Sypris Solutions' (SYPR) CEO Jeffrey Gill on Q1 2016 Results - Earnings Call Transcript

| About: Sypris Solutions, (SYPR)

Sypris Solutions, Inc. (NASDAQ:SYPR)

Q1 2016 Results Earnings Conference Call

May 18, 2016, 9 AM ET

Executives

Jeffrey Gill - President and CEO

Anthony Allen - Vice President and Chief Financial Officer

Analysts

Jim Ricchiuti - Needham & Company

Operator

Good day and welcome to the Sypris Solutions, Inc., First Quarter 2016 Earnings Conference Call. Today's call is being recorded.

At this time for opening remarks, I would like to turn the call over to the President and Chief Executive Officer, Mr. Jeffrey Gill. Please go ahead, sir.

Jeffrey Gill

Thank you, Angela, and good morning, everyone. Tony Allen and I would like to welcome you to this call, the purpose of which is to review the company's financial results for the first quarter of 2016.

For those of you who have access to our PowerPoint presentation this morning, please advance to slide 2 now. We always begin these calls with a note that some of what we might discuss here today may include projections and other forward-looking statements. No assurance can be given that these projections and statements will be achieved, and actual results could differ materially from those projected as a result of several factors. These factors are included in the company's filings with the Securities and Exchange Commission.

And in compliance with Regulation G, you can access our website at sypris.com to review the definitions of any non-GAAP financial measures that may be discussed during this call. With these qualifications in mind, we'd now like to proceed with the business discussion.

Please advance to slide 3. I will lead you through the first half of our presentation this morning, starting with an overview of the highlights for the quarter to be followed by a brief discussion of each of our two business segments. Tony will then provide you with a more detailed review of our financial results for the quarter.

Now let's begin with the overview on slide 4. The financial performance for the company during the first quarter of 2016 marked a material improvement when compared to the prior year’s results, even after taking into account the softness in demand from the commercial vehicle market.

Revenue declined $5.2 million from the prior year period, excluding the results from our former Morganton production facility, while gross profit increased significantly as both operating units contributed to the comparable period improvement.

Gross margin expanded to 2.7%, up significantly from the loss of 8.5% for the prior year, reflecting the positive impacts of both cost reduction activities and improved product mix. As a result, earnings per share improved on both a year over year and on a sequential basis.

As we mentioned during our call in March, our momentum at year end continued to accelerate as we entered 2016. On the bookings front, orders for Sypris Electronics reached $29 million during the quarter, exceeding both our expectations for the period and last year's bookings of $4.6 million. We will delve further into this important achievement shortly, but needless to say that it represents a very important building block going forward.

We also noted that we’ve completed the sale of our underutilized real estate in Toluca, Mexico on March 9, generating gross proceeds of approximately $12.2 million. The book value of the property approximated $3.2 million. As part of the transaction, the company entered into a lease with the buyer for the space currently occupied by Sypris, which accounts for roughly 40% of the facility.

Tony will be pleased to address the accounting for this transaction with you momentarily. In conjunction with the sale leaseback transaction, we agreed to some changes in our revolving credit facility that resulted in a further increase in availability for the company going forward.

And finally, our adjusted net debt at quarter end approximated $15.4 million, which included $3.3 million for the capitalized lease obligation associated with the sale leaseback transaction and $6.5 million of subordinated debt.

In summary then, the company reported a year over year increase in gross profit of $3.9 million and an $8.2 million increase in EBITDA, reflecting the positive impact of reduced costs and improved product mix. Sypris Electronics reported bookings of $29 million and the company further increased its liquidity through the sale of underutilized assets.

Clearly, significant progress has been made over the past 15 months. The company's fixed overhead has been meaningfully reduced, underperforming and underutilized assets have been divested, significant liquidity has been raised and important new business has been secured. We have more work yet to do, but we have a great team and the company is clearly positioned for a much better 2016.

Turning now to slide 5, the long-sought-after turn in the financial performance of Sypris Electronics commenced during 2015 and continued to progress during the first quarter of 2016 as investments in new products and security technologies began to gain traction in the marketplace.

More specifically, revenue increased slightly when compared to the prior year, while gross profit increased 46% year over year, reflecting the impact of the new sales mix and the revised cost structure and profitability. As you would expect, gross margin improved in a similar fashion to 15.2%, up from 10.6% for the first quarter of 2015. As the business continues to grow, we expect to benefit from the additional financial leverage associated with improved mix and reduced costs.

As I mentioned a moment ago, the level of new bookings recorded by Sypris Electronics during the first quarter represented a significant accomplishment for our team. We received a purchase order in the amount of $13.8 million for the manufacture of circuit card assemblies for use in a program of the United States Armed Services. Deliveries under this new contract are scheduled to begin in the fourth quarter of this year and will continue through 2018, with an estimated $12 million of the order supporting production requirements beyond 2016.

We were awarded a $5 million engineering services contract during the quarter for a defense program, which is expected to be a key contributor to our margin expansion objectives. We received orders of $4.1 million for encryption cards as well as another contract for the purchase of the Cyber Range from Kyushu University in Fukuoka, Japan. Plans are to use the Range as a security training platform in preparation for the 2020 Olympics, which will be hosted in Tokyo.

In a similar vein, we were notified by an agency of the Department of Defense that its intent to deploy Range to test, evaluate and train personnel for the next generation of cyber threats. Most certainly the rate of year over year bookings growth will moderate as we move forward into subsequent quarters, but it does provide us with an increasingly solid foundation from which to expand the top line and margins of the business during 2016.

Turning now to slide 6, as the commercial interest in the Range continues to accelerate, we see an increasingly wide variety of applications for its use. For example, the Range appears to be an excellent tool for use by corporations to assess their cyber resilience and to increase the effectiveness of their responses to future cyber attacks.

We are evaluating the merits of providing secure online access to the Range for classrooms and other remote training opportunities where the income stream would be in the form of a service or a subscription. We have a substantial backlog of quotes, yet we seem to just be getting started. We will see.

During October, we successfully completed the demonstration of our new SiOMetrics identity authentication solution at Dell World, using sensors by Analog Devices, gateways by Dell, and cloud management systems by NEC. The purpose of the demonstration was to show how SiOMetrics might be used to provide end-to-end security, from the sensor through the gateway to the cloud.

We believe SiOMetrics to be a potential game-changer in the development of security architecture, where we believe that SiOMetrics eliminates many of the vulnerabilities inherent in existing public key infrastructure systems, the architecture used today by the majority of commercial security applications, thereby positioning it well for use in the rapidly growing applications for the Internet of Things.

The technology is less costly, highly scalable; we have demonstrated its ability to successfully scale to 1 million endpoints; and we believe that it is capable of being integrated seamlessly with existing systems across industrial, financial, commercial, healthcare, and government sectors.

The technology is targeted for future use in a wide variety of applications, ranging from securing mobile payments, enterprise computing and social networking infrastructures to automobiles, industrial automation equipment and missile defense systems. We have received five patents to date, with 14 additional patent applications pending.

As we mentioned in March, our task moving forward is to generate positive financial results in return for the time and investments we have made over the past several years. We believe that our new cyber security solutions business lines are poised for strong double digit growth in 2016, supported by recent awards, Cyber Range sales and pending applications for SiOMetrics.

The benefits associated with Sypris Electronics’ lower cost structure should continue in 2016, with the expectation that SG&A expenses will once again be meaningfully lower than those of the prior year. The combination of top line growth, improved mix and lower costs is expected to yield positive year over year results with expanding gross margins.

Now, let's take a quick look at Sypris Technologies beginning the slide 7. Revenue decreased from the prior year period, reflecting the sale of our nonstrategic Morganton operations during 2015, softness in the commercial vehicle market and some inventory rebalancing during the period by our customers.

Gross profit, however, increased by $3.4 million despite the decline in sales, reflecting the lower cost structure of the business and improved production throughput. We have made and will continue to make adjustments to our workforce to align with demand from our customers to ensure our mutual success.

As we mentioned earlier, we completed the sale and leaseback transaction of our underutilized Toluca facility during March of this year, which represented an important accomplishment and effectively converted an underutilized asset into lower net debt and a real source of liquidity for use in building the business going forward.

We currently have over 100 part numbers in queue for PPAP approval, which is the acronym used in the industry referred to Production Part Approval Process. As we pass testing and secure approval from our customers during the coming months, these parts will move into production and provide the business with important new revenue as the year progresses.

And finally, the energy markets appear to be firming with the price of oil rising during the quarter from $29.92 per barrel at the end of December to $40.75 per barrel at the conclusion of April, and more recently the price of Brent crude exceeded $49 per barrel. In any event, price stability in the $40 to $60 range would be a real plus for the industry.

As many of you know, our revenue from this part of our business has remained steady on a year over year basis, reflecting our solid revenue stream from MRO activity, which benefits from 60 years of installed base as well as from our increased market penetration into natural gas applications. Should the increase in prices lead to new projects, we will be in a good position to benefit.

Now, let’s wrap up on slide 8. The outlook for the markets served by Sypris Technologies continue to be buffeted in the short term by uncertainty and softness. More specifically, the production of Class 5-8 commercial vehicles is forecast by ACT to decline 14% in 2016 when compared to the prior year, with production forecasts for each quarter of 2016 to be below that of 2015 on a year over year basis. ACT is forecasting a return to comparable period growth beginning in Q2 of 2017.

We are looking forward to another stable year from our natural gas, oil and petrochemical markets, despite the continued uncertainties in the energy field. Most of our products are used in transmission, processing and storage, which we hope will continue to be less subject to the pressures emanating from the price of crude. We are also introducing several new products in 2016, which we hope will further increase our book of business with existing customers.

Our priorities for 2016 are clear. We must successfully launch the patented Sypris Ultra series light-weight axle shaft with Detroit Axle. We must ramp up new programs successfully. We must close on the additional new programs that are close to the boat and that can utilize our productive capacity effectively, especially in Toluca, Mexico.

We plan to invest to increase productivity and efficiency, driving process improvements through the use of TPS techniques to reduce cycle times and increase reliability. And we will continue to aggressively monitor costs to match our revenue profile.

In summary, the first quarter of 2016 marked a period of important and continued progress for the company. The cost of fixed overhead was reduced, underutilized assets were divested, liquidity was increased and substantial new business was secured. Our job is not yet done, but we're looking forward to a much improved year in 2016.

Turning now to slide 9, Tony will lead you through the balance of our presentation this morning.

Anthony Allen

Thanks, Jeff. Good morning, everyone. I'd like to take you through the highlights of our financial results for the first quarter of 2016 and I will begin with our consolidated results and ask to you advance to slide 10.

Q1 consolidated revenue totaled $26.9 million, down $10.1 million compared to the prior year. The decline in revenue for the first quarter period is attributable to Sypris Technologies as Sypris Electronics increased $200,000 over the prior year. The two primary factors for the revenue decrease at Sypris Technologies are the loss of revenue associated with the trailer manufacturing operation we sold in 2015 and reduced demand from customers in the commercial vehicle market. These factors will be discussed further on our next slide.

Gross profit improved to $700,000 in the quarter from a loss of $3.2 million in the prior year period. Both segments contributed to the improvement in gross profit, with favorable revenue mix contributing to the improvement at Sypris Electronics and cost reductions throughout 2015 primarily driving the improvement at Sypris Technologies.

EBITDA improved to negative $2.3 million in the quarter from negative $10.5 million in the prior year period. The increase in EBITDA of $8.2 million primarily reflects the improvement in gross profit, lower SG&A expense and the gain recognized on the sale leaseback transaction for our Mexico real estate during the quarter.

Our SG&A cost was $2.6 million lower in Q1 as compared to the prior year, primarily reflecting reduced spend on professional fees associated with litigation on contract matters with Dana and lower employment cost attributable to headcount reductions. Partially offsetting these SG&A reductions was a $500,000 charge in Q1 of 2016 for our estimated ongoing and final repairs related to the facility occupied by Sypris Electronics.

The lease for this facility expires at the end of 2016 and we are currently involved in litigation with the landlord over responsibility for certain improvements to the facility which requires that these amounts be reserved. This charge is classified within SG&A expense in our statement of operations.

On the other income line of our P&A, we reported a gain of $2.4 million in Q1 of 2016 on the sale leaseback transaction related to the portion of the Toluca, Mexico facility sold which was not lease backed by Sypris. Additionally, we recorded a deferred gain of $5.5 million which will be recognized over the term of the lease.

The portion of real estate not leased back by Sypris in this transaction was vacated by Dana at the end of 2014 and had not been occupied since that time. The sale leaseback transaction enabled us to monetize the unutilized portion of this facility and secure a multi-year lease for the portion we have occupied since we acquired the property in 2004.

Our adjusted net debt as of the end of the first quarter decreased $1.1 million to $15.4 million from $16.5 million at the end of Q1 2015. Adjusted net debt includes amounts due under our credit agreement, less cash balances on hand, including restricted cash. As of the end of Q1 2016, adjusted net debt also includes a $3.3 million obligation for the capital lease on our Toluca, Mexico facility.

Let me now shift to segment performance and ask you to please advance to slide 11. Sypris Technologies reported $17.8 million in revenue, negative $700,000 in gross profit and positive $300,000 in EBITDA. As noted earlier, there are two primary factors for the revenue decrease for Sypris Technologies.

First, in July 2015, we sold our Morganton, North Carolina facility to Meritor. Although we transferred certain manufacturing assets related to axle machining from Morganton to our Louisville, Kentucky facility, the trailer axle business produced in Morganton transferred to Meritor as part of the transaction. The divestiture of this business accounts for $4.8 million of the decrease in revenue for the comparable period.

The second factor for the change in revenue is market related. Beginning in November 2015, our customer orders dropped reflecting reduced demand from the OEMs that flowed to our customers as the Class 8 commercial vehicle market abruptly tightened. The impact of inventory levels at the dealer level and more specifically at our customers has resulted in sharp order reductions that continued through the first quarter of 2016.

The current forecast by ACT Research shows a 26.8% decline for full year 2016 from 2015 for North American Class 8 production. The quarterly Class 8 production forecast is calling for sequential declines from Q2 through Q4 of 2016. So we anticipate demand from our existing commercial vehicle customers will continue to be unfavorably impacted by market conditions for the balance of the year.

ACT's current forecast for North American Class 5-7 production shows an increase of 2.7% in 2016 over 2015, which provides some relief to the Class 8 forecasts, but still results in an overall drop for medium and heavy commercial vehicle demand for the balance of the year.

Gross profit in Q1 improved $3.4 million for Sypris Technologies from the prior year period, reflecting the actions taken throughout 2015 to bring our cost structure in line with the revenue profile of the business and to drive productivity improvements in Louisville and Toluca.

Efforts continue to further align cost to balance with the market fluctuations we are experiencing and to improve our operating metrics based on the current volume and mix at each plant. Additionally, Morganton trailer axle operation we divested in 2015 had negative gross profit in Q1 2015 and therefore the divestiture of that operation contributed to the year over year improvement in gross profit.

EBITDA for Sypris Technologies improved significantly from Q1 2015 to Q1 2016. The $7.6 million year over year increase reflects the gross profit improvement, the SG&A decrease and the sale leaseback gain previously discussed.

Sypris Electronics reported $9.1 million in revenue, $1.4 million in gross profit and negative $300,000 in EBITDA. Revenue in Q1 for Sypris Electronics had more product and cyber revenue and less electronic design and manufacturing service revenue than the prior year quarter, driving a change in mix and a slight increase in revenue over 2015. The EDMS business was lower primarily due to one large program that shipped in Q1 and Q2 of 2015 prior to going end of life. The revenue increase and mix change gave rise to improved gross profit as the contribution margins for Cyber Range and certain product sales are typically higher than those for our EDMS programs.

EBITDA for the first quarter improved $1.1 million over 2015. Like its sister company, Sypris Electronics also reduced SG&A expense through headcount reductions throughout 2015 and is continuing to work to control spending in Q1 2016. Although we are reporting EBITDA negative $300,000 in Q1, if you exclude the $500,000 charge for the estimated repairs to the Tampa facility, EBITDA was positive $200,000 for the first quarter of 2016.

Let me now close with a brief summary and ask you to please advance to slide 12. Revenue in Q1 was $26.9 million, reflecting a reduction in demand in the market for commercial vehicles, the rebalancing of inventory by our customers and the divestiture of the non-core trailer axle business in 2015, which accounted for $4.8 million of revenue in the prior year first quarter period.

Our gross margin improved to 2.7% of revenue compared to a loss of 8.5% for Q1 of 2015, primarily reflecting a lower fixed overhead structure within Sypris Technologies compared to the prior year and a change in product mix within Sypris Electronics. First quarter EBITDA increased $8.2 million over the prior year, primarily driven by the improved operating results and the gain recognized in the first quarter of 2016 on the sale leaseback transaction in Mexico.

The sale leaseback transaction generated $12.2 million in gross cash proceeds. The net proceeds after transaction-related expenses were $11.1 million, of which $6 million is being held in a cash collateral account against our term debt, with the balance of the net proceeds available to fund our operations in the US and Mexico.

One of the highlights of the quarter that didn't impact our financial results in Q1 but certainly provide support for the business going forward is the receipt of orders by Sypris Electronics valued at $29 million. This order total compares to $4.6 million in Q1 of 2015 and represents the highest quarterly orders total in several years.

These orders support all of the service and product offerings of Sypris Electronics and results from the actions of all of our employees to pursue and win these important programs. Thanks and congratulations to the entire team at Sypris Electronics. And finally, we will continue working to control costs, while taking actions to rebuild and diversify our customer base.

This concludes our call today. And at this time, I'd like to turn it back over to Angela so that we can open it up for any questions you might have for us at this time. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] We will take our first question from Jim Ricchiuti with Needham & Company.

Jim Ricchiuti

Tony, just first off on SG&A, so the total charge in SG&A for the quarter?

Anthony Allen

Related to the Tampa lease was $0.5 million.

Jim Ricchiuti

$0.5 million, okay. So going forward, how should we maybe think of that SG&A expense? Do you anticipate it dropping ex-that, would you anticipate being able to see lower SG&A this quarter?

Anthony Allen

Excluding the charge, certainly we will see – we anticipate seeing a drop related to that charge not recurring. But beyond that, I do think we have some opportunity to reduce our SG&A. We also had in the first quarter some professional fees related to our debt amendment and some of those activities that we aren’t anticipating to reoccur.

Jim Ricchiuti

And on the [indiscernible] Sypris Electronics, good margins in the quarter. Would you anticipate that mix will be – there will be a mix shift in the June quarter that could provide a little bit – some pressure on the margin sequentially? Just sounds like you had a good mix of revenues in Q1 and that may not be sustainable in Q2.

Anthony Allen

We have an opportunity in Q2, it's not going to be the same mix. But if you look at our split in our EDMS business and with some of our severe customers, in the severe environment side of the manufacturing service business, we have some opportunity there. Certainly, the Cyber is a little lumpier and we won't see the same benefit in Q2 that we had in Q1 from the Cyber business. But we still have some opportunities there as well. So there will be some pressure on that, Jim, but we're trying to manage that as we go through – sequentially go through our quarters.

Jim Ricchiuti

Jeff, are you more optimistic on the Cyber side as you look out over the balance of the year?

Jeffrey Gill

I think 2016 will be a very good year for us Cyber area, Jim. So, yes, we're optimistic.

Jim Ricchiuti

And so from a booking standpoint, while there – this may not actually be able to maintain this level of bookings necessarily, you still feel pretty good or reasonably confident that you turn the corner on that side of the business?

Jeffrey Gill

Knock on wood, yes sir.

Jim Ricchiuti

Looking at the commercial vehicle market, I mean it appears to have deteriorated further since the end of March, I’m not sure that's consistent with the ACT data or not, but as I think about the second half of the year, do you have the potential to show improvement just on the basis of maybe the Ultra program and some of these other parts programs that you discussed or is it just – is the market just going to be too much of a headwind?

Jeffrey Gill

At the moment, Jim, our outlook is that the PPAP process, as we move through that in these new parts and their production is that – our outlook is that we will be able to offset the headwinds associated with the commercial vehicle market. But we’re sitting here in May and who knows what could happen in August or September. But at the moment, our outlook is that we have the opportunity to offset that. So we would look at the year as being plus or minus relatively stable rather than having significant deterioration.

Operator

[Operator Instructions] I’m seeing that there are no other questions. I'd like to turn the conference back to Mr. Gill for any additional or closing remarks.

Jeffrey Gill

Thank you, Angela. Tony and I would like to thank you all for joining us on the call this morning. We welcome your continued interest and, of course, your questions about our business. Thank you and have a great day.

Operator

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation.

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