Sypris Solutions Inc (SYPR) 2014 Q2 法說會逐字稿

Good day, everyone, and welcome to the Sypris Solutions Incorporated 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.

Thank you, Dana, and good morning, everyone. 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 second quarter of 2014. 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 now would 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 sections. 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.

I'm pleased to report that the Company posted another positive quarter with revenue, gross profit, gross margin, and earnings per share all rising on a year-over-year basis. Consolidated sales increased 13% to $93.1 million, up from $82.2 million for the second quarter of 2013. Gross profit rose 30% to $11 million, up from $8.3 million for the prior-year period while gross margin increased 150 basis points to 11.6%. The results were also favorable when compared on a sequential basis to the first quarter of 2014, with sales up 10% and gross profit up 2.5% on a slight decline in gross margin, which reflected a change in mix between the two periods.

The Company reported earnings of $0.02 per diluted share, which reflected a positive increase in the second quarter of 2013. Cash flow from operations remained healthy and, even with the increased levels of capital investment, resulted in positive free cash flow for the period.

As many of you may recall, last quarter we announced the award of a contract with NEC Asia Pacific to develop a cyber security lab for the Singapore government. The lab will be used to train homeland affairs and other personnel in the defense of and response cyber security attacks on agencies of the Singapore government. NEC will provide the hardware for the platform including the Internet traffic-generation equipment, while we will provide the simulation and training software. The value of our portion of the contract approximates $3.1 million, which does not include the value of options for annual licensing and maintenance fees that may be exercised in the future. Initial commissioning is scheduled for mid-year, with total program deliveries to take place over the ensuing 18 months. I am pleased to report this morning that we are on schedule and look forward to the commissioning shortly.

New business opportunities accelerated across the Company, with quoting activity for new programs increasing substantially during the quarter for both business segments. In summary then, we were pleased with the results for the quarter. We are off to a good start for 2014, and we look forward to more progress as we move through the year.

Turning now to slide 5, revenue for our aerospace and defense segment increased 22% to $9.4 million from $7.7 million in the same period in 2013. Gross profit remained unchanged, while gross margin improved slightly during the quarter due to the change in revenue and mix during the period. It is important to note, however, that the quarter did not contain any contribution from the award of the Singapore cyber security lab contract which will be recognized in future periods. The Cyber Range represents the first of three technological platforms that have been under development for the past several years, with the range being the first to market. As many of you may recall, the range has been developed into a critical platform for organizations to train their personnel to expertly identify, prioritize, and respond to increasingly complex cyber attacks.

The recent award by the Singapore government represents our first international sale, where momentum continues to build with sales discussions now exceeding $25 million of potential business. During the quarter, we maintained our investments in new product development. The financial impact of which was reduced on the P&L when compared to prior periods due to the receipt of customer funding to complete the development of our second platform, SYPHER, a field-programmable gate array that will serve as the encryption for future secure communications products.

We also continue to hold discussions with potential customers to complete the proof of concept for our third platform, SIOMETRICS, which is a breakthrough technology that utilizes unique characteristics of the silicon wafer for identity authentication rather than a software-based identification. The potential for this technology is quite intriguing for a couple of reasons. To start with, it eliminates the need to authenticate and store end-user passcodes, thereby making identity authentication more easily scalable. The potential applications are numerous, ranging from use in missile defense systems, UAVs, and the smart grid, to large-scale commercial networks and automobile electronic systems. It becomes even more interesting, however, when the SIOMETRICS technology is combined with our SIPHER encrypted processors, which results in a chip set that is exponentially less vulnerable to cyber attacks.

As I mentioned a minute ago, we are currently under review by several customers to fund the integration of SIOMETRICS technology into an existing application. We believe that it should take an estimated 18 months to complete this work. In the short-term, any customer funding would serve to reduce expenses currently being incurred by Sypris. In a long-term, however, if successful the potential would appear to be significant.

The first quarter continued on a positive note for EMS sales to customers with applications in severe environments including Northrop Grumman, Lockheed Martin, and Exelis. Business activity continued to grow in this area, supporting our expectations for double-digit growth in 2014.

Turning to slide 6, we expect the impact of sequestration and other DOD funding-relating issues to continue to affect our business until such time as new programs, products, and cyber-related services achieve sufficient traction to offset these issues. As we discussed, we are making important progress with our efforts to secure additional customer funding for specific research and development opportunities. If successful, these funds would help us to accelerate the introduction of these new promising technologies into the marketplace and will reduce the expense being incurred on our financial statements.

We are optimistic that we will make additional inroads with our secure communications product marketing efforts in Canada, Norway, and Germany as we increasingly become the standard for key field devices around the globe.

We will continue to focus on EDMS sales for end-use applications that exhibit the high cost of failure and therefore require the unique pedigree, certifications, and traceability standards that have long been an important part of our heritage. And we will pursue synergistic acquisitions as a means to both supplement our existing capabilities and to accelerate replacement of revenue that has been lost or delayed to the issues we mentioned earlier.

Now let's take a quick look at our industrial group, beginning with slide 7. Sales increased 12.5% to $83.7 million, up from $74.4 million for the second quarter of 2013. Gross profit [grossed] 28.5% to $11.4 million, up from $8.9 million for the prior-year period, while gross margin increased 170 basis points to 13.6%. EBITDA increased to $9.4 million, approximately 11.2% of sales. The strong performance for the quarter reflected solid demand across all markets and the impact of TPS initiatives on operational efficiencies. Key metrics for quality and delivery remain at world-class levels.

Our investments and process improvements and the results from our partnering with Toyota are beginning to pay real dividends in terms of increasing manufacturing efficiencies and improving equipment uptime, while simultaneously reducing cycle times and scrap. We remain optimistic that the Company will realize substantial additional benefits as we continue to implement the TPS tools and culture at all of our plants during the coming years. We were notified of several new business awards during the quarter with customers in the agricultural, light truck, and commercial vehicle markets. These new programs are expected to launch during the first half of 2015.

Turning now to slide 8, the outlooks for the markets served by our industrial group continue to be positive for the coming year. The commercial vehicle market for Class 8 trucks continues to improve. The production of Class 8 vehicles is forecast by ACT Research to accelerate during the second half of 2014, increasing 25% in Q3 and 27% in Q4 on a year-over-year basis, resulting in a 21% increase for the full year. The combination of an improving economy, aging fleets, rising freight pricing, growing trucker profitability, and better fuel economy are all combining to create a positive environment for new purchases. Demand for Class 4 through 7 medium-duty trucks continues to recover, along with the housing markets, while the outlooks for our light-truck and trailer markets, as well as for our off-highway and agricultural markets, also appeared to be in good shape for the rest of the year. We are looking forward to another year of profitable growth from our natural gas, oil, and petrochemical markets where demand for our highly engineered closures, insulated joints, and other specialty piping components continues to be quite strong.

With all of the operational progress that has been made in recent years, it should be of no surprise that our quoting activity for new business with both existing customers and with new potential customers is quite active. As many of you may recall, we recently reported that the potential aggregate contract value of these discussions range from $85 million to $110 million per year. This funnel has since increased to the $140 million to $150 million range, validating the results of the team's work and strategy. We continue to make investments during the period in production technology and product engineering, resulting in patent applications for new drive train component designs that are expected to reduce the weight of certain parts by as much as 16% when compared to current customer designs.

The first such product is a lightweight axle shaft that has been developed for the commercial vehicle market. The product weighs six to seven pounds less than the current designs, which translates into a 24-pound to 28-pound savings for a Class 8 vehicle. The benefits are numerous from a cost standpoint, for the design results in a meaningful savings of material, processing, and freight while offering the end user a less expensive and significantly lighter product. The commercial reactions to the shaft have been extremely positive, and we hope to formally introduce the product to the marketplace later this year.

As we look forward to the balance of the year, you can expect that we will continue to focus our efforts on three key strategic initiatives: investing to increase productivity and efficiency, driving process improvements through the use of TPS techniques to reduce cycle times and increase reliability, and selectively pursuing strategic opportunities to expand our customer market share to leverage our fixed cost and organizational capabilities.

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

Thanks, Jeff, and good morning, everyone. I'd like to take you through the highlights of our financial results for the second quarter of 2014. I will begin with our consolidated results and ask you to advance to slide 10.

Q2 consolidated revenue totaled $93.1 million, up $10.9 million, or 13.3%, as compared to the prior year. While both segments report increased revenues year over year, our industrial group led the way with a $9.3 million improvement. This increase in revenue primarily reflects increased customer demand across all markets, led by higher commercial vehicle volumes. Our A&D segment also increased nearly $1.7 million year over year to $9.4 million for the quarter. Gross profit increased 30% to $10.8 million in the quarter from $8.3 million in the prior-year period. We achieved a gross margin of 11.6%, driven by the performance of our industrial group reflecting favorable product mix and greater operating efficiencies. Earnings per diluted share came in at $0.02 per share versus a loss of $0.08 per share in the second quarter of 2013. Our bottom-line improvement was driven by revenue growth, favorable mix, and operating efficiencies for the industrial group and provides a solid foundation for the year given our current view of the market for the balance of 2014.

Let me move on to our sequential consolidated second-quarter results and ask you to please advance to slide number 11. Consolidated revenues increased 10.5% sequentially from the first quarter, rising to $93.1 million, while the industrial group was up 10.4% and A&D was up 11.9%. Our consolidated gross profit of $10.8 million for the quarter was up approximately $300,000, or 2.5% sequentially from Q1, attributable to the industrial group. However, gross margin declined 90 basis points to 11.6% from 12.5% in Q1. In the first quarter, we reported a favorable product mix for the industrial group, all of which did not repeat in the second quarter. However, we continue to drive the continuous improvement initiatives in both segments contributing to gross margin above 11%.

And finally, our second-quarter earnings of $0.02 per share was down sequentially from Q1's reported earnings of $0.08 per share and was impacted by increased expense for legal and other professional services during the quarter. Our effective income tax rate also increased from Q1 due to the mix of domestic and foreign pre-tax profit during the two periods.

Next, we will discuss our aerospace and defense segment's performance and ask you to please advance to slide 12. Starting on the left side, we had an increase in second-quarter year over year revenue of $1.7 million, or 22%, to $9.4 million for the quarter. Sequentially, our A&D revenue increased $1 million, or 12%, from the first quarter of 2014. Our customer base in electronic manufacturing service operations continue to respond favorably to our successful onboarding of new EMS programs, and we are actively pursuing opportunities to increase scope on certain programs, and we are competing for new business with both existing and potential customers.

We continue to await approval from a customer to begin production on a sizable EMS contract, as discussed during Q1. The delayed approval is related to the pending resolution of a technical issue between our customer and the end user. Material for the program is in-house. Our manufacturing process is proven. And we will begin production immediately upon receipt of customer approval.

We also note that revenue associated with the cyber lab contract announced in the first quarter of 2014 will be recognized in future periods based upon the applicable accounting guidance. However, the achievement of contract milestones during the second quarter enabled us to invoice and collect cash during the period to favorably impact cash flow.

Moving to the right side of the slide, our gross profit remained below breakeven for the quarter, with a loss of nearly $600,000, which was basically flat with both the comparable prior-year quarter and the sequential quarter. Gross margins improved slightly for the second quarter as we continue to move beyond the ramp-up period for new EMS programs although our fixed cost structure leaves us below breakeven at current volumes. Our team for the A&D segment continues to control variable spending; however, our challenge is to continue to win new programs and drive more topline growth to return this segment to profitability.

Let me now shift to our industrial group performance and ask you to please advance to slide 13. Our team at Cypress Technologies delivered another quarter of strong results, generating $83.7 million in revenue and $11.4 million in gross profit. On the left side of the slide, we show a year-over-year revenue increase of $9.3 million, or 12.5%, and the sequential quarterly increase of $7.9 million, or 10.4%.

Our customer demand seems to be following the trend of the overall commercial vehicle market which increased again during the second quarter and continues to show a forecast that should support comparable period revenue growth for the industrial group throughout 2014. The recent industry forecast by ACT Research now shows full-year Class 8 production up 21.2% in 2014 over 2013, and classes 5 through 7 up 6.3% in 2014 over 2013. We believe our team is well-positioned to meet this growth and demand as the market upturn continues.

Shifting over to the right side of the slide, you'll see gross margin for the industrial segment showed a year-over-year improvement of 170 basis points, while we were down 110 basis points sequentially due to the favorable product mix we enjoyed in the first quarter. Our team remains focused on the daily execution in meeting customer demand while maintaining our quality, equipment uptime, on-time delivery, and other operational metrics.

Let me now close with a brief summary of our second-quarter performance and ask you to please advance to slide 14. We are pleased to report earnings of $0.02 per share for the second quarter, bringing our first-half earnings to $0.10 per share. Our order board for the industrial group as we execute to continues to hold, and the industry outlook for the balance of 2014 for the commercial vehicle market includes year-over-year growth in North American Class 8 production in excess of 25%. We continue to hit our targets in the industrial group for quality, on-time delivery, and other key operational metrics as we respond to the increased demand. The deployment of TPS across all industrial group facilities is generating additional production capacity as we reduce setup, changeover, and production cycle times and increase equipment uptime in our existing operations. The successful on-boarding of EMS programs by our aerospace and defense segment is driving revenue growth and supports our pursuit of new business opportunities with existing and potential customers. Our A&D team's progress on the Cyber Security Laboratory contract announced in Q1 is on schedule, and it enhances our marketing efforts with our business partners and potential customers.

And our final point is that our A&D segment continues to develop additional technology platforms through both internal and external funding to support the long-term plans for this segment.

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

(Operator Instructions) Alan Weber, Robotti & Co.

Good morning. First question was, you kind of alluded to the higher SG&A in the second quarter, and I guess it was a little less than $2 million higher than last year. Can you just talk about what occurred there?

Yes, we referenced in the text, Alan, some legal and professional expenses that were incurred this year above the prior-year levels.

Okay. And then — I guess I missed that. Then when you talk about for the industrial, you talk about quotation of $140 to $150 million per year. Can you just explain what you actually mean by that in terms of do you expect — are these contracts that are close to winning? Or what does that actually mean in kind of the timing?

Sure. Alan, this is Jeff. The $140 to $150 million would be the basket of active quotation activity that we have going on in the marketplace. And within that basket, you can have a range of status on those bids range from pending contract to negotiation to quoting. I'd say there's a pretty good mix all through there. We mentioned today that we have been notified of an award of a number of different contracts. That would be contracts that are also included in that basket, and they would be scheduled to launch in the first half of 2015.

Okay. And did you quantify the revenue potential from the contracts that you've won?

No, we did not.

Okay. And you don't want to?

Not this time. Thank you.

Okay, that's fine. And I guess my last question was on the A&D side, do you talk about some revenue potential like that? Do you have kind of internally a target of when you expect or hope the A&D should be above breakeven?

Certainly by the time we are in 2015.

Okay. Great. Thanks very much.

Thank you, Alan.

Brad Mas, Needham & Company.

Back on A&D, I'm wondering what the backlog and visibility you guys have, how we should think about second half. If we should assume it looks kind of similar to the first half.

It does look similar. We do see sequential growth in Q2 — or, excuse me, from Q2 to Q3 and from Q3 to Q4 at this point. Some of that, Brad, is in our existing backlog. Some of it is businesses we are pursuing that we believe we have a real opportunity to book and turn and convert to revenues this year.

Okay. And with the Singapore contract, is that expected to be meaningful in the second half?

Not meaningful in the second half. The more significant piece of that will be recognized in 2015.

Okay. And then on the industrial side, wondering if there's any reason to not think that the strength that you are seeing in oil and gas flow will continue in 2015.

No. Brad, this is Jeff. Every indication we are seeing now is that we expect the growth to continue.

Okay. And with the forecast you provided for the Class 8, does that tie into what you are hearing from your large customers?

Yes.

Okay. And then on a couple of quick consolidated questions, I mean R&D, obviously $10,000 related to SYPHER — I assume with the customer funding. Are you seeing — is there any update you can provide on SIOMETRICS customer funding?

At this point, we are in discussions with some — for some potential customer funding fund that. Nothing has been locked down. We are looking at investment in that as we move through the second half. Some of that will be internal. And right opportunities fall into place, we will also have customer funding for a portion of that.

Okay. Any color on — obviously R&D is going to be up in Q3. Any color you can provide on SG&A next quarter?

Sequentially, I think we will see an SG&A decline from Q2. Q2 should be the peak for this year.

Okay. And then, last one, just tax rate going forward — I mean, it was a bit high this quarter. Is there any color you can provide there?

Yes. You know, when we reference the mix of foreign and domestic earnings, the issue that we run into is because we are in Mexico and in the US and we accrue taxes based upon the effective tax rate assumed for each jurisdiction, that sometimes our effective tax rate on a consolidated basis can swing considerably. So one of the ways you might look at that is to look at it more in an aggregate dollar number as opposed to a percentage. As you look from Q1 to Q2 for 2014, you will see a relatively constant number for our tax provision. And I think that's what I would look at going forward.

Okay. Great. Thank you. That's all for me.

(Operator Instructions) Justyn Putnam, Talanta Investment Group.

First question I have is maybe a follow-up on the A&D segment. Obviously you've experienced some pretty good growth here recently. You've got some interesting projects in the pipeline. But I want to talk a little bit about the existing business in that segment. I mean, obviously there is some existing business that's pretty unprofitable. And I was curious to hear your thoughts and maybe your goals as you think about getting those businesses to profitability. And are there metrics or goals that if you don't meet that maybe you look to get rid of some of this unprofitable business at some point in the future?

Justyn, this is Jeff. Good set of questions. We expect our aerospace and defense business to continue to improve sequentially as we move through 2014 and into 2015. And as we mentioned a moment ago, we expect to get back to the breakeven level during 2015, and preferably earlier in 2015 rather than later.

The issues that we are having currently with regard to profitability in this segment are less to do with unprofitable programs than they are just simply in volume and scale. And if we were to track back in time to 2013 with the sequestration efforts and those things, we were surprised by the fact that we had some customers insource some long-standing commercial satellite programs that had been meaningful contributors to the profitability of this business. And the work was insourced because the customers were looking to fill their plants. And it wasn't performance based. It wasn't a competitive loss. It was simply a need to have absorption in their own plants. And so that had been a surprise to us. We hadn't expected that going into 2013. So since that point, our team has been working to rebuild the base, if you will. And they have been making good progress; it's just taking some time. But we expect this business to be back in the black as we go certainly through 2015.

If it is a volume story in that business then, what — as it stands now, what is your breakeven level from a revenue standpoint?

Well, it will depend upon mix, certainly. But I would say by the time we get to the fourth quarter of this year, we will be much closer. And certainly by all outlooks that we have today, by the time we get into the first half of next year that we should be getting very, very close.

Okay. Well, I guess where I was going with that was if you don't meet your revenue top-line volume growth goals, is there opportunity to maybe lower your cost structure by getting rid of some of these more unprofitable businesses and still be able to — is there opportunity in that frame?

I guess what I was trying to convey is that the programs we have are good. So we are not dealing with poor programs; we just need more scale. And when you asked about kind of a revenue breakeven line and we hedged by saying that depends on mix — for example, if we have more product sales, if we have cyber-related sales compared to EMS sales, well then, the breakeven point is far lower than if you have a higher mix of EMS sales. So the guys are working hard to bring these new products to market. We're starting to get traction. The reviews have been quite favorable. And so with any luck, we will have a mix going forward that will be attractive for the business.

Okay. And just to clarify, mid-2015 is when you expect to be profitable in that business.

Yes.

Okay. And now if I could just clarify, is that as an operating income basis or gross margin basis?

Operating.

Okay. And then, Tony, I guess I have a quick question for you on the one-time expenses in the quarter. Your legal and professional fees — can you quantify that? Is that the majority of the increase we saw in the quarter?

It is sequentially. If you look year over year, there is some other items in there. But certainly on a sequential basis, that's the primary cause.

Okay. And then, I guess, Jeff, back to you real quick. On the Dana contract negotiations, is there any update on that or any progress on that?

Not at this point, Justyn. We expect these discussions to go on for some time. And certainly as we make progress of that, we will let everyone know.

Okay. Thank you very much.

Tristan Thomas, Sidoti & Company.

Two quick questions. Could you talk a little bit to the product/product mix shift in industrial from Q1 to Q2?

Sure. In the industrial group in Q1, when we had the uptick in margins, a lot of that was driven by our ag and off-highway business and the oil and gas market. And even within those two segments, we had a couple of programs that were more profitable that we shipped. And those segments — those markets performed well in the second quarter, just not as well as they did in Q1.

Okay. So Q2 is a much more normalized kind of expectation?

Yes.

Okay. And just one final question. I believe you mentioned housing. What are you really seeing on your end from some of your customers regarding expectations moving forward in the housing market?

In the housing market? By all accounts, we expect to see kind of a steady growth in the Class 4 through 7 trucks which are the medium-duty trucks that typically service the construction industry. And so both from our customers and from the independent research, it looks like we will have nice growth this year. And they are forecasting similar type growth for 2015 and 2016.

Okay. Great. Thank you.

Alan Weber, Robotti & Co.

Just a follow-up. When you talk about — as you look out increased revenues from new programs from both businesses, can you talk about what investments are there — is there additional capital expenditures requirements? Or would it mostly be just be kind of working capital related to fund the programs?

Alan, I think you can expect that the primary investment will be working capital. Certainly in the aerospace and defense side, we have ample capacity to handle the incremental growth. And in the industrial side, there may be increments of capital required for specific requirements but nothing of a major nature.

Okay. Great. Thank you very much.

Gentlemen, we have no further questions at this time.

Thank you, Dana. Thank you, everyone. Tony 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.

Thank you. And that does conclude today's conference. Thank you for your participation.