Sypris Solutions Inc (SYPR) 2015 Q2 法說會逐字稿

Good day and welcome to the Sypris Solutions conference call. Today's conference is being recorded. At this time for opening remarks, I would like to turn the conference over to the President and Chief Executive Officer, Mr. Jeffrey Gill. Please go ahead, sir.

Thank you, Kyle 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 2015. 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 line, 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 an overview on slide 4. As we mentioned in our last call and in our annual report to stockholders for the year 2014, the discontinuation of the long-term supply agreement with Dana at year-end was expected to have a material impact on the future outlook for our business since Dana represented approximately 59% of consolidated net revenue in 2014.

We noted that the brunt of the financial impact was expected to be felt during the first half of 2015 after which the combined contribution from reduced costs and new program launches was anticipated to have an increasingly positive impact on the Company's cash flow from operations and bottom-line results. The first quarter met expectations as did the second, which marked a significant improvement in financial performance on a sequential basis. Revenue increased 10%; gross profit increased by $3.1 million, or 100%, while EBITDA increased by $5.5 million or 53% from the first quarter of this year. The results would've been even better had it not been for customer delays that impacted shipments and earnings for Sypris Electronics, which we will address shortly.

The team did an outstanding job managing manpower, working capital and most importantly morale as we adjusted to the lower levels of demand while simultaneously preparing to launch new programs. As a result of these efforts, we are now positioned for a much better second half of the year.

We had a number of important events take place subsequent to quarter-end that are also expected to have a positive impact on the balance of 2015. In July, we announced the amendment of the Meritor note and the sale of our plant located in Morganton, North Carolina to Meritor for $15.7 million of cash proceeds. In addition, we retained over 50 pieces of valuable axle shaft machining equipment and certain operations that will be relocated to other Sypris facilities. The proceeds were used to reduce the Company's indebtedness while the gain on the sale and the avoidance of future operating losses otherwise associated with the plant are expected to have a positive material impact on the Company's earnings in Q3 and beyond.

We believe that the move was a great one for Meritor, which is uniquely positioned to fill the plant with additional work in support of its main assembly operations located close by in Fletcher and Forest City, North Carolina. The team at Meritor was wonderful to work with on this project and we are very appreciative of their continued long-term support.

In July, we also amended our term sheet for the planned refinancing of the Company's credit facilities to reflect the sale of the Morganton assets, as well as the asset purchase agreement for the acquisition of Reynolds Machine to extend the proposed closing date to mid-September. The months of July and August were also consumed with the implementation of additional overhead cost-reduction initiatives that impacted all operations. With an estimated annual savings in excess of $4.7 million per year, the benefits should start to flow through the Company's financial results later this year.

So to summarize, the second-quarter results marked an important improvement when compared to the first quarter of this year. We believe that we are well-positioned for further progress in the second half of 2015 with the cost reductions in place and new revenue in the process of coming online. Change has clearly taxed our organization in many, many ways, but the outlook for the balance of the year is now much brighter as the result of the hard work and dedication of so many.

Once again to those of you who are listening today who have been involved, who have lent a helping hand, thank you. Much hard work certainly remains and I am certain that there will be many bumps in the journey ahead, but we have an excellent team and we are looking forward to the second half of 2015.

Turning now to slide 5, revenue for Sypris Electronics declined 7% to $8.7 million from the same period in 2014 and declined 2% sequentially from the first quarter of this year. Gross profit was flat year-over-year. These results were not consistent with our expectations, but reflected the impact of unexpected delays on two important programs. The first delay pushed back the date for the commissioning of our cyber range and the cybersecurity lab of the Ministry of Home Affairs in Singapore. The cause for the postponement had nothing to do with Sypris, but rather reflected the complications associated with working through the commissioning of this highly classified operation. We now expect to go live in Q3.

The second delay was a result of an all-too-familiar problem, the prolonged processing of approvals and releases by our federal agencies. We simply did not receive the required paperwork in time despite the fact that the orders had been produced and were ready to ship well in advance. The combined impact of these two delays moved approximately $4 million of revenue into the third quarter. The quarter was notable for several positive developments. During the period, we were awarded an important contract by Textron to develop an embedded encryption module to protect UAVs from cyber attack. We conducted multiple demonstrations and entered into advanced discussions during the quarter with a number of potential customers to delay dispersion of our cyber range.

Our team remains quite optimistic about the future prospects for this leading edge capability and response training product. The installation of the cyber range for the Ministry of Home Affairs in Singapore continues to progress with the commissioning of this important installation now scheduled for the third quarter of this year. The cybersecurity lab that we are constructing with NEC Asia-Pacific, of which the range is an integral component, is quite impressive and has served as a key demonstration site for us as we discussed potential installations with prospective customers in Asia and Europe.

The quarter was also notable for the latest advancements that were made to our SIOMETRICS identity software, which is now fully plug-and-play and backward-compatible with existing public key infrastructure systems that are currently used in most commercial security applications. We recently received purchase orders to demonstrate the effectiveness of SIOMETRICS for two automobile manufacturers who are interested in protecting their vehicles from cyber attack. We should have the results during the coming quarter.

We continue to hold discussions with potential integrators of this unique software stack, as well as with venture capital and other investment firms as a means for facilitating the early rollout and adoption of this new technology. We've now filed for more than a dozen patent applications to protect the unique features of this software, which we believe has the potential to dramatically reduce exposure to cyber attacks.

Turning to slide 6, as we have said on many occasions, we expect the impact of DOD funding-related 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. The good news is that we are making some progress. Our outlook for the third quarter of this year takes into account the delays we discussed a moment ago with revenue, gross profit and EBITDA each targeted to increase materially on both a year-over-year and on a sequential basis. These improvements reflect the positive impact of the cost-reduction initiatives, increase production shipments and the commissioning of the cyber range in Singapore.

Now let's take a quick look at Sypris Technologies beginning with slide 7. The long road to recovery is underway. Sales increased 14% sequentially as new programs and increased demand began to fill the void left at year-end. Gross profit increased by $4.7 million, but EBITDA increased by $7.2 million during the quarter to achieve breakeven status. The team did an excellent job managing the down-scoping of operations in both North Carolina and in Mexico, the two primary locations affected by the reduced levels of business.

With the completion of the sale of the Morganton plant, headcount is now down 50% below 2014 levels and should be stable going forward. Inventory levels were watched closely while quality and delivery to customers remained at world-class levels. No mean feat during this period of change and disruption.

New programs were launched during the quarter for carriers and tubes in Morganton, while the balance of the business benefited from the start of new production for knuckle machining and axle shaft and I-Beam forging and machining. This new business is important to us and the financial results for the quarter reflect the benefit of both increased revenue and lower costs.

As we mentioned a moment ago, the sale of the Morganton plant to Meritor represented another key step in our journey forward. In addition to the receipt of cash, the avoidance of future losses and the recognition of a gain on the transaction, we were able to retain over 50 pieces of valuable axle shaft machining equipment that will be relocated to other Sypris facilities.

Toyota has agreed to assist us with the planning, layout and integration of this equipment during the coming months. Just as importantly, however, the move was a good one for our employees. Meritor is a leader in our industry, a big employer in North Carolina and a wonderful company at which to build a career. Meritor is also in the unique position to be able to fill the plant with new work faster and more effectively than most. As a result, the future outlook for our former employees just improved dramatically while Meritor picked up some first-class people. Clearly, a good move for all.

Turning now to slide 8, we recently entered into a new contract with Volvo for the forging and machining of axle shafts. This represents our first direct contract with Volvo and we hope that it leads to additional opportunities for this large OEM down the road. We also received a contract for the forging and machining of our new Ultra Series axle shaft and are in the process with another.

As you may recall, the potential benefits of this new product are meaningful in terms of material savings for the customer and weight savings for the end user who will benefit from fuel savings and/or greater load capacity. We are preparing our plants in Kentucky and Mexico for the production of this breakthrough product, which is lighter, stronger and less costly to produce than other axle shafts currently on the market. We hope to be in production later this year.

We continued to make progress on the acquisition and joint venture front during the quarter. We have substantially completed due diligence with regard to the purchase of Reynolds Machine, which we have discussed on our recent calls with the closing now targeted to take place in September in conjunction with the completion of our new long-term credit facilities. We continue to move forward with our joint venture project in India for the production of axle shafts for the local light truck market. The groundbreaking on the new factory has taken place and the construction of the new facility is underway. We are very excited about this project, which will enable us to put to use some underutilized equipment into service with a very experienced partner.

Turning now to slide 9, the outlook for the markets served by Sypris Technologies remain positive. The commercial vehicle market for the Class 5 through 8 trucks continues to expand with production expected to climb 8% in 2015 while the forecast for the light truck, trailer, off-highway and agricultural markets remains solid.

We benefitted from some important strength in our energy markets during the second quarter, but with the recent slide in the price of oil, we have yet to see how or if this event will play through future demand. Our outlook for the third quarter reflects in part the robust nature of our markets and the results that we expect to generate in the lower-cost profile and improved revenue position mentioned earlier. We will benefit from the gain on the sale of the Morganton assets, as well as from the avoidance of the operating losses otherwise associated with the plant. The outlook for EBITDA is therefore targeted to improve significantly during the third quarter and return to profitability the second half of 2015. Turning now to slide 10, Tony will lead you through the balance of the presentation.

Thanks, Jeff and good morning, everyone. I'd like to take you through the highlights of our financial results for the second quarter of 2015. I'll begin with our consolidated results and ask you to advance to slide 11. Q2 consolidated revenue totaled $40.8 million, an increase of $3.8 million sequentially, but down $52.3 million compared to the prior year reflecting the discontinuation of shipments to Dana effective January 1. The sequential growth from Q1 is primarily attributable to the ramp of new programs and the continued strength in the overall commercial vehicle market.

Gross profit for the second quarter was right at breakeven compared to a loss of $3.2 million in the first quarter of 2015, but well below the $10.8 million gross profit in the prior-year period, which included the Dana volume. The sequential improvement in gross profit from Q1 reflects revenue growth with our commercial vehicle customers and cost reductions implemented during both the first and second quarters of 2015 that was partially offset by a soft Q2 for Sypris Electronics as the cyber range commissioning and certain product sales expected during the quarter were delayed into the third quarter. The impact of these delays on revenue for the second quarter was just under $4 million and the estimated impact on gross profit was approximately $1.5 million.

SG&A expense was slower in Q2 as legal fees related to litigation proceedings declined significantly from Q1 to Q2, which is reflected in the improvement of EBITDA of approximately $5.5 million that will be covered on our next slide. And finally, free cash flow for Q2 was a negative $6.3 million compared to negative $5.6 million in Q1. The sequential improvement in EBITDA and its impact on free cash flow was offset by the expected sequential change in working capital as a source of cash.

During the second quarter, working capital provided a source of cash of approximately $2 million compared to a source of cash of over $7 million in Q1 as working capital was being reduced to align with a reduction in revenue. Additionally, free cash flow includes higher interest costs during the second quarter, reflecting increases in our debt balances and our effective interest rate.

Additional workforce reductions by Sypris Technologies in response to the decline in revenue gave rise to our second consecutive quarter of severance costs of approximately $300,000, which has been classified as a separate line item in our income statement. For this presentation, we have not included severance as an add-back to EBITDA.

Please advance to slide 12 and I will discuss EBITDA for the second quarter. The most significant item in the walk from Q1 to Q2 of 2015 relates primarily to the revenue growth and cost reductions for Sypris Technologies, which was partially offset by a sequential decline for Sypris Electronics. Our consolidated EBITDA increased $3.3 million sequentially on these actions as we continue our initiatives associated with the loss of the Dana contract.

Legal costs declined sequentially from the first quarter on the arbitration and legal proceedings with Dana. However, this was partially offset by other professional fees incurred to assist in the deployment of our strategic initiatives to return our business to profitability. Our second-quarter EBITDA also includes a settlement received from the arbitration proceedings of approximately $0.5 million. The workforce reductions in Q1 and Q2 accounted for severance expense of approximately $300,000 in each quarter and therefore doesn't appear as a variance in our sequential walk. We expect additional severance costs may be incurred in the third quarter as we continue to identify cost-reduction opportunities.

Let me now shift to segment performance and ask you to please advance to slide 13. Sypris Technologies reported $32 million in revenue, $0.6 million in gross profit and was breakeven in EBITDA during the second quarter. The sequential improvement in each metric relates to the revenue growth and cost-reduction efforts previously discussed. With the completion of the sale of the Morganton assets on July 9 and further cost-reduction actions underway, we anticipate delivering positive EBITDA for this segment beginning in Q3.

Sypris Electronics reported $8.7 million in revenue, negative $0.6 million in gross profit and negative $2.4 million in EBITDA. Although revenue decreased only $0.2 million from the prior-year period -- or from the prior period -- the decline included a sequential reduction in one of our higher contribution margin severe environment EDMS programs. The resulting change in mix drove gross margins below breakeven for the quarter. The return to negative margins was a disappointment as we had expected the cyber range commissioning and the release of orders for certain classified products to contribute positively during the second quarter. As noted earlier, the impact on revenue from these delays was nearly $4 million and the estimated impact on gross profit approximates the $1.5 million variance between Q1 and Q2.

Please advance to slide 14 and I will discuss our debt status. The Morganton transaction with Meritor closed subsequent to the end of Q2 and represented a significant step forward with our plans to improve our balance sheet and our operating results. Proceeds from the transaction were applied to reduce outstanding borrowings under our senior credit facility and as of August 10, 2015, we had approximately $2.9 million outstanding on our senior debt facility and $11.9 million in total debt outstanding.

We are continuing to implement additional cost-reduction actions to drive EBITDA improvements and improved cash flow. We are also pursuing opportunities to generate liquidity from the sale of other underutilized assets in our portfolio as we continue to realign our assets and our cost structure for the future.

Let me now close with a brief summary and ask you to please advance to slide 15. Our results of operations for the second quarter reflect the actions initiated in Q1 to add volume back into the facilities impacted by the Dana contract and reduce costs across the system. We have identified additional cost reductions and plan on continuing our efforts to systematically bring our costs in line with our current and projected revenue base. The cost reductions being implemented beginning in Q3 are expected to deliver $4.7 million in annualized savings for the Company.

In a transaction with Meritor on July 9, we sold the Morganton facility and amended out note payable to Meritor, which generated $15.7 million in cash proceeds. The transaction benefited both parties in that it provided Meritor with a strategic asset for its business model and monetized an asset for Sypris that was underperforming following the end of the Dana contract.

We are continuing diligence efforts on the synergistic acquisition opportunity Jeff discussed earlier, as well as a new credit agreement to fund the acquisition and refinance our existing debt. The term sheet for the refinancing and the asset purchase agreement were each amended to reflect the Meritor transaction on July 9 and established mid-September as a target for the closing date.

We are also exploring the sale of other underutilized assets to provide liquidity for our business. Our business development funnel remains robust, as Jeff mentioned earlier in the presentation, and new business launches are expected to begin contributing to further improvements in operating results for Sypris Technologies during the second half of 2015. And finally, we will continue to dedicate all resources to deliver results and build profitability.

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

(Operator Instructions). Jim Ricchiuti, Needham & Company.

A couple of questions just on the shift of revenues on the electronics side of the business, that $4 million going into Q3. It sounds like you are pretty confident about the commissioning of the Singapore cyber range. Is that fair to say? Is that the bulk of that?

We are confident and knocking on wood at the same time. It's actually scheduled for later this month and so hopefully when we get through the month, we will be all smiling and happy and that will be good. And it represents a little over half of the amount that we are talking about.

Okay. And then regarding that other half, which sounds like that might be more problematic just given the timing and the various delays that you can run into with the agencies you work with, how confident are you about that portion of the revenue shifting?

That's certainly a fair question. What we do know is that, in this case, that the services have a need for the product, that they've submitted their requisitions for the product and in some cases are clamoring for the product and it's a matter of processing. And so we are hopeful that those blocks get eliminated. We are told that they will be, but, as you know all too well, we've been told that story before. So we are trying to be conservative in our approach, but optimistic in our hopes.

Got it. The loss that was associated with Morganton, $1.8 million I believe in the quarter, is that separate from the $4.7 million of annualized savings that you are anticipating?

Yes.

And does that $1.8 million -- you are moving equipment and I am just wondering do you anticipate that realizing the benefit of that full $1.8 million in the second half?

Well, we certainly do because we won't be bearing that operating loss. We will have to spend a couple hundred thousand dollars to move the equipment. But other than that, that should be a complete pickup.

And that equipment that goes into the other plants that you have, do you expect to see utilization rates on that equipment fairly soon?

Yes. We've had a situation where we actually have, particularly in our plant here in Kentucky, we have more demand than we are able to fill at the moment. And so by bringing this equipment up, we will be able to both upgrade some of the sales we have, as well as to add additional capacity and so we should be able to take on more business as a result of putting this stuff into service.

Okay. Tougher question. I don't know if you are prepared to answer it. How should we think about margins in the two businesses going forward?

Sorry, I didn't quite --.

Yes. This is a little bit more challenging question. I'm just wondering if you are prepared to talk a little bit about how we should think about margins, gross margins in the two businesses going forward.

Sequentially, I think as we move through the third quarter and fourth quarter with the industrial group, we will continue to see an improvement in gross margins as we step forward. So whereas we were negative in Q1 and positive, slightly positive in Q2, we will continue to see that trend improve as we go to Q3 and Q4.

On the electronics business, it's certainly going to be impacted by the timing of some of those orders that we discussed earlier and with the cyber commissioning coming in, if that occurs in Q3 as planned, and subject to the timing and release of the orders on the classified products, we could see that business return to margin levels that are more in line with what we saw certainly in Q1 and then potentially improving beyond that.

Okay. That's helpful. Last question. I was just wondering if you can talk a little bit about what Reynolds would bring to the Company.

In terms of margin, Jim? I'm sorry --.

No, just in terms of revenue opportunity or just -- you obviously want to move forward with this. What would this do to the business? Additional customers, work with existing customers, new work with additional -- with existing customers?

It brings a number of things to the table for us. First of all, Mr. Reynolds has done an excellent job with this business over the years and it's truly a very modern, well-equipped, well-run operation that is solidly profitable, very low turnover in people. In terms of what it adds to the Sypris equation, first of all, it brings some machining capability for products that is far better than what we used to have in Morganton in terms of machining, diff cases and bearing cages and things of this nature that go on the commercial vehicle.

It brings an opportunity for us to expand. It's located in Wisconsin, which is close to the casting manufacturers, which makes it efficient from a logistics standpoint. There are customers that we have that have manufacturing operations in the Great Lakes area. And so, therefore, it will be an opportunity for us to expand with those customers again because we won't have the logistics of bringing the castings south and then turning around and sending them back to the north. So we are very excited about that.

The customer base includes our existing customer base, so there's a consistency there. Meritor, in particular, has been very supportive of the transaction and views it as a positive step forward, not just for Sypris, but for the long-term strategic relationship that we have with Meritor. So we've been very fortunate to have Meritor's strong support. So I think it's one of those situations where we are very fortunate to be in the right place at the right time when Mr. Reynolds, who's in his mid-70s now and would like to retire and spend more time down in Florida, it's hard for us to blame him, but we are looking forward to taking care of his business and growing it once we close.

Great. That's helpful, Jeff. Thanks. Good luck.

(Operator Instructions). It appears we have no further questions in queue at this time. I would now like to turn the call back over to the moderator for any additional or closing remarks.

Thank you, Kyle. Tony and I would like to thank everyone for joining us this morning. We certainly welcome your continued interest and of course, your questions about our business. Thank you and have a great day.

This does conclude today's conference call. Thank you all for your participation. You may now disconnect.