, 2017 (the “Note”), by and between Assignee and the Bank, and secured by a certain Fee and Leasehold Mortgage and Security Agreement (the “Mortgage”), dated November 30, 2017, as well as a collateral Assignment of Leases and Rents. On July 26, 2021, the Company closed on the sale of the 555 Building and satisfied the loan.

The Note was payable in 60 consecutive equal monthly installments of $62,481 including interest and a final balloon payment upon maturity which was to be in December 2022. The balance outstanding as of June 30, 2021 and December 31, 2020 were approximately $9.1 million and $9.3 million respectively. The Note bore interest for each Interest Period (as defined in the Note), at the fixed rate of 3.9148%. As a condition of the Bank making the Loan, the Company was required to guaranty Assignee’s obligations under the Loan pursuant that certain Unlimited Guaranty, dated November 30, 2017 (the “Guaranty”). As of June 30, 2021, the full amount of this Note is recorded as Liabilities Held For Sale (see Note 8 and Note 14).

NOTE 7:         LONG-TERM DEBT (continued)

The Company is in compliance with its financial covenant under the mortgage at June 30, 2021.

On April 21, 2020, the Company entered into a loan agreement (the “Loan Agreement”) with HSBC Bank USA, National Association pursuant to which the Company was granted a loan in the principal amount of $2,415,970, pursuant to the Paycheck Protection Program (the “PPP”) under Division A, Title I of the CARES Act, which was enacted by the United States Congress on March 27, 2020.

The PPP loan, the obligation of which is represented by a note issued by the Company, was to mature on April 21, 2022 and bore interest at a rate of 1% per annum. The note may be prepaid by the Company at any time prior to maturity with no prepayment penalties. Under the terms of the PPP, all or a portion of the Loan may be forgiven, based upon payments made in the first twenty-four weeks following receipt of the proceeds, related to payroll costs, continue group health care benefits, utilities and mortgage interest on other debt obligations incurred before February 15, 2020. The Company filed an application for forgiveness in April 2021 and on June 14, 2021 the Company received a notification from its lender that on June 10, 2021 the SBA approved the Company’s PPP Loan forgiveness application and remitted payment to the lender for the entire principal amount of the PPP Loan and accrued interest. As a result, the Company has recognized in the three and six months ended June 30, 2021 Gain on debt extinguishment in the amount of $2,443,418.

NOTE 8: ASSET AND LIABILITIES HELD FOR SALE

In order to increase the Company’s liquidity and to provide necessary working capital to support its on-going business and operations, the Company has decided to sell the 555 Building. Management has determined the 555 Building was not needed for present and future business operations, and any remaining elements of the Materials Business can be consolidated into the 355 Building, which management believes can accommodate any needs for the Company’s growth for the foreseeable future.

On March 29, 2021, the Company entered into an agreement with Steel K, LLC for the sale of its 555 Building, and on July 26, 2021 the Company closed on the sale of the 555 Building. The sale price was $24,360,000, subject to adjustment for apportionments, adjustments and credits. A portion of the sale proceeds were used to satisfy the existing mortgage debt on the 555

NOTE 8: ASSET AND LIABILITIES HELD FOR SALE (continued)

Building, including interest and fees, in the amount of $9.4 million, as well as various costs related to the closing of the transaction. As a result, the Company has classified the carrying value of the building of $16.2 million as Assets held for sale (which was utilized by CVD Materials) as part of current assets at June 30, 2021, which were previously recorded at December 31, 2020 and prior as part of property, plant and equipment on the Company’s consolidated balance sheet.

In addition, the Note related to the 555 Building was classified as part of current liabilities at June 30, 2021, Liabilities Held For Sale in the amount of $9.1 million, which were previously recorded at December 31, 2020 and prior as part of both current and long term debt on the Company’s consolidated balance sheet.

NOTE 9:         STOCK-BASED COMPENSATION EXPENSE

The Company recorded, as part of general and administrative expense, $62,000 and $113,000 during the three and six months ended June 30, 2021, respectively, and during the three and six months ended June 30, 2020, $69,000 and $141,000, respectively, for the cost of employee and director services received in exchange for equity instruments based on the grant-date fair value of those instruments.

A summary of the stock option activity related to the 2001 Stock Option Plans, the 2007 Share Incentive Plan and the 2016 Share Incentive Plan for the period from January 1, 2021 through June 30, 2021 are as follows:

NOTE 9:         STOCK-BASED COMPENSATION EXPENSE (continued)

For the six months ended June 30, 2021, the Company granted 150,000 stock options, vesting 25% per year over four years, with a ten-year life. The Company determined the fair value of stock options granted during the six months ended June 30, 2021 is based upon assumptions as provided below.

NOTE 9:         STOCK-BASED COMPENSATION EXPENSE (continued)

The Company has a total of 560,000 outstanding stock options, of which 390,000 were exercisable under the three plans at June 30, 2021.

The following table summarizes information about the outstanding and exercisable options at June 30, 2021.

No options were exercised during the six months ended June 30, 2021. As of June 30, 2021, there was $385,960 of unrecognized compensation costs related to stock options expected to be recognized over a weighted average period of 3.9 years.

The fair value of the outstanding restricted stock awards will be recorded as stock compensation expense over the vesting period. As of June 30, 2021, there was $89,000 of total unrecognized compensation costs related to restricted stock awards, which is expected to be recognized over a weighted-average period of .5 years.

The total fair value of vested restricted stock units was $29,700 for the six months ended June 30, 2021.

The fair value of the outstanding restricted stock units will be recorded as stock compensation expense over the vesting period. As of June 30, 2021, there was $14,000 of total unrecognized compensation costs related to restricted stock units, which is expected to be recognized over a weighted-average period of .7 years.

NOTE 10:         INCOME TAXES

As of June 30, 2021 and December 31, 2020, the Company has provided a full valuation allowance against all of the net deferred tax assets. This was based on management’s assessment, including the last three years of operating losses, that it is more likely than not that the net deferred tax assets may not be realized in the future. On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) was enacted by the United States Congress. As a result of the enactment of the CARES Act, net operating losses (“NOL’s”) generated in 2018-2020 can now be carried back for five years and resulted in the Company recognizing approximately $1.5 million of a tax benefit, of which $.7 million is a receivable at June 30, 2021 and December 31, 2020. Management continues to evaluate for potential utilization of the Company’s deferred tax asset, which has been fully reserved for, on a quarterly basis, reviewing our economic models, including projections and timing of orders, and cost containment measures.

NOTE 11:         EARNINGS PER SHARE

Basic earnings per share is computed by dividing net earnings available to common shareholders (the numerator) by the weighted average number of common shares outstanding (the denominator) for the period presented. The computation of diluted earnings per share is similar to basic earnings per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued.

A reconciliation of basic to diluted shares used in the earnings per share calculation is as follows:

The following table represents common stock equivalents that were excluded from the computation of diluted earnings per share for the three and six months ended June 30, 2021 and 2020, because the effect of their inclusion would be anti-dilutive.

Stock options to purchase 560,000 shares of common stock were outstanding and 390,000 were exercisable during the three and six months ended June 30, 2021.

The dilutive potential common shares on options is calculated in accordance with the treasury stock method, which assumes that proceeds from the exercise of all options are used to repurchase common stock at market value. The number of shares remaining after the proceeds are exhausted represents the potential dilutive effect of the securities.

NOTE 12:          SEGMENT REPORTING

The Company operates through three (3) segments: CVD Equipment (“CVD”), Stainless Design Concepts (“SDC”) and CVD Materials (“Materials”). The CVD segment is utilized for chemical vapor deposition equipment manufacturing. SDC is the Company’s ultra-high purity manufacturing division in Saugerties, New York for gas control systems. The Materials segment was established to provide material coatings for aerospace, medical, electronic and other applications. The Company evaluates performance based on several factors, of which the primary financial measure is income or (loss) before taxes.

The Company’s corporate administration activities are reported in the Eliminations and Unallocated column. These activities primarily include intercompany profit, expenses related to certain corporate officers and support staff, expenses related to the Company’s Board of Directors, stock option expense for shares granted to corporate administration employees, certain consulting expenses, investor and shareholder relations activities, and all of the Company’s legal, auditing and professional fees, and interest expense.

Three Months Ended June 30,

(In thousands)

*All elimination entries represent intersegment revenues eliminated in consolidation for external financial reporting.

NOTE 13:          SIGNIFICANT EVENTS- CORONAVIRUS (COVID-19)

The Company has been actively monitoring the coronavirus (COVID-19) outbreak and resulting pandemic and its impact on both the global economic and operating environment and specifically on its impact to the Company, its employees, its operations and its financial condition.  In March 2020, the World Health Organization recognized the COVID-19 outbreak as a pandemic based on the global spread of the disease, the severity of illnesses it causes and its effects on society. In response to the COVID-19 outbreak, the governments of many countries, states, cities and other geographic regions have taken preventative or protective actions, such as imposing restrictions on travel and business operations, including complete or partial government shutdowns of many schools and businesses, including our Company, and advising or requiring individuals to limit or forego their time outside of their homes. Accordingly, the COVID-19 outbreak has severely restricted the level of economic activity in many countries, including the United States, and continues to materially and adversely impact global economic activity.  In particular, the aerospace sector, for which the Company relies on a significant part of its business, has been faced with significant reductions to its business due to lack of air travel. The Company’s new order levels commencing in the first quarter of 2020, continuing into the first quarter of 2021 have seen substantial reductions, while new orders in the second quarter of 2021 where substantially higher at approximately $6.0 million, and which have materially and adversely affected revenues commencing in our second quarter of 2020. While the financial results for the Company’s first quarter of 2020 reflected the initial impact of COVID-19, and the year ended  December 31, 2020 and first six months ended June 30, 2021 reflected a substantial adverse effect, the Company is unable to predict the extent of the impact the pandemic will have on its financial position and operating results for the remainder of 2021 due to numerous uncertainties, but the impact could be material during any future period affected either directly or indirectly by this pandemic.  The Company intends to continue to evaluate the various government sponsored plans and programs put in place in response to the COVID-19 pandemic and further plans to take advantage of any such government benefits reasonably available to it.  Moreover, the Company will continue to monitor developments in that area as new government initiatives are passed.