Sypris Solutions Inc (SYPR) 2010 Q3 法說會逐字稿

Good day, and welcome to the Sypris Solutions third quarter earnings conference call.

Today's call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to the President and Chief Executive Officer, Mr.

Jeffrey Gill.

Please go ahead.

Thank you, Katie, and good morning, everyone.

Brian Lutes, Tony Allen, and I would like to welcome you to this call, the purpose of which is to review the trends reflected in the Company's financial results for the third quarter of 2010.

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.

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 would 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 quarter, to be followed by a brief discussion of each of our two business segments.

Brian will then provide you with a more detailed review of our financial results for the quarter.

Now let's begin with an overview on slide four.

We are pleased to report that the Company continued to make important progress during the quarter.

Revenue increased 16.3% sequentially to $73.4 million during the period, driven by a 25% increase in AMD revenue and a 13.2% increase in industrial sales.

Gross profit increased 55.3% sequentially to $7.7 million, up from $4.9 million in Q2, reflecting the impact of a 101% increase in AMD gross profit.

Gross margin increased to 10.4% of revenue, up from 7.8% sequentially, and up from 8.3% for the third quarter of last year, reflecting the impact of AMD margin expansion to almost 26% during the period.

We were also pleased to report three important nonfinancial developments here recently.

The first was the award of $3.1 million of R&D funding by the Department of Energy for a project to protect US power grids from cyber attacks.

The second was the formation of an international strategic alliance with Cassidian, formally known as EADS Defense and Security, which is the second-largest division of the EADS Group.

And finally, we announced plans to create an international cyber range to host cyber warfare testing for the US government and its partners.

We plan to address each of these three exciting announcements a little later in our presentation, but needless to say, when combined with the continued improvement in financial results for the quarter, it was a very positive and meaningful period for Sypris.

Let's turn to slide five now, and take a quick look at our industrial group.

The demand for commercial vehicles continued to recover, driving a 41.9% increase in revenue during the period, or $15.6 million when compared to the prior year quarter.

Gross margin increased to 4.4% from 0.3%, highlighting the benefits of the higher volume and impact of a dramatically lower cost base.

We initiated an important program launch for a new customer during the quarter, the cost to which depressed our short-term performance.

Launch is expected to complete during the current quarter with positive results to follow in 2011.

We also kicked off a comprehensive readiness plan to prepare our operations for the forecasted increases in the truck cycle in 2011 and beyond.

These forecasts range from 25% to 55%, depending upon the source, and the investments that we are making include additional maintenance, repair, and rebuilding of equipment, special training programs for existing and new hires, the acceleration of lean initiatives to reduce cycle time, change overs, and direct costs, and the investment in additional inventory buffers, spare parts, and tooling.

What's important to take away from this last point is the fact that we are investing rather heavily both in preparation and in time to make certain that as the truck market starts to rebound to let's call it more normal levels, is that, first of all, we are able to meet that demand efficiently and timely for our customers, but also, secondly, that we are able to take advantage of what we believe will be significant operational leverage that comes as the market returns to normalcy.

Now let's take a look more specifically at the outlook on slide six.

In the area of medium duty, inventories appear to have bottomed out, and are viewed by many as being quite lean.

What the implication of this is, is that, as demand picks up, that should translate immediately into increased production.

In the area of heavy duty, North American orders continue to trend higher and freight growth is expected to be above historical averages for the next several years, all of which portends continued growth in this important market for some time to come.

Trailers, the outlook is similar.

It remains positive but, of course, is subject to the vagaries of the economy as we all know.

There are a couple of other interesting points that could affect this market, both in a positive and a negative way.

First, there is a sort of vision of service hours under consideration which would reduce the amount of hours that a driver can drive from 11 to 10.

If this is adopted, it would have an impact on the demand for trucks by increasing the need 10 to 15% above current forecasts, and 10 to 20% above current forecasts for trailers.

Offsetting this, is also some concern about the availability of truck drivers.

It has been widely speculated that with the economy slowly picking back up, but more importantly, demand for vehicles having to pick up even more significantly to replace retiring vehicles, is that the availability of truck drivers is going to cause a problem for fleets.

Depending upon the source of research, that shortage can be as much as 5% to 6% on a base of three million truck drivers.

So, if that, in fact, occurs, it will be a dampening effect on demand.

But in any case, as you look at the chart here on the bottom of this slide, the important take away is under a variety of scenarios, we are looking at material double-digit increases in demand over the next several years.

And that, in an effort to be conservative, we believe it is appropriate to plan for the higher volumes rather than the lower volumes, because that means the equipment will be ready, the people will be ready, the processes will be ready, and we will be in a position to meet that demand efficiently.

If it comes slower than what is forecast, that won't be an issue for us.

So now let's take a look at Aerospace and Defense, beginning on slide seven.

Revenue increased 25% sequentially with the resumption of shipments that had previously been placed on hold by the government.

With the return of revenue, gross margin increased almost 26% during the quarter from 16% in the second quarter of this year, reflecting the positive impact of increased volumes and the continuous improvement activities that we've discussed in the past.

Costs were incurred during the quarter to complete the consolidation of our Colorado facility into our main Florida operation, the result of which is expected to have a further positive impact on our cost profile going into 2011.

Bookings and backlog continued to strengthen, posting the third consecutive quarter of growth during the period, while quoting activity remained positive, providing important support for our plans for 2011 and beyond.

And as we mentioned at the beginning of our presentation this morning, several important announcements were made in the key management and cyber security areas.

We would like to take a moment now to go into each of those more fully.

So let's advance to slide eight and start with the award we received from the Department of Energy.

The award was received during the quarter.

We expect to have the actual contract finalized in the fourth quarter of this year.

But basically, we received $3.1 million of funding from the Department of Energy to develop a centralized cryptographic key management system to protect the nation's electric power grid from cyber attacks.

The project is intended to improve the security of the SmartGrid meters at residences by utilizing electronic data keys to limit access while preventing intruders from launching a cyber attack on the system.

We are partnering with Purdue University, Oak Ridge National Laboratory, and the Electric Power Research Institute on this important three-year project.

And we were one of eight projects -- ours was one of eight projects that was awarded by the DOE that is focused on efforts to strengthen the US electric grid against cyber intrusion.

What is really interesting about this is that if our hypothesis is proved out, if we are able to effectively demonstrate that we can use key management to secure the power grid, the next phase, the implementation phase, offers some very interesting opportunities.

Whether that is through licensing of the technology we develop, whether it is through partnering, whether it is through products, the opportunities here offer quite an open vista if we are successful in demonstrating our hypothesis.

So we'll see.

All right.

Let's go to slide nine, and talk a little bit about our international strategic alliance with Cassidian.

As we mentioned before, this is the second-largest division within the EADS Group, which to us is kind of the Boeing of Europe.

The agreement provides a means for both companies to share best in class technologies for several critical information assurance areas, including key management, secure communications, and cyber security.

The objective is simple.

It's to expand the product portfolios of both companies.

It is expected to increase our global reach by being able to access new international markets and new domestic markets, quite frankly, that prior to this were not available to us.

We also have plans to pursue additional key management, secure communications, and cyber security initiatives with Cassidian going forward.

So, this could prove to be a real interesting partnership for both companies.

So, if I were to summarize this one for you, I would say very simply the opportunity to share resources, technology, and products across markets that are currently not serviced by us, offer some real interesting potential.

Finally, on slide 10, let's talk about our plans to develop an international cyber range.

Our objective is to accelerate the advances in cyber security and cyber warfare initiatives.

We expect the range to be operational by the first quarter of 2011.

We will provide governments with a secure environment in which to test network and system attack and defense strategies.

We expect to leverage the supports of globally recognized universities and cyber experts as well as use cutting edge tools and techniques to provide a high caliber next generation test bed service for the advancement of global security research.

And by the end of 2011, if things have progressed on schedule, we expect to open the Range for users in adjacent markets, such as large financial institutions that want to protect their critical infrastructure.

Put very simply, the Range will enable us to test leading edge solutions under a variety of sophisticated environments, which we hope will lead to additional hardware and software market opportunities for Sypris.

So as we summarize our Aerospace and Defense segment, I think it is safe to say that we see this segment of the market, Defense in particular, as going into a period of significant change.

We believe that budgets will be cut.

We are noticing that large primes are moving away from platforms, and we believe that cyber security, secure communication, these areas are going to be hotbeds for growth for years to come, as the nation works to adjust to the new areas of attack.

We are very pleased with that, and we think the opportunities for Sypris are significant.

So with that, I'd like to turn the balance of our presentation over to Brian.

Great.

Thanks, Jeff.

Good morning, everyone.

I'd like to briefly discuss the third quarter financial results.

As Jeff has done this morning, highlight some of the key areas in terms of how they translated in the P&L.

At this time, we'll start with the consolidated performance on slide 11.

Consolidated revenues for Q3 were $73.4 million, up 17% or $10.7 million, compared to the prior year period, primarily as a result of the increased demand for medium and heavy duty commercial trucks, and increased volumes for trailer axles.

Gross profit for the quarter was $7.7 million, up 47%, or $2.4 million from the prior year quarter, driven largely by the reductions made in our Industrial Group's fixed overhead structure, and combined with the substantial operational improvements being realized in our A&D segment.

The gross margin at 10.4% reflects a 2.1% expansion over the prior year quarter, again, driven by the increased revenues of the resumption of A&D as well as the ongoing market upturn in our Industrial Group.

The productivity improvements within our Industrial Group and the intensive lean and Six Sigma initiatives we've discussed in the past that are well underway in our A&D segment.

Finally, for the quarter, EBITDA was $3 million, up $3.2 million from the prior year quarter.

Again, reflecting the benefits of the restructurings and the realized efficiencies from all the targeted cost initiatives and, certainly, the adoption of lean throughout our operations.

Let me talk briefly on our industrial results, and ask you to advance to slide 12.

The Industrial Group revenues increased $15.6 million or 42% to $52.8 million compared to the prior year quarter, as volumes for heavy duty commercial trucks, and the light trucks as well as trailers continue to improve.

The gross profit for the quarter was $2.3 million compared to $104,000 for the prior year quarter, again, driven by the increased volumes and the impact of the restructurings.

As you can tell, we have lowered our breakeven point and the efficiencies that we are realizing are driving positive conversion.

Another important accomplishment was the Industrial Group's $2.9 million comparable period increase in EBITDA, and again, this reaffirms the impact of the effort that the teams undertook over the large portion of 2009 and into the front end of 2010 in the restructuring efforts.

With respect to our Industrial Groups, as we have talked about, sequential results and viewing that in a continuum, if you would advance to slide 13.

As you'll note, the revenues continue to strengthen, improving nearly $6.2 million or 13.2% to $52.7 million from the second quarter, or $8.6 million, up 19.6% from the first quarter of this year, again, reflecting the overall ongoing demand and market upturn that our Industrial Group is experiencing.

Gross margin did decline 0.5% from the prior quarter and was attributable to the costs related to the upturn readiness programs you heard Jeff discuss earlier, the cost incurred with the new customer program launch as well as seasonal peak rates in terms of electricity at a couple of our plants.

We would have expected our gross margin percentage in Q3 to be higher, but we are committed to the readiness of spending you heard Jeff talk about.

In light of the market outlook and the associated vehicle replacement estimates, we believe that is where we need to continue our focus and preparation for 2011.

As we've talked in the prior calls, our plants continue to focus on productivity, targeted cost programs in order to achieve ongoing sequential improvements in manufacturing conversion on any realized volume increases.

Let me shift gears and move over to our Aerospace and Defense segment and the team in Tampa, and ask you to advance to slide 14.

Revenue in our A&D segment declined 19.1% or $4.9 million to about $20.7 million from the prior year quarter, primarily due to the completion of shipments of certain older, lower margin legacy programs.

However, gross profit for the quarter was $5.3 million, an increase of $206,000 compared on revenues that were $4.9 million lower.

The improved margin is driven by, certainly, a more favorable product mix, reduced production costs, and the efficiencies that are being realized through the lean efforts and their impact on improving the entire supply chain and its overall efficiencies.

The gross margin increase of 5.8% to 25.8%, despite the 19% revenue decline from the prior year quarter, provides very important insight into A&D's future and the efforts that the team have put forth in terms of the future earning potential.

We did continue our positive EBITDA trend despite the changing mix.

In addition to the favorable financial results, our A&D segment and their transformational efforts are not only delivering significant improvements in quality and on-time delivery but, certainly, deepening the ability to collaborate with their customers on new business opportunities.

Something also worth noting is looking at our Aerospace and Defense business's sequential results.

To do that, I would ask you to advance to slide 15.

As Jeff talked about earlier, we did resume shipments of the government program that had been delayed.

As we had talked in our prior earnings release, we received the government approval at the end of Q2 to resume the shipments.

Resumed shipments under these programs contributed to an increase in revenue of 25% from Q2 to Q3.

The increased revenues, combined with A&D's efforts around their supply chain, drove a gross profit improvement of nearly $2.7 million and gross margin improvement of almost 10% to 25.8% sequentially.

Finally, EBITDAR increased from Q2 to Q3, driven by this increase in revenues, the efficiencies that are being driven, as well as the changing mix.

It is important to note that these results combined with the consolidation of the Colorado facility into our main Tampa, Florida operation should drive further positive impact on its cost profile going into the new year.

Shifting gears from the financials, let me conclude with a few of the important points that I think are relative to the quarter and ask you to advance to slide 16.

The gross margin increased to 10.4%, up from 8.3% in the prior year, and up from 7.8% sequentially, and underscores the impact of the restructuring and the continuous improvement actions undertaken to take meaningful and lasting changes to our cost structure.

As a result, as Jeff mentioned earlier, we believe both business segments are well-positioned to capitalize on the improving economy.

In our Industrial Group, you heard Jeff speak to the investments and equipment processes, training, and inventory that are underway to ensure that we benefit from the growth in the truck market.

This is of utmost importance, because as we carried out with you earlier on, heavy vehicle demand forecast is expected to grow in a range of 25% to 55% per ACT in 2011.

In our Electronics Group and the team, in the significant efforts to transform that business, not only operationally but taking its key -- core competencies in key management, we announced the important award with the Department of Energy for a project designed to protect the US power grid from cyber attacks, an international strategic alliance with Cassidian, and plans to develop an international cyber range to host cyber warfare testing for the US and its partners.

Each of which project -- each of these projects hold interesting prospects for the future, of not only Tampa, but for our entire Company.

In short, we continue to make important progress.

Again, we believe we are well-positioned for an increasingly profitable 2011 as we bring 2010 to a close.

This highlights Jeff and I's highlights of the third quarter.

At this time, we will turn it back over to Katie for questions.

Thank you.

(Operator Instructions).

We will take our first question from Jim Ricchiuti with Needham & Co.

A couple of questions.

First, on the Electronics business.

Trying to get a better handle on how we might think about the revenues in that business in Q4.

I don't know if there was some catchup related to the resumption of that specific government program you alluded to.

Normally, you see some seasonality in Q4, but you also, on the other hand, have some, I guess, some legacy product from last year.

So how should we think about Q4 in Electronics, guys?

Well, there, Jim, this is Brian.

Certainly, there was some catchup in Q3, but one of the things to be sensitive to is the ramp up of meeting the catchup associated with other demand from the product.

So we would look at Q4 to be perhaps in line or closely in line with our achievements in Q3 in the A&D segment.

Okay.

That's helpful.

Brian, there were some costs associated with I assume the consolidation of the Colorado facility.

Can you -- is there a way to break that out just so we can think about gross margins in Q4 in that business?

Yes.

I think, Jim, in the Q2, we were in a range of just over $800,000.

I think we took through about another just over $0.5 million in Q3 associated with the moving of the Colorado facility.

Okay.

And that's completed?

Essentially completed, yes.

Great.

Just turning to the Industrial business, clearly, you had some nice sequential improvement in revenues, but down in gross margins.

It sounds like you had some higher costs associated with a couple things, but this new program launch that you alluded to, is there a way to break that out so we can get a better sense as to what type of impact that might have had on gross margins in the quarter?

Yes, we look at that program.

Certainly, we'd perform a deep dive on all the programs to learn lessons learned on what we can do going forward, better.

We think that in that particular program, we probably incurred costs in the range of just in the $300,000 to $325,000 range in Q3.

Okay.

And that is something that you might still experience some higher costs in Q4?

We think, Jim, that the program is on track to get to the margin performance that we designed the program or built the P&L to.

I would not, nor would the team, expect to incur any of those types of expenses in Q4; certainly, not in that range.

Okay.

But there -- might there be some -- you talked about planning for 2011 in terms of training and potential new hires.

Does that impact you in Q4?

Yes, it does.

Okay.

Okay.

And then last question for me just because it is very intriguing.

Just with respect to what you are doing in cyber and, for instance, the Department of Energy award, if this is carried forward, the implementation, you talk about licensing and partnering.

So, just -- so, for me to understand this a little better, would this potentially be partnering with the suppliers of smart meters, companies like an Itron or an Echelon?

I'm still not quite clear on where you would fit in this.

Right.

At the moment, Jim, it is pretty fluid.

But it could range from the public utilities to suppliers of meters to any range of potential applications.

And so we just need to, first of all, prove out the hypothesis and see what form that takes, but it could be very, very interesting.

And Jeff, you are clearly focusing a lot of development efforts in this area.

So, two final questions, if I may, and then I'll jump back in the queue.

So do we anticipate R&D going up as a result of this?

And do you have a target in mind as to where you would like to see the cyber business representing of your total A&D say a couple years out?

Well, I think it's going to determine how successful we are, you know, as to what it represents.

But clearly, Jim, the efforts in this key management and cyber, secure communications, information assurance, is taking on some very interesting forms for us.

Both in terms of our -- working on our legacy products, but more importantly our partnering with universities; our partnering with companies like EADS and Booz-Allen.

We announced one of those earlier.

So, I mean, there are a lot of interesting seeds that are being planted.

And so as we look at this, we don't see this being a big 2011 driver other than that we are really starting to populate a wide range of opportunities that for the ones that come to fruition will really change the profile of this business.

But from an R&D standpoint, you probably have to step up the investment a little bit in 2011 versus --?

Yes.

And so where the team has been focused is on driving gross margin so that we can cover that increased investment without diminishing income.

Okay, thanks a lot.

Congratulations on the quarter.

Thank you.

(Operator Instructions).

We will take a follow up with Jim Ricchiuti with Needham & Company.

Just curious.

In the past, you've talked about the tone from your customers in the Industrial business.

Are they, would you say, more positive today versus where they were a few months ago in terms of the way they are looking at their build rates?

Jim, I think everyone quotes the same sources.

(laughter) So everyone is saying things are lining up for a period of prolonged growth.

Yet at the same time, everyone says but there is uncertainty.

We were talking with a customer late last week who said that he had just come out of meetings with Volvo and International, and that they were very bullish and said it's coming.

On the other hand, when you look at the information, the backlogs of the OEMs are not long.

And so the order cycle is short, meaning that the fleets feel like they can get their trucks on very short notice.

They don't have to line up in queue to get their fleets.

So, the combination of a short backlog gives them hesitancy; the outlook is saying here are the trucks that need to replace that are coming out of service, but need to do all that, gives them reason to be optimistic.

And so I've just characterized it as everyone is cautiously optimistic.

Okay and (laughter) --

I wish I could give you a clearer view, but we subscribe to a lot of different research.

We talk with all of our customers, we talk with their customers.

That is kind of the response everybody gets.

Yes, that's fair enough.

I mean, it does seem like the data is - there's a pretty wide range out there.

On the Electronic side of the business again, the backlog and bookings have been improving.

I am wondering if you can give us any more in the way of specifics in terms of the backlog where you stand in that part of the business?

Or maybe just how it compares previously.

And then just to follow-up on your gross margins.

I don't recall ever seeing your gross margins in this business this high.

Is that something you think is still sustainable, given the mix of business that you see going forward?

With regard to backlog, it has been trending up since the fourth quarter of last year.

We can get back to you with the specific numbers later, but I am going to guess that the backlog is up 10% to 12% from the fourth quarter of last year.

With regard to the gross margins, we're going to -- this is much higher than our old business model.

The team in this side of our business has done an excellent job of shedding low margin, more commodity type work, and focusing more on the areas in which we add more value-add and which we, quite frankly, get more of an attractive pricing because it is unique.

So we need to maintain the margins up higher so that we can support higher levels of R&D to really drive the future of this business.

Okay.

Thanks a lot.

(Operator Instructions).

At this time, with no further questions in the queue, I'd like to turn the conference back over to our speakers for any additional or closing remarks.

Thank you, Katie.

Brian and I would like to thank you for joining us on this call.

We certainly welcome your continued interest, and of course your questions about our business.

Thank you and have a great day.

This concludes today's conference.

We appreciate your participation.