SYPR - NASDAQ

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, Anthony, and good morning, everyone. Rich Davis and I would like to welcome you to this call, the purpose of which is to review the company's financial results for the third quarter of 2022. 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'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 an update on the outlook for each of our primary markets. Rich 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. The headline for our business continues to be the strength of new order flow and contract awards for our manufacturing and engineering services from customers serving the defense and secured communications markets. Orders for Sypris Electronics increased 75% during the quarter, compared to the same period in 2021, driving firm backlog up in excess of $100 million, representing a 99% increase over the prior year period and an 86% increase year-to-date. The strong performance follows an equally impressive second quarter, during which orders for this segment of our business increased 524% year-over-year and 240% year-to-date. The balance of our business also continued to show important strength with orders for our proprietary energy products rising 33% during the period, driving backlog up 15% year-over-year and up 84% year-to-date. This performance followed a 13% increase in orders during the second quarter of this year. Demand from all-terrain, commercial vehicle, and specialty automotive customers remained solid as it has been all year with the OEM supply chain constraints serving as a main limitation on higher levels of production. The strength of new business awards across our company resulted in a 61% increase in consolidated orders for the period, pushing backlog up 92% year-over-year. This growing trend in new order generation follows the 360% increase we reported for the second quarter of this year. The outlook for the balance of the year continues to remain positive and we are optimistic that we will continue to benefit from the underlying strength in several of our markets. Our challenge has been and continues to be the, impact of supply chain shortages and late deliveries. As many of you may recall, last quarter, we reported that our gross margin was negatively impacted as we work to adjust production schedules to accommodate changing material deliveries, among other items. At the time, we mentioned that we expected these issues to be substantially behind us within the next few months. Much important progress has been made, but in the interim, the impact of these disruptions on revenue and gross profit for the quarter was significant, resulting in a material shortfall to planned shipments for the period. We now expect much of these delayed shipments to be recovered in the fourth quarter, the result of which should support the highest level of revenue the company has reported in many years, subject, of course, to no further surprises. Turning now to Slide 5, we have issued several important announcements during – both during and immediately following the quarter. More specifically, in September, we announced the receipt of an award for specialty high-pressure closures for use in the Permian Highway Expansion Project. The project will provide an outlook for increased natural gas production from the Permian Basin to growing market areas along the Gulf Coast, including new LNG facilities that will be in service in the next few years. The project is expected to increase the capacity of the Permian Highway pipeline by approximately 550 million cubic feet per day. According to news releases, the expansion could not come at a better time and is expected to foster future natural gas production growth in West Texas and provide several LNG facilities along with Texas Gulf Coast with a more affordable, reliable supply. The project is also expected to alleviate transportation constraints out of the Permian Basin, in support of growing domestic and global energy demand. The project is proposed to be in service in late 2023. Sypris has agreed to manufacture and supply its Tube Turns-branded specialty high-pressure Tool-less and Threaded closures for use on the filtration systems protecting the compressor stations of the project. These closures will range in size from 12 inches to 70 inches in diameter and away from an estimated 250 pounds up to as much as 20,000 pounds each. Shipments under this award are expected to be completed by year end. In September, we also announced the acquisition of intellectual property rights for the rapid opening closure line from Pipeline Engineering and Supply of the United Kingdom. The purchase of the IP provides Sypris with the exclusive right to manufacture and sell the product line to end users globally, including those in the oil, gas, petrochemical and industrial markets. Under the agreement, we will also have the capabilities to supply spare parts and provide field service for any installation that contains the product line. The transaction combines certain of the flow assurance products of PE with over 50 years of installed base with the Tube Turns-branded products from Sypris, which has been producing and selling highly engineered competing products globally for over 60 years. The acquisition of the product line is highly synergistic and is expected to expand our market presence in Europe, Asia, and the Middle East. In early October, we announced that we had entered into an amendment to an existing multi-year supply agreement to include the production of electronic power logic assemblies for a large mission-critical Navy program. The amended contract, including options, now provides for the purchases up to $77 million of assemblies from Sypris over the term of the agreement, representing a 39.5% increase in potential volume, when compared to the original base contract announced earlier this year. In conjunction with the amendment, we also received releases for the first year of production with shipments scheduled to begin in 2023. The modules to be produced by Sypris will be integrated into an electronic warfare improvement program for the U.S. Navy. According to new sources, the upgrade will provide the capability to actively jam incoming missiles that threaten a warship, cue decoys and adapt quickly to evolving threats. The improvements to the electronic attack portion will provide integrated countermeasures against radio frequency-guided threats according to the Navy. The U.S. Naval Institute reported that the system's capability for non-kinetic electronic attack options can be further deployed in additional critical areas. From advanced communications to multi-role waveforms, the multifunction applications of this system will provide enhanced mission capabilities to the U.S. Navy fleet while presenting opportunities for future reductions in cost, size, weight and power. And in November, we announced that we received a follow-on award from a U.S. DoD prime contractor to manufacture and test embedded circuit card assemblies that will perform certain of the cryptographic functions for the Army Key Management System. The AKMS is a fielded system that consists of three subsystems: Local Communications Security Management Software, the LCMS; Automated Communications Engineering Software, the ACES; and the simple kilo device. Under the umbrella of our nation's electronic key management system, the AKMS provides tactical units in sustaining basis with an organic key generation capability and an efficient secure electronic key distribution means. The LCMS workstation provides automated key generation, distribution, and communication security accounting. The ACES, which is the frequency management portion of the AKMS, has been designated by the Military Communications Electronics Board as a joint standard for use by all services in the development of frequency management, cryptographic net planning and signal operation instructions generation. The embedded circuit card assemblies to be produced by Sypris will perform the cryptographic functions for ruggedized, portable, handheld, simple key load device that will be used to securely receive, store, and transfer data between compatible cryptographic and communications equipment. The device incorporates features that provide for the streamlined management of communications, security key, electronic protection of data, and signal operation instructions. Production is expected to begin in 2023. These recent contracts are representative of the high cost of failure applications which Sypris is well known. We expect the momentum of new contract wins to continue and we remain very optimistic about the potential for future program and revenue growth as we move forward. Now let's advance to Slide 6 to review the outlook for each of our major markets. According to ACT Research, the production of Class 8 heavy vehicles is expected to increase 17.5% in 2022, before softening somewhat in 2023 as the economy cycle stem. There are many factors that are having a positive influence on demand for transportation, pent-up demand from the period of pandemic, manufacturing prosperity, carrier profitability and the acceleration of the transition to e-commerce are combining to drive demand for freight to high levels. Shortages of semiconductor chips, steel and other key components are serving to hold back even higher levels of production. The current outlook for 2023 is for demand to soften somewhat during the second half of the year resulting in a 4.7% year-over-year reduction, when compared to 2022. In any event, we anticipate that new programs planned for 2023 provide revenue support for any softening that may occur in the broader market. Turning now to Slide 7, the market for the transportation and use of natural gas is key for Sypris, to be followed by the market for the transportation and processing of crude oil. U.S. natural gas prices have increased significantly over the past year, with spot prices rising to $7.88 per million BTU, up from $5.16 at this time last year. Oil prices have also increased over the past year with the price of West Texas Intermediate up 7% from September of 2021. Brent is up 13% for the same period. The current outlook is for oil prices to remain in the range of $80 to $90 per barrel for the remainder of the year. Although the outlook for the energy market is somewhat uncertain, our backlog through September of this year is up 84% year-to-date, which is perhaps a positive sign of things to come. As you will see from the chart on Slide 8, the long-term market for defense spending remains positive and within the overall budgetary allocations, spending for technology upgrades on strategic platforms continues to be a very high priority. Our backlog of future business exceeds $100 million, up 99% year-over-year and up 86% year-to-date with firm orders now extending into 2025. We are very pleased with the level of new business momentum and we are optimistic that this important trend will continue going forward. During our previous calls, we discussed the changes that have taken place in our market mix over the past several years. Turning now to Slide 9, please note the revenues forecast to increase 20% to 25% for 2023 with shipments to our customers in defense-related markets expected to rise to 42% of sales in 2023, up from an estimated 30% of sales for 2022. We believe that additional opportunity exists to further diversify our business and we will continue to aggressively pursue this outcome. Now let's turn to Slide 10 for a brief summary. Our backlog rose dramatically during the period, rising 92% year-over-year and 86% year-to-date reflecting the impact of a 61% increase in orders year-over-year during the third quarter. Defense spending is rising. Our backlog for this segment now exceeds $100 million, up 99% year-over-year and 86% year-to-date and the outlook for further strategic investment in this sector appears to be strengthening on a global basis. The energy sector should benefit from our current global issues with the potential for increased capacity investments to support the export of LNG from North America to Europe and other locations rising in priority. Our recent contract awards are expected to provide further support for top-line growth going forward, while we remain optimistic about the potential for yet additional contract wins and successes. We have issued our initial outlook for 2023, with the top-line expected to increase 20% to 25% year-over-year. We now expect gross margin to accrete 150 to 200 basis points for 2023, when compared to our current outlook, while cash flow from operations is forecast to remain strong, supported by earnings growth and working capital improvements. Our backlog is strong, so our focus must and will be on execution. The almost daily supply chain trials will continue and there will be surprises and most assuredly challenges, but this is always the case. Quite simply, we are really looking forward to the task of building the business profitably during the balance of this year and beyond. Turning now to Slide 11, Rich Davis will lead you through the balance of our presentation this morning. Rich?

Thanks, Jeff. Excuse me. Good morning, everyone. I'd like to discuss with you some of the highlights of our third quarter financial results. Please advance to Slide 12. Q3 consolidated revenue was $25.2 million, a decrease of $500,000 or 1.9% from the third quarter of last year, driven mainly by a material miss to forecast revenue due to supply chain challenges. Consolidated gross profit was $2 million for the quarter, a decrease of 50.5% from the prior year as gross margin was up 770 basis points at 7.8% for Q3. Margins dropped due to revenue miss and unfavorable mix shift and inflationary cost pressures. Revenue for Sypris Technologies increased 1.8% to $17 million for the quarter, but gross margin was 6.3%, down 630 basis points from the prior year due to lower shipments of higher value-added automotive components and raw material price increases passed through to the customer without markup. Production in the Class 8 market at the OEM level continues to be impacted by supply chain constraints unrelated to the availability of the drive axle shafts and other components we manufacture. This has in turn, reduced our shipment volume as our customers adjust their inventory levels to align with demand from the OEMs. Current forecast for Class 8 demand this year indicated a 17.5% increase over 2021 and Class 8 backlog currently stretches into 2023. Recent orders and quote activity for energy products are improving and we expect revenue will increase in Q4 from these products. On the cost side, we are also experiencing some of the inflationary pressures that are being felt across the economy. Prices of consumable supplies and tooling have increased as have utility rates. We have programs focused on identifying opportunities to reduce our supply consumption and we are working with our vendors on cost-effective solutions to control spend in this area. We also incurred additional costs during the year to support new programs and the forecasted demand in the commercial vehicle market over the balance of 2022 and 2023. The price of steel has increased over the prior year and certain of our contract terms provide for sales price adjustments to pass the increased costs on to our customers. This material price adjustment is based on market prices and flows through as additional revenue and cost of goods sold. While the impact of the steel price adjustments does not have a direct impact to our gross profit, the adjustments do reduce our gross margin percentage. Our engineering and product development teams also have initiatives underway to reduce steel consumption in both our forging and machining processes to improve our margins and deliver cost savings to our customers. Revenue for Sypris Electronics was $8.2 million in Q3, a decrease of 8.7% from the prior year and gross margin was at 11%, a decrease of 980 basis points from the prior year. The decrease in revenue was primarily due to supply chain shortages and disruptions, which caused a material reduction in forecast shipments for the quarter, primarily on several large programs. These programs are part of a record backlog that we currently enjoy and with some improvement in material availability, recovery in those shipments is expected to contribute significantly to our top-line in Q4 and continuing into 2023. We expect to be ramping up on an advanced version of an assembly for a large defense electronics program in Q4, while production for communication customers remains at a steady pace. We continue to expand our workforce in Q3 at Sypris Electronics to support the rising backlog. We are not limited by material availability. This expansion has been successful and will serve to increase capacity for the expected increase in volume in Q4 and into 2023. With improved material availability, the increased production in Q4 required to meet the expanded shipment schedule is also expected to significantly improve our manufacturing overhead absorption. As we increase production and transition from limited rate to full build rate on programs, our margin rates typically improve during the life of the program as labor productivity improves and engineering resource requirements and rework declines. As programs mature, we also have the opportunity to reduce material cost by working together with our suppliers and customers to qualify components that lower our cost per unit. Operating income for Q3 was a $1.6 million loss, compared to a $1 million income for the prior year due mainly to the miss in forecast shipments for the quarter. We expect the rebound in shipments in Q4 should flow through to improved operating income. Our operations teams are focused on execution and meeting our objectives for customer service and cost. The record backlog in place also provides a solid foundation to support this growth into 2023. Please advance to Slide 13. Year-to-date consolidated revenue was $80.4 million, an increase of $8.8 million or 12.2% from the prior year. Both segments contributed to the year-over-year revenue growth. Year-to-date consolidated gross profit increased 1.6% to $10.3 million. Gross margin decreased year-over-year by 130 basis points to 12.8% on unfavorable mix. Year-to-date revenue for Sypris Technologies increased 10.8% to $52.1 million and gross profit increased 9.4% to $6.3 million. Gross margin decreased 10 basis points to 12.2% for the period. Year-to-date revenue mix for Sypris Technologies was unfavorable, compared to the prior year due to increased revenue from material price pass-through adjustments, which increased revenue without increasing gross profit, driving a decrease in gross margin. Year-to-date revenue for Sypris Electronics was $28.3 million, an increase of 15% from the prior year, though gross profit increased 9% - decreased 9% to $3.9 million. Gross margin declined 360 basis points to 13.9%. The comparison of year-to-date revenue and gross margin for Sypris Electronics reflects the material availability challenges we faced during Q3 of 2022 and unfavorable mix compared to the prior year. Our year-to-date operating loss was $400,000, a decrease of $1.2 million from the $800,000 in operating income reported for the same period a year ago. The comparison of year-to-date net income highlights the $3.6 million benefit recognized in 2021 for the forgiveness of the PPP loan. Please advance to Slide 14. On this slide, we show our trend of consolidated gross margin for 2021, along with the performance expected for 2022 and 2023. The outlook for 2022 is reduced by 100 basis points from the prior year on production inefficiencies and unfavorable mix, while the outlook for 2023 is up by 180 basis points on the strength of the volume increases required by our record backlog. We expect gross margin to improve during Q4 as we recovered shipments delayed in Q3 due to supply chain challenges. We want to again recognize the efforts of all of our teammates involved in securing the orders received in the first nine months of this year to push our backlog to a record level and we are excited about the opportunity this provides to improve our margins and profitably grow our business. The contract awards demonstrate the trust and confidence our customers have in our business, and we look forward to continuing to meet and exceed their expectations. We will also continue our efforts to diversify our markets served and our customer base to deliver more value-add service and deliver more value-add services to our customers, which we believe can further provide upside to our current margin levels. Please advance to Slide 15 for a quick summary of our comments. A key highlight for the quarter and the year was a significant increase in orders and backlog in both segments. Sypris Electronics orders were up $15.4 million for Q3 and $74.7 million year-to-date, up 75% and 79.6%, respectively, increasing its backlog to $100.4 million. Sypris Technologies’ energy products orders were $5.8 million for Q3, up 33.5% over the prior year period. The outlook for Sypris Technologies remains favorable as the current forecast for Class 8 production in 2022 shows a 17.5% increase from last year, with a slight reduction in 2023 expected to be offset by expansions of certain programs with existing customers. Sypris Technologies has purchased the intellectual property rights to a rapid opening closure line of a competitor which expands its energy products presence in Europe, Asia and the Middle East. We expect both segments will generate double-digit year-over-year top-line growth in Q4 this year with both quarterly revenue and gross margin significantly increasing sequentially in Q4. Based on our record backlog and momentum in orders, we expect continued revenue growth of 20% to 25% and a 150 to 200 basis point improvement in gross margin in 2023. Thank you for your continued support and interest in our business. Now I'd like to turn it over to Jeff for closing remarks.

Thank you, Rich. We'd like to thank you for joining us on this call this morning. We are looking forward to another year of double-digit growth in 2023, expanding margins and increased profitability. And please note, we certainly appreciate your continued interest in our business. Thank you, and have a great day.