Sypris Solutions, Inc. (NASDAQ:SYPR) Q4 2015 Results Earnings Conference Call March 30, 2016 9:00 AM ET
Jeffrey Gill - President and CEO
Tony Allen - CFO
Jim Ricchiuti - Needham & Company
Good day, and welcome to the Sypris Solutions, Inc. Conference Call. Today’s call is being recorded. At this time for opening remarks, I would like to turn the call over to President and Chief Executive Officer, Mr. Jeffrey Gill. Please go ahead, sir.
Thank you, Lisa, 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 fourth quarter and full year 2015. For those of you, who have access to our PowerPoint presentation this morning, please advance to slide two 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 three. I will lead you through the first half of our presentation this morning, starting with an overview of the highlights for the year to be followed by a brief discussion each of our two business segments. Tony will then provide you the more detailed review of our financial results for the quarter and year.
Now, let’s begin with the overview on slide four.
The year 2015 represented a period of significant change and adjustment for the Company. As most of you know, our inability to successfully resolve our contractual dispute with Dana resulted in the termination of all shipments to Dana as of December 31, 2014. The resulting loss of approximately $200 million per year of business was significant under any circumstances, but especially so for the Sypris plants located in North Carolina and Mexico that were previously all but dedicated to supplying Dana.
Much of the year was spent responding to our new reality. We implemented system-wide cost reduction initiatives that exceeded $9 million of savings on an annualized basis. We raised $15.7 million in transactions related to the sale of our underutilized manufacturing facility in Morganton, North Carolina, recognizing a gain on the sale $7.7 million in the process. We secured $27 million of new financing in October, consisting of an asset-based revolving credit facility for up to $15 million and a $12 million term loan to replace revolving credit facility that had been in place previously. And we raised $5.5 million of subordinated debt to further support our liquidity requirements and operational needs.
We were successful in securing new long-term contracts with Volvo and Detroit Axle for the supply of drive-train components for years to come. We commissioned our first Cyber Range for the Security Operations Center, operated by the Ministry of Home Affairs in Singapore and we sold another Range to the NEC Corporation for its internal use in the cyber security training, modeling and simulation.
Our momentum continued as we entered 2016; advancing to slide five. We were awarded $5 million contract during the first quarter of the New Year for engineering services for a defense program. The Company was notified by an agency of the Department of Defense of its intent to deploy the Cyber Range to test, evaluate and train personnel for the next generation cyber threats. We also received a purchase order from Cyber Range for Kyushu University in Fukuoka, Japan.
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 program are scheduled to begin late this year and will continue through 2018.
On the liquidity front, we completed the sale of our underutilized real estate in Toluca, Mexico on March 9th, generating gross proceeds of approximately $12.1 million. The book value of the property was $3.2 million. As part of the transaction, the Company entered into a lease to the buyer for the space currently occupied by Sypris, which accounts for roughly 40% of the facility, much of the gain on the transaction will be recognized over the life of the lease. We also agreed to some changes in our revolving credit facility that resulted in increased availability.
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.
I think that it’s appropriate to pause for a moment and thank all of those who played a part in the many accomplishments that we’ve just reviewed. We sincerely appreciate your hard work and dedication. This made a significant difference. So, on behalf of the Company, thank you.
Turning to slide six, the long side after turn [ph] in the financial performance of Sypris Electronics commenced during 2015 as the investments in new products and security technologies began to gain traction in the marketplace. More specifically, revenue increased 14% to $37.2 million when compared to the prior year, representing an important inflection point for the business. The story becomes even more interesting however when you consider what the impact of a new sales mix and revised cost structure had on profitability.
For 2015, sales increased by $4.7 million but operating income increased by $5.8 million or 123% of sales. As the business continues to grow, we expect to benefit from the additional financial leverage associated with the improved mix and reduced costs. Orders for the year increased 20% to $36.7 million, outpacing the percentage growth in sales. Importantly, this momentum, as we discussed a moment ago, has carried over into 2016 with a booking of NEC, Kyushu and other programs in Q1. We now expect orders for the first quarter to reach $24 million compared to $4.6 million for the comparable period in 2015. Most certainly, the rate of year-over-year bookings growth will moderate as we forward into subsequent quarters that will provide us with an increasingly solid foundation from which to grow the top-line of the business during 2016.
Orders for the Cyber Range continue to gain attraction, beginning with the installation and commissioning of our Range in the Security Operations Center of Singapore during the third quarter. In the fourth quarter, we received an order for a Range from the NEC Corporation for its internal use. NEC plans to use the Range as a platform for cyber security training, modeling and simulation.
During the first quarter of 2016, Range was sold for installation at Kyushu University in Fukuoka, Japan. Plans are to use the Range as a security training platform in preparation for the 2020, which will be hosted in Tokyo. In a similar vein, we were notified by an agency of the Department of Defense of its intent to deploy a Range to test, evaluate and train personnel for the next generation of cyber threats.
Turn now to slide seven. As the commercial interest in the Range continues to accelerate, we see an increasingly wide variety of applications for it 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, [ph] yet we seem just begin and start it; 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 to 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 the existing public key infrastructure systems the architecture used today by the majority of commercial security applications, thereby positioning it well for using the rapidly growing applications for the Internet of Things.
The technology is less costly, highly scalable, we have demonstrated its ability to successfully scale through one million end points, and we believe that it is capable of being integrated seamlessly with existing systems across industrial, financial, commercial, healthcare, and government sectors. The technology can be used 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. 2015 also closed out on a positive note for trusted manufacturing sales to customers with applications in severe environments, including Northrop Grumman, Exelis, Lockheed Martin, L3 and TE Subcom. Business activity continued to grow in this area during the year, thereby positioning this business for a further potential expansion in 2016. The recent $13.8 million multiyear purchase order for circuit card assemblies was certainly an additional positive building block in this regard.
Turning now to slide eight, 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 cyber security solutions business is poised for strong double-digit growth in 2016 supported by the recent awards, Cyber Range sales and pending applications for SiOMetrics, among others.
The benefits associated with the 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 cost is expected to yield positive year-over-year results with expanding gross margins.
Now, let’s take a quick look at Sypris Technologies beginning with slide nine. Revenue decreased significantly during 2015, as the business adjusted to life after the termination of shipments to its largest customer. The key item to note is that despite the meaningful reduction in revenue, gross profit for the business remained positive in each of the three quarters following Q1. It’s also worthwhile to note that EBITDA for the year was positive as was free cash flow. This was no small feat and was a result of diligent cost management and close control over working capital by our team in this business. We should also point out that quality and on time delivery remained at world class levels despite all of the destruction emanating from the change.
As we mentioned a moment ago, the Company sold its manufacturing operation in Morganton, North Carolina to Meritor and raised approximately $15.7 million in connection with this transaction and in the process, recognized a gain of $7.7 million on the transaction. It should also be noted that the receipt of these proceeds was not included in the determination of positive free cash flow for the year but was otherwise additive to our results. We have made and continue to make adjustments to our workforce to align with demand from our customers. As we mentioned earlier, volume fell dramatically during the fourth quarter of 2015, reflecting the decline in demand for new trucks and some inventory rebalancing by our customers.
Turning now to slide 10, during the year, we announced the award of new long term contracts with Volvo and Detroit Axle, a unit of Daimler Trucks North America. We also expanded our sales with a range of other customers due to our increased book of business and the continued strength of the commercial vehicle market during the first 10 months of the year. The global energy market was negatively impacted in almost unprecedented fashion during 2015 as the price of oil fell from a $100 per barrel in August of 2014 to $29.92 in January of 2016. The impact on petrochemical projects has been significant and certainly impacted our plans to expand further during the year.
The good news is that our revenue from this part of our business remains steady on a year-over-year basis, reflecting our solid revenue stream from MRO activity, which benefits from 60 years in installed base as well as from our increased market penetration into natural gas applications. And with all the operational progress that has been made in recent years, it should be of no surprise that our coding [ph] activity for new business with both existing customers and with new potential customers is quite active.
Now, let’s wrap up on slide 11. The outlooks for the market served by Sypris Technologies continue to be buffeted in the short term by uncertainty and softness. More specifically, the production of Class 8 heavy duty trucks is forecast to decline 27% in 2016 when compared to the prior year with material declines in production forecast for each quarter of 2016 on a year-over-year basis. ACT is forecasting a return to comparable period growth beginning in Q3 of 2017. The forecast for demand for Class 4 through 7 medium duty trucks continues to remain steady for 2016, when compared to the prior year. When combining with the Class 8 outlook, ACT is forecasting 16% year-over-year decline in truck production.
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 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.
As we mentioned earlier that year 2016 will also benefit from the sale leaseback of our underutilized real estate in Toluca, Mexico. In March of this year, we received an estimated $12.1 million from the sale of the property, which carried a book value of $3.2 million. As part of the transaction, the Company entered into a lease with the buyer of the space, currently occupied by Sypris, which accounts roughly 40% of the facility. Much of the gain on the transaction will be recognize over the life of the lease.
Our priorities for 2016 are clear. We must successfully lunch the patented Sypris Ultra series light-weight axle shaft with Detroit Axles this coming spring. We must ramp up our new programs successfully. We must close on those additional programs that are close to the boat and 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 then, it has been a year of dramatic change, one in which we have by necessity had to reconfigure our business. Costs have been addressed; underperforming and unutilized assets have been divested; liquidity has been raised; and new business has been secured. Our job is not yet done, but we’re looking forward to a much improved year in 2016.
Turning now to slide 12, Tony will lead you through the balance of our presentation this morning.
Thanks, Jeff, and good morning, everyone. I’d like to discuss with you some of the highlights of our fourth quarter and full year 2015 financial results. I’ll start with our consolidated results and ask you to advance to slide 13.
Q4 consolidated revenues totaled $29.1 million, down $58.1 million or 67% from the prior year, primarily related to the discontinuation of business with Dana at the end of 2014 and the divestiture of our Morganton, North Carolina operation at the beginning of Q3 2015. Q4 revenue was also impacted by an overall reduction in the Class 8 commercial vehicle market, which experienced a sharp reduction in orders beginning in November 2015. These market conditions are expected to remain soft with current forecast showing a reduction in Class 8 production in the range of 25% in 2016 from 2015.
On a positive note, full year revenue for Sypris Electronics increased $4.7 million or 14% from 2014. Consolidated gross profit for both the fourth quarter and full year declined from the prior year levels, primarily due to the significant reduction in revenue. This impact of the lower volume was partially offset in both the quarterly and full year comparisons by cost reductions in both segments and a more favorable revenue mix for Sypris Electronics that generated an increase in gross profit.
We decreased SG&A expense by $4.7 million and $7.7 million for the comparative Q4 and full year period, reflecting overall cost reduction measures implemented during 2015 including headcount reductions and lower professional fees among other changes. EBITDA for Q4 and full year was negative $2.8 million and negative $12 million respectively with the full year number inclusive of a $7.7 million gain on the sale of Morganton in the third quarter. A comparison of first half versus second half consolidated EBITDA excluding the gain on the Morganton transaction shows an improvement from negative $15 million in the first half to negative $4.7 million in the second half.
Free cash flow was negative $2.4 million in Q4 and negative $15.3 million for the full year 2015. We define free cash flow as cash flow from operations less capital expenditures. And therefore, the proceeds from the Morganton transaction in Q3 of 2015 are excluded in free cash flow.
Let me now discuss our segments and start with Sypris Technologies on slide 14. During 2014, Dana accounted for approximately 65% of segment revenue for Sypris Technologies. The loss of business with this customer combined with the divestiture at the Morganton operation in Q3 and the Class 8 market downturn in Q4 drove a revenue decrease of 75% to $20.2 million for the quarter as compared to Q4 of 2014. Revenue for the full year decreased 66% to $108.1 million compared to $322.3 million in 2014. The management team of Sypris Technologies implemented a series of cost reduction actions throughout 2015 to offset the impact of the revenue decline whilst driving to retain the key talent within all levels of our organization to enable us to execute our recovery plans to emerge as stronger Company.
After starting 2015 with a loss at the gross profit line in Q1, Sypris Technologies generated positive gross profit in each of the last three quarters, totaling $3.3 million for the last nine months, which equaled 4.1% of revenue for that period. Although our gross profit remained positive in Q4 at $0.8 million, the pressure of the declining Class 8 market and its impact on our revenue in Q4 reversed our trend of sequential quarterly gross profit improvements from Q1 to Q3. We also controlled SG&A expense throughout 2015 with sequential reductions each quarter with Q4 finishing the year at 8.7% of revenue compared to Q1 at 17.5% of revenue.
Moving on to Sypris Electronics, please advance to slide 15. Fourth quarter revenue came in at $8.9 million, up $1.8 million or 26% from the prior year quarter. Full year 2015 revenue was $37.2 million, an increase of 14% from 2014. Revenue from manufacturing service programs for both defense and severe environment customers accounted for the majority of the increase for the full year competitive period while the Q4 increase was primarily attributable to secure communication product sales.
The revenue mix for both the fourth quarter and full year periods for 2015 was favorable compared to the prior year periods, resulting in higher variable contribution margins; combined with other reductions in fixed overhead, gross profit increased $1.3 million in Q4 and $4.3 million for the full year. Similar to the technology segment controls over SG&A spend were implemented during 2015 and SG&A expense was reduced to 17.7% of revenue in Q4, compared to 25.4% of revenue in Q1. We continued to invest to develop our new technologies during 2015 with internal R&D spend of $0.7 million.
On the next slide, I’ll highlight changes in our debt structure and I ask that you please advance to slide 16. As previously reported, we entered into new senior secured debt agreements on October 30, 2015 consisting of a revolving credit facility with maximum borrowings up to $15 million and a $12 million term loan. Availability under the asset base revolving credit facility is determined based on specified percentages of eligible accounts receivable and inventories. The proceeds received from the new debt agreements for use to repay in full, both the senior secured credit facility with our prior lender and the subordinated debt incurred in 2015 and payable to Meritor. In connection with the refinancing of the senior debt, the Gill Family also agreed to extend the maturity date of its subordinated loan to the Company.
Let me now wrap up with a brief summary of 2015 and ask you to please advance to slide 17. We faced many challenges during 2015, resulting from the loss of a major customer for Sypris Technologies that impacted our financial performance, while results for Sypris Electronics improved as new programs started to gain traction. We have reduced our fixed overhead, sold underperforming and underutilized assets, improved our liquidity and landed important new business to improve our outlook for the coming year. We generated $15.7 million in cash proceeds through transactions involving a sale of our manufacturing assets located in Morganton, North Carolina. We secured new credit facilities of upto $27 million and raised $5.5 million in subordinated debt.
Subsequent to quarter end, we completed the sale-leaseback for our Toluca, Mexico facility, generating approximately $12.1 million in gross proceeds. We also amended our subordinated debt to provide additional liquidity. And Sypris Electronics received several significant awards in Q1 of 2016, ranging from circuit card assemblies to Cyber Range sales and expect Q1 bookings to reach $24 million. Summary, we made important progress in 2015 with further margin expansion and EBITDA growth targeted for 2016.
This concludes our call today. And at this time, I’d like to turn back over to Lisa to answer any questions you might have for us at this time. Thank you very much.
Thank you, sir. [Operator Instructions] And we will take our first question from Jim Ricchiuti from Needham & Company.
I have a few questions. Jeff, I’m wondering is what you’re hearing from your commercial vehicle customers, is it consistent with some of the data that you cite in the presentation in terms of the decline in the Class 5 through 8 markets?
Yes, it’s certainly not more optimistic at this point. I think that ACT may be tracking in the middle of the road. And so, we believe that I think ACT is forecasting 235,000 units for Class 8 this year. And we’ll see how that runs; it may be a little softer than that but we’ll see. But yes, generally speaking.
Okay. Is there -- I’m wondering to what extent there could be some incremental revenues from either new programs or new customers that perhaps can mitigate some of the weakness in the market as we look at 2016.
Certainly, we’ve got a lot of folks for the Sypris Ultra series shaft. And as that moves into the production here in the next several months, we believe that that will give us some lift. We also have several new programs that we’re working on that could be additive, particularly through our Mexican operation.
Okay. And with Ultra, so what kind of milestones do we need to see? I think I heard you mention this spring and maybe you could talk a little bit about what we should anticipate or what we should be watching for?
I don’t know that there’ll be anything publicly, Jim, but the Ultra is scheduled to become a significant proportion of the axle shaft components used by Detroit Axle. And we’ve been going through a lot of let’s call low rate production to provide Detroit Axle with samples to look at in a variety of areas. But, depending on how quickly Detroit Axle replaces its existing design with the new Ultra series will certainly have an impact on us. And if that goes more quickly than not, then we should expect to see some lift.
Okay. And the orders that you are anticipating on the electronic side of the business, $24 million in Q1, first off, I was wondering can you provide and kind of backlog for the electronics business. I’m just curious what you may have exited the year with in terms of backlog in that business.
Let us get back to you on that Jim. We don’t that data handy here.
Okay. I guess what I’m getting to is if we think about the business that you have in this $24 million that you’re anticipating, what kind of -- what do you think is going to shippable first of all of this $24 million that you’re anticipating, how much would be shippable in 2016?
Okay. Well, let me break it into pieces for you then. Of the 24, roughly $14 million would be tied to the circuit card assembly contract we just received and in that 14, the shipments begin in Q4 and run through 2018, so essentially, a little over 24 months. And so that contract would impact us primarily late this year. In terms of the remaining $10 million of backlog, roughly $5 million of that is tied to an engineering services contract. And the agency that awarded us that contract is behind. And so, while normally it’s a 22-month deliverable on that, we have the ability to draw as much of that into 2016 as we can with our resources. And so, we’ll be working to do that. And so whether we end up shipping half of that, $5 million in 2016 or earning it in 2016 or whether we can get to 60% or 70%, that’s kind of the range I think that would be logical. And then the balance of the backlog is all shippable this year or balance of these orders we receive is all shippable this year.
Okay. And then last question, just curious, cyber. How meaningful, Jeff, do you think that could be for you from a revenue standpoint in ‘16? I mean it sounds like you’ve got couple -- few irons in the fire here, some encouraging signs. Could it be a meaningful revenue stream?
Well, for us, Jim, just about anything at this point is meaningful. But yes, without being precocious, yes, it can be and will be. And just as importantly, the margins that we’re realizing off this now that the development expenses have for all intents and purposes wrapped up, at least in terms of the current versions. So, we’re having some very nice yields off of this. And so, the profit contribution, quite frankly, far outweighs the top-line contribution.
Yes. And then that’s actually where I was going to. So, if I think about the mix of the electronics business in ‘16, if things work out, we could see -- it sounds like you could see a nice improvement in margins, even if revenues are below historical levels going back two years?
Yes, I think you’re absolutely right. We should expect from this side of our businesses, we will have top-line growth this year. It will be a fairly material change in mix. And in that change in mix, we’ll have a lot more higher margin cyber security products, if you will. And then combining that with the SG&A that we’ve taken out over the past 12 to 15 months, we feel that there is a lot of leverage there.
Okay, great. Thanks a lot.
Yes. Thanks Jim.
And gentlemen, we currently have no additional questions on the phone.
Okay. Lisa, then, on behalf of Tony and the rest of us here, we’d like to thank everyone on this call for joining us. We welcome your continued interest and of course questions about our business. Thank you and have a great day.
And ladies and gentlemen, this does conclude today’s conference. We do thank you for your participation. You may now disconnect and have a wonderful rest of your day.
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