Sypris Solutions Inc (SYPR) 2016 Q2 法說會逐字稿

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 the President and Chief Executive Officer, Mr. Jeffrey Gill. Please go ahead, sir.

Thank you, Brian, and good afternoon, 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 second quarter of 2016 as well as the transaction we announced this morning with Analog Devices.

For those of you who have access to our PowerPoint presentation this afternoon, please advance to the 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.

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

Please advance to slide 3. I will lead you through the first half of our presentation this afternoon, starting with an overview of the highlights for the quarter, to be followed by a brief discussion of the transaction with Analog and the outlook for our business going forward. Tony will then provide you with a more detailed review of our financial results for the quarter and the impact of the CSS sale on our business.

Now let's begin with the overview on slide 4. The financial performance for the Company during the second quarter of 2016 marked a material improvement when compared to the prior year's results, even after taking into account the recent softness in demand from the commercial vehicle market. Revenue declined $3.4 million sequentially to $23.5 million from the first quarter of 2016, while gross profit increased significantly on a year-over-year basis as a result of the improved performance in product mix at Sypris Electronics.

Gross margin expanded to 3.1%, up from a slight loss for the prior year and up from 2.7% during the first quarter, reflecting the positive impacts of both cost-reduction activities and improved product mix. Gross margin for Sypris Technologies improved sequentially despite a 17% sequential reduction in revenue, while the gross profit for Sypris Electronics increased $1.6 million from the prior-year period, driven by the improved product mix I mentioned a minute ago.

During the quarter, we entered into a long-term lease for a manufacturing facility that will serve as the new home for Sypris Electronics and our trusted manufacturing operations. The facility represents a substantial upgrade from the property that we have occupied for the past 50 years.

The smaller footprint and more modern infrastructure are expected to save the Company as much is $2 million per year in operating expenses. We plan to be in the new facility and operating before the year is out.

Now let's turn to slide 5 to discuss the important news we announced morning. Yesterday we closed on the sale of our Cyber Security Solutions business to Analog Devices. The CSS business, as we refer to it internally, is the segment of Sypris Electronics that supplies secure communications equipment, identity authentication, key management, and encryption services to the US government and its foreign allies. The all-cash purchase price was $42 million.

The transaction was structured as a purchase of assets, excluding most working capital, and included all intellectual property and know-how associated with the SiOMetrics, SYPHER, Cyber Range, and data systems product lines. The gain on the sale after expenses and escrow is expected to approximate $33 million or $1.67 per share.

The net proceeds of approximately $37.5 million will be used in part to repay all senior debt, leaving a cash balance in excess of $28 million available to reinvest in the Company going forward. Tony will review these and other details with you shortly.

Advancing to slide 6, approximately 67 people or 33% of the Sypris Electronics workforce will transfer to ADI as part of the transaction, but are expected to remain in their existing geographic locations of Tampa, Florida; Columbia, Maryland; West Lafayette, Indiana; and Copenhagen, Denmark. The transaction also includes a long-term supply agreement between Sypris and Analog under which Sypris will continue to build circuit card assemblies for certain of the product lines being purchased by ADI.

We believe that this transaction will be viewed as one of those rare but nice occurrences when an event is truly a win-win for all parties involved. For our people in the CSS business, they will find a new home with a large, extremely well-run technology company with a global footprint. With the addition of ADI's resources, the opportunity will exist to greatly accelerate the introduction of SiOMetrics, SYPHER, and the Cyber Range into a wide variety of automotive, industrial, aerospace, healthcare, IoT, and safe cities applications. The Internet of Things will become a reality for these technologies, and the unique capabilities of our people in conjunction with the resources of ADI will be the key drivers that make it happen.

We will certainly miss them and we wish them much success. What an opportunity.

For Sypris, we can now move forward with a strong liquid balance sheet and start building our business for the future. We will have a refined focus on providing manufacturing services for a select group of strategic customers that need the unique qualifications that we bring to the table. If you love building product, what a great place to be.

Turning now to slide 7. Sypris will retain its core trusted manufacturing operations in Tampa, Florida, with plans to relocate the business into a smaller manufacturing footprint with approximately 130 employees prior to year-end. We will continue to focus on the special needs of customers such as Harris, Lockheed Martin, Northrop Grumman, Rockwell Collins, TE SubCom, and now Analog Devices, where the cost of product failure is significant and therefore the reliability of the product is paramount. Typical applications include satellites, deep sea communications, and aircraft avionics.

The business is healthy and poised for a very bright future. Backlog at the end of the second quarter reached $26.8 million, up from $8.7 million for the second quarter of 2015. A new chapter is opening for Sypris Electronics, and we expect it to be an interesting, fun, and rewarding read.

Now let's turn to slide 8 and conclude the first half of our presentation this afternoon with Sypris Technologies. The Class 8 demand for vehicles in North America continued to soften during the quarter which, when combined with inventory rebalancing by a few customers, led to the 17% decline in sequential revenue for Sypris Technologies during the quarter.

ACT is forecasting a 28% year-over-year decline in Class 8 production, which would indicate that we will see some further softening as we move through the balance of 2016. The demand for medium-duty trucks, on the other hand, continues to remain solid, driven in part by the strong automotive and housing sectors.

The energy markets appear to be firming, with the price of oil rising for the quarter from just under $30 per barrel at the end of December to $46 per barrel recently. In any event, price stability in the $40 to $60 range would be a real plus for the industry.

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

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

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

In summary, the second quarter of 2016 marked a period of important continued progress for Sypris, while the just-completed transaction with ADI represents a significant positive inflection point for the Company. Turning now to slide 9, Tony Allen will lead you through the balance of our presentation this morning. Tony?

Thanks, Jeff. Good afternoon, everyone. I'd like to begin by taking you through the highlights of our financial results for the second quarter of 2016 followed by more discussion on the recently completed transaction.

Please advance to slide 10. Q2 consolidated revenue totaled $23.5 million, down $17.3 million compared to the prior year. The decline in revenue for the second-quarter period is attributable to Sypris Technologies, as Sypris Electronics was flat compared to the prior year.

The two primary factors for the revenue decrease at Sypris Technologies, both of which were discussed during our first-quarter call, are the loss of revenue associated with our former trailer manufacturing operation and reduced demand from customers in the commercial vehicle market. Before it was sold in July of 2015, the trailer operation contributed $7.5 million to revenue in Q2 of 2015.

We expect demand in the commercial vehicle market to remain challenging for the balance of 2016, and current industry forecasts are pointing toward further tightening in 2017. We continue to pursue new business opportunities to offset the overall market weakness, and we remain focused on our continuous improvement programs to improve productivity and reduce costs.

Another factor impacting revenue in the second quarter was the revaluation of steel, resulting from lower market prices, with certain of our major customers. This revaluation resulted in a dollar-for-dollar decrease in both our material cost for steel purchased, on the cost side of the equation, offset by a decrease in our selling price to the customer, on the revenue side of the equation.

Compared to Q2 2015, the revaluation reduced revenue by nearly $2 million. However, this does not directly impact gross profit.

Finally, our product sales to the oil and gas market declined from the prior year, which is more reflective of the timing of shipments within 2016 as opposed to weak market conditions. Backlog and quoting activity for these products is robust, which we expect will contribute to revenue growth later this year.

Gross profit improved to $700,000 in the quarter compared to the near breakeven amount in the prior-year period. Favorable revenue mix and cost reductions contributed to the improvement at Sypris Electronics.

Sypris Technologies reported lower gross profit, primarily attributable to the revenue decline. Sypris Technologies improved their gross margin percentage from Q1 2016; however, a 17% sequential decline in revenue impacted our ability to move above breakeven in gross profit. Revenue mix was also a factor in the year-over-year comparison for Sypris Technologies, as the reduction in oil and gas product shipments drove lower margin percentages for the Q2 periods.

EBITDA improved to negative $2.5 million in the quarter from negative $4.8 million in the prior-year period. The increase in EBITDA of $2.3 million primarily reflects the improvement in consolidated gross profit and lower SG&A expense. Our SG&A cost was $2.1 million lower in Q2 as compared to the prior year, primarily reflecting lower employment costs attributable to headcount reductions, reduced spend for legal and other professional fees, and the elimination of G&A expense for the trailer operations sold in 2015.

Our adjusted net debt as of the end of the second quarter was $17.7 million, as compared to $23.7 million at the end of Q2 2015. Adjusted net debt includes amounts due under our credit agreements, less cash balances on hand, including restricted cash. As of the end of Q2 2016, our adjusted net debt also includes a $3.3 million obligation for the capital lease for our Toluca, Mexico, facility.

Further discussion on the impacts of the recent transaction on our debt status will be addressed in a few slides.

Let me now ask you to please advance to slide 11 for comments on the transaction. As Jeff described earlier, the gross proceeds from the transaction were $42 million cash. After deducting the direct transaction costs and the net book value of assets divested, our preliminary estimate of the gain on the sale for accounting purposes is currently estimated at approximately $33 million or $1.67 per share.

Direct transaction costs are estimated at $3 million. And $1.5 million will be held in escrow for one year for indemnifications related to the transaction. After deducting these amounts from the sale price, the net proceeds available to Sypris at closing was approximately $37.5 million.

The Company also repaid all senior debt outstanding with the proceeds. The debt repayment totaled $16.8 million, including certain early repayment fees on the term debt, which was partially offset by the release of the $6 million cash collateral balance. The cash collateral was previously carried on our balance sheet as restricted cash.

We will use the balance of the proceeds to invest in our business, including capital expenditures in support of new programs being pursued for both segments of our business, for funding working capital, and for general operating purposes. The repayment of our senior debt will eliminate approximately $600,000 per quarter or $2.4 million per year in interest expense for the Company.

Continuing with this discussion, let me ask you to please advance to slide 12. The assets sold in the transaction include intellectual property, certain inventory, and PP&E directly related to the CSS business. We retain substantially all working capital and manufacturing equipment located in Tampa, Florida. These assets will continue to be used to support the trusted manufacturing operation in providing services to the customers Jeff described earlier.

Our preliminary estimate of the net value of divested assets is approximately $5 million. The book value of intangible assets was not material, as the majority of the development costs related to the CSS operations had been expensed as incurred in prior years. Our preliminary estimate of the pro forma CSS financial results for the 2015 year reflected $16.7 million of revenue and a $3 million operating loss.

The retained trusted manufacturing business will be relocating to a new facility in January 2017 with a reduced footprint. As a result of this move, we estimate we will achieve a $2 million annual operating expense savings as compared to the costs at our current facility. The transaction also eliminates approximately $600,000 of annualized R&D spend, based on historical rates, that was previously attributable to the CSS operation.

Please advance to slide 13 for a discussion of our debt and cash positions. This table reflects our actual debt and cash balances as of Q2 2016 and the comparative pro forma balances, reflecting the net proceeds from the sale and the repayment of debt.

Both the term data and the revolver were paid in full. We retired the term debt, but we are keeping the revolver in place with certain modifications, including a reduction in the total commitment from $15 million down to $8 million. The subordinated debt of $6.5 million will remain outstanding also, with a scheduled maturity date in January 2019.

The debt table also reflects an estimate for the write-off of unamortized loan costs associated with the term debt of $1.2 million. The pro forma result is total debt of $9.7 million, consisting of our subordinated debt to a related party and the capital lease obligation for our Toluca facility. Our pro forma cash position increases to approximately $30 million, consisting of available cash of $28.5 million and the $1.5 million of restricted cash for the escrow agreement.

Let me now close with a brief summary and ask you to please advance to slide 14. The commercial vehicle market conditions provided headwinds for our business during Q2; however, cost-reduction actions in favorable revenue mix for electronics drove improvements in consolidated gross profit and EBITDA. Our balance sheet will benefit immediately from the transaction for the CSS business: increasing available cash by nearly $27 million, increasing shareholders' equity by over $30 million, and eliminating senior debt of $15.5 million.

During this presentation, we have also highlighted some of the factors we expect will drive increases in our Company's profitability in future periods that combine to approximately $5 million. These include: a reduction in interest expense of approximately $2.4 million annualized; a reduction in facility operating expenses, as Electronics relocates in the beginning of 2017, of approximately $2 million annualized; and a reduction in research and development cost of approximately $0.6 million annualized.

The completion of this transaction represents the last major building block in our transformational process that began in early 2015. I'd like to personally express my appreciation and gratitude to everyone on the Sypris team for their contributions to our business, in particular, during the last 20 months, which have been challenging for us all.

We would not be in this position without the persistence, effort, and dedication of a great team. Thank you.

And finally, we are excited to move into the next phase in the Company's history and we look forward to the opportunity to build a stronger and more profitable business. This concludes our call today, and at this time I'd like to turn it back over to Brian so we can open it up for any questions you might have for us at this time.

(Operator Instructions) Jim Ricchiuti, Needham & Company.

Hello; good afternoon. Congratulations on the transaction. I guess I wanted to start, if I may, with the backlog number that you gave, provided, for Sypris Electronics. That was $26.8 million on a pro forma basis for the backlog for the go-forward business?

That's correct.

Okay. Is that a multiyear backlog? I'm trying to get a sense how much of that backlog, Jeff or Tony, might be shippable over the next 12 months.

You know, Jim, the answer to your question is that there is part of the backlog that goes into 2017 and bleeds into 2018. To break that out for you in what covers the next 12 months, I think Tony would have to get back to you.

Yes, the majority of it is within the 2017 calendar year, the substantial majority of it. But, as Jeff said, there is a tail that would go into 2018.

Okay. What I'm trying to get to, as you guys probably know, is just what the business might look like on a go-forward basis. Are we looking at revenues in the $25 million or so area? Don't know if there is any help you can provide along those lines.

And then what the gross margin profile might also look like. Because we had a couple of moving parts for the CSS business that you divested; there was a higher-margin piece that was profitable and then the investment piece on the Cyber side.

So is there anything you can provide along those lines that might give us a little color on how to think about the business going forward?

Sure, Jim. The revenue number you called out is in line with what we would see for the business going -- at least initially launching out. We think we obviously feel strongly about the business and the prospects for trusted manufacturing, so we think we can grow that. But I think initially that $25 million number is the right place to start.

And as far as margin percentages, I think for trusted manufacturing initially we're going to be in the mid to upper teens, with the ability to improve on that as well as we move forward.

Okay. That's helpful, Tony; thanks. You also provided some nice color just in terms of how we can think about some of the savings associated with the transaction and other steps that you are taking. How should we think about the investment piece of that?

Because clearly now you're in a position where you can invest in not only Sypris Electronics but also on Sypris Technologies. Is there -- is that going to be meaningful, do you think, over the next year, now that you have this flexibility with the balance sheet?

Well, certainly, Jim, there are some investments that we'll want to make in the near term, given that the liquidity this transaction provides is something more significant than what we've had to work with the past couple of years, in particular. So, there are some things that are queued up that we'll look at for the next 12 months.

But I think the larger part of the answer to your question would be it's going to be subject to the new program activity and the wins, the rate of win that we have on some of these programs that we're pursuing.

Got it. Okay, thanks. I'll jump back in the queue. Thank you.

(Operator Instructions) Jim Ricchiuti, Needham & Company.

Yes, just if we could maybe talk a little bit about what your sense is on the industrial side of the business. Sounds like, given the outlook that you're seeing from ACT, another tough quarter, maybe over the balance of the year, in the Class 8 market. Are you hearing anything from your customers that gives you reason to be at all a bit more optimistic as you look out in 2017, or is this still a pretty uncertain environment?

That's a great question, Jim. It is an uncertain environment, and I think that overall the consensus is that it will remain soft and perhaps get a bit softer in the aggregate going into 2017.

From a Sypris standpoint, we have a number of programs that we're launching or have just launched that we expect to counteract that softness as we look forward into next year. So we anticipate that we'll actually see some incremental year-over-year growth as opposed to seeing the business decline further in the coming year.

And, Jeff, is that a scenario where you might see sequentially improving, albeit maybe modestly, but sequentially improving revenues in that part of the business over the course of the year?

Yes.

Terrific. Thanks very much.

(Operator Instructions) And there are no further questions in the queue at this time.

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

And ladies and gentlemen, that concludes today's conference call. We thank you for your participation.