Sypris Solutions, Inc. (NASDAQ:SYPR) Q2 2022 Earnings Conference Call August 16, 2022 9:00 AM ET
CompanyParticipants
Jeffrey Gill – President & CEO
Tony Allen – VP & CFO
Conference Call Participants
Operator
Good day, and welcome to the Sypris Solutions, Inc. Conference Call. Today’s call is being recorded. At this time, for opening remarks, I’d like to turn the call over to President and Chief Executive Officer, Mr. Jeffrey Gill. Please go ahead, sir.
Jeffrey Gill
Thank you, Nick, and good morning, 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 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. 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 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 each of our primary markets. 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. We’re pleased to report that revenue for the quarter increased 12% year-over-year, driven by a 26% increase for Sypris Electronics, and a 5% increase for Sypris Technologies. We are also pleased to note that this topline performance was achieved despite the impact of material shortages and supply chain issues that continue to challenge our business. The headline for the quarter, however, resides with the amount of business commitments the company received during the period in the form of new contract awards and expanded releases under existing agreements. Orders increased 360% year-over-year, and 169% sequentially, driven by a series of wins at Sypris Electronics, where orders 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 engineered products rising over 13% during the period, while demand from our all-terrain commercial vehicle and specialty automotive customers remained solid. As a result, backlog for the company jumped 77% year-over-year, and increased 70% year-to-date, reflecting the highest levels we have reported in more than 10 years. Backlog for Sypris Electronics is now up 84% year-over-year, and 73% year-to-date, with orders on the books now extending well into 2024. We expect this rapidly-growing backlog to provide important support for higher levels of shipments beginning later this year, before rising further during 2023. Gross margin for the company decreased 360 basis points year-over-year, reflecting the impact of several short-term issues as we work to adjust production schedules to accommodate changing material deliveries, launch new programs, and support capacity improvements. We expect these issues to be substantially behind us within the next few months, the result of which is forecast to support a 400 to 500 basis point expansion of gross margin by the fourth quarter of this year, up from levels reported for the current period.
Turning now to Slide 5, we have been pleased to announce several additional new contract awards, and expanded releases under existing agreements during the period. More specifically, in Sypris Electronics, in May, we announced the receipt of a multi-million-dollar follow-on contract award from a global defense contractor to produce modules to be incorporated into an advanced integrated electronic warfare and communications avionic system for one of the largest programs of the Department Of Defense. The program is for an American family of single-seat, single-engine, all-weather stealth, multi-role combat aircraft that is intended to perform both air superiority and strike missions. The aircraft is also able to provide electronic warfare and intelligence, surveillance, and reconnaissance capabilities. According to news sources, the US plans to purchase versions of the aircraft through the year 2044, and the aircraft is projected to operate until 2070.
The first operational supersonic short-takeoff and vertical landing stealth fighter, the aircraft emphasizes low observables, advanced avionics, and sensor fusion that enables a high level of situational awareness and long-range lethality. The US Air Force considers the aircraft to be its primary strike fighter for conducting the suppression of enemy air defense missions, owing to its advanced sensors and mission systems. Sypris will produce and test the advanced integrated electronic avionic system modules for the communications, navigation, and identification suite of the aircraft. This system supports the simultaneous operation of multiple critical functions, such as identification of friend or foe, precision navigation, and various secure voice and data communications. Production is expected to begin in 2022.
In early June, we announced the receipt of a multi-year follow-on award from a US DOD contractor to produce and test multiple power supply modules for the upgrade of an electronic warfare suite of another important US fighter aircraft program. The power supplies to be produced by Sypris will be incorporated into a suite that will replace the functionally obsolete self-protection system of existing aircraft. The upgrade is intended to significantly improve the aircraft’s capability to detect, identify, and locate radio frequency threats automatically. Updating the electronic warfare suite is critical to the aircraft, which is scheduled to be in service through the year 2040. According to news sources, the system will deliver fully integrated radar warning, situational awareness, geolocation, and self-protection capabilities to maximize mission effectiveness and survivability of the aircraft in highly contested environments. This advanced all-digital system enables deeper penetration against modern integrated defense systems, and provides rapid response capabilities designed to protect the air crew. This program is expected to transition to full-rate production beginning in 2022 as well. And in late June, we announced the receipt of releases under a new multi-year production contract that was first announced in February of this year. The order, which provides for Sypris to begin full-rate production beginning in 2022, calls for the manufacturing test of power supplies for an initial five systems to be supplied to a US DOD contractor. The modules produced by Sypris will be integrated into an electronic warfare improvement program for the US 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, and extended frequency range coverage, according to the US Navy. The system’s capability for non-kinetic electronic attack options, can be further deployed in additional critical areas, from advanced communications, to multi-role wave forms, the multi-function applications of the system will provide enhanced mission capabilities to the US Navy fleet, while presenting opportunities for future reductions in cost, size, weight, and power, according to the US Naval Institute. The contract calls for a significant increase in production volume from existing levels beginning this year.
Turning now to Slide 6. At Sypris Technologies, we announced the receipt of a multi-year contract extension in April to provide drive train components for use in the production of medium and heavy-duty commercial vehicles with a leading global commercial vehicle original equipment manufacturer. The components produced by Sypris for use in the drive train in medium heavy-duty trucks, are essential to the performance of the drive axle of the vehicles. The award of the contract extension is timely, for the commercial vehicle market is in the middle of a multi-year expansion. The production of heavy-duty vehicles increased 23% in 2021, while the outlook for 2022 anticipates a further 17% increase in demand, according to ACT Research. These recent contracts are representative of the high cost of failure applications for which Sypris is well known. We expect momentum of new contract wins to continue during 2022, and we remain very optimistic about the potential for future program and revenue growth as we move forward. In summary, we are pleased with the progress that continues to be made across our business. The strong trend line for orders and backlog expansion is very positive, and provides solid support for topline growth of 25% to 30% in 2022. Our outlook for gross margin accretion has been tempered to 25 to 50 basis points for the year, reflecting the near-term impact of supply chain disruptions, and costs incurred to support capacity improvements. Cash flow from operations is expected to increased materially for the year, driven by increased profitability and working capital improvement.
Now let’s advance to Slide 7 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 17.2% in 2022, before softening somewhat in 2023 as the economy cycles back. There are many factors that are having a positive influence on the demand for transportation. Pent-up demand from the period of the 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, effectively pushing the market peak into the second half of 2022.
Turning now to Slide 8. 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. US natural gas prices have increased significantly over the past year. The spot price is rising to $7.70 per million BTU, up from $3.26 at this time last year. Oil prices have increased significantly over the past year, with the price of West Texas Intermediate up 36% from July of 2021. Brent is up 37% for the same period. The current outlook is for oil prices to remain in the range of $90 to $100 per barrel for the remainder of the year. Although the outlook for the energy market is somewhat uncertain, our backlog through June of this year is up 20% year-to-date, which is perhaps a positive sign of things to come.
As you’ll see from the chart on Slide 9, 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 is up 84% year-over-year, and 73% year-to-date, with firm orders extending well into 2024. We’re very pleased with the level of new business momentum, and we’re optimistic that this important trend will continue going forward. During previous calls, we discussed the changes that have taken place in our market mix over the past several years.
Turning now to Slide 10, please note that revenues forecast increased 25% to 30% for 2022, with shipments to our customers in defense-related markets expected to rise to 34% of sales in 2022, up from 29% of sales in 2021. 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 11 for a brief summary. Revenue for the quarter increased 12% year-over-year, driven by the 26% increase in Sypris Electronics, and despite the challenges presented by supply chain disruptions across our business. Our backlog rose dramatically during the period, rising 77% year-over-year, and 70% year-to-date, reflecting the impact of a 360% increase in orders year-over-year, and a 169% increase in orders since year-end 2021. Defense spending is rising. Our backlog for this segment is up 84% year-over-year, and 73% year-to-date. And the outlook for further strategic investment in the sector appears to be strengthening on a global basis. The energy sector should continue to 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 topline expansion during the year, while we remain optimistic about the potential for yet additional contract wins and successes. We have confirmed our revenue outlook for 2022, with the topline expected to increase 25% to 30% year-over-year. We now expect gross margin to accrete 25 to 50 basis points in 2022, while cashflow from operations is forecast to increase materially year-over-year, 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 12, Tony Allen will lead you through the balance of our presentation this morning. Tony?
Tony Allen
Thanks, Jeff. Good morning, everyone. I’d like to discuss with you some of the highlights of our second quarter financial results. Please advance to Slide 13. Q2 consolidated revenue was $29 million, an increase of $3.1 million or 11.8% from the second quarter of last year, with both segments contributing to the year-over-year revenue growth. Consolidated gross profit was $3.8 million for the quarter, a decrease of 12.3% from the prior year, as gross margin was off 360 basis points at 13% for Q2. Margins dropped in both segments, as our revenue mix shifted, inflationary cost pressures increased, and additional costs were incurred to support our growing backlog and projected demand in the second half of this year and 2023.
Revenue for Sypris Technologies increased 4.7% to $18 million for the quarter. And gross margin was at 11.9%, down 270 basis points from the prior year. Production in the Class 8 market at the OEM level, continues to be impacted by supply chain constraints unrelated to the availability of drive axle shafts and other components we manufacture. This, in turn, has trickled down into our shipment volume, as our customers adjust their inventory levels to align with demand from the OEMs. Current forecasts for Class 8 production this year indicate a 17% increase over 2021. Class 8 backlog currently stretches into 2023. And while ongoing supply chain issues appear to be easing somewhat, OEMs seem to be cautious on opening order boards for 2023. OEM daily build rates for the second half of 2022 are expected to increase approximately 11% from the first half of this year, which could ease some of the pressure on our customers’ inventory levels.
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 well as 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 second quarter to support new programs in 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. It flows through as additional revenue and cost of goods sold. While the impact for the steel price adjustments do not have a direct impact to our contribution margin or gross profit, the adjustments do serve to reduce our margin percentage. Our engineering and product development teams have initiatives underway to reduce steel consumption and our forging and machining processes to improve our margins and deliver cost savings to our customers. The decline in gross profit for the period also reflects a lower mix of our proprietary energy and higher value-add products during the second quarter. Recent orders and quote activity for these products are improving, and we expect revenue will increase in the second half from these products.
Revenue for Sypris Electronics was $11.1 million in Q2, an increase of 25.6% from the prior year. And gross margin was at 14.9%, a decrease of 550 basis points from the prior year. The increase in revenue is primarily due to two follow-on programs with one of our key customers. We are currently ramping to full production rates on these programs, which will continue over the second half of the year. These programs are part of the record backlog we currently have, and are expected to contribute significantly to our topline growth later in the second half and continuing into 2023. We are also in the manufacturing development phase of a recent new program award that will continue into Q3 and transition first into limited-rate production, before entering a full-rate build that is expected to continue for multiple years. As we increase production and transition from limited-rate to full-rate build on our programs, our margin rates typically increase 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 costs by working together with our vendors and customers to qualify components that lower our cost per unit. We expanded our second shift workforce in June at Sypris Electronics to support the existing backlog, focusing the production during this shift on programs that have a higher-than-average run rate, and require fewer manual assembly operations. The first month of expanded operations for the second shift in Q2 was successful, and will serve to increase capacity for the expected increase in volume over the balance of the year. The additional volume from our backlog is also expected to further improve our manufacturing overhead absorption. Material availability factors into this as well, as it allows us to more efficiently plan our operations, run longer build cycles, and minimize changeovers.
Our consolidated SG&A expense was 3.7 million for Q2, an increase of 9.4% year-over-year, as compensation reductions implemented in response to COVID, were phased out over the last year, and other employment costs increased. SG&A as a percent of revenue decreased to 12.9% in Q2 from 13.2% a year ago. Operating income for Q2 was just above breakeven. And while this was below our expectations, we remain committed to driving profitable growth for the business. The record backlog in place provides a solid foundation to support this growth. Our operation teams are focused on execution and meeting our objectives for cost, quality, delivery, and service for our customers. The comparison of net income for Q2 highlights the benefit recognized in 2021 on the forgiveness of the PPP loan for $3.6 million.
Please advance to Slide 14. Consolidated revenue for the first half was $55.2 million, an increase of $9.3 million or 20.1% from the first half of last year. Consistent with Q2, both segments contributed to the year-over-year revenue growth. Consolidated gross profit for the first half increased 35.3% to $8.3 million. Gross margin also improved year-over-year by 170 basis points to 15%. Revenue for Sypris Technologies increased 15.8% to $35.1 million, and gross profit increased 43% to $5.3 million. Gross margin increased 290 basis points to 15% for the period. The revenue mix for the first half period for Sypris Technologies was favorable compared to Q2, in that revenue from our proprietary, energy, and other higher value-add products, including automotive and sport utility components, increased year-over-year, driving an improvement in gross margin.
Revenue for Sypris Electronics was $20.1 million, an increase of 28.7% from the prior year. And gross profit increased 23.8% to $3 million. Gross margin had a slight decline of 60 basis points to 15.1%. In addition to the factors previously noted for Q2, the comparison of revenue and gross margin for Sypris Electronics for the first half periods, reflects the material availability challenges we faced in the prior year, primarily during Q1 of 2021. While certain programs continue to be impacted by material availability during 2022, the impact has been less significant than in the prior year.
Our consolidated SG&A expense was $7.1 million for the first half, an increase of 13.1% over the prior year. Fewer travel restrictions, increased healthcare costs, and the phase-out of compensation reductions, contributed to the increase. SG&A as a percent of revenue decreased to 12.9% from 13.7% a year ago. Our operating income was $1.2 million for the first half, an increase of $1.3 million from the loss reported for the same period a year ago.
Please advance to Slide 15. On this Slide, we show our trend of consolidated gross margin over the most recent five years, along with the performance expected for 2022. While the revenue outlook remains unchanged, our expected gross margin improvement for 2022 has been updated to a range of 25 to 50 basis points above last year. Q2’s margin performance factored into the margin adjustment, as well as our expected revenue mix for the second half, the impact of steel price adjustments on our margin percentage, and inflationary pressure. We expect gross margin to improve during Q4, as Sypris Electronics advances further into their full-rate production cycle on our high-volume programs. We want to recognize the efforts of all of our teammates involved in securing the orders received in the first half of the 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 expectation. We will also continue our efforts to diversify our markets served and our customer base, and to deliver more value-add services to our customers, which we believe can provide further upside to our current margin levels.
Please advance to Slide 16 for a quick summary of our comments. We are pleased to report year-over-year revenue growth at the consolidated level, as well as within both segments. Consolidated revenue increased 11.8% for Q2, and 20.1% for the first half. Sypris Electronics was up 25.6% for the quarter, and 28.7% year-to-date. Revenue growth for Sypris Technologies slowed to 4.7% in the second quarter, but still shows double-digit growth of 15.8% for the first half. Consolidated gross margin declined in the second quarter, but the first half comparison is favorable, with an increase of 170 basis points to 15%. And our year-to-date gross profit of $8.3 million is 35.3% ahead of the prior year. A key highlight for the quarter was the significant increase in orders and backlog, primarily driven by recent contract awards for Sypris Electronics. Orders for the second quarter increased over five times for this segment, contributing to a 360% increase in consolidated orders over the prior year, and a 169% increase over Q1. Our consolidated backlog increased 77% from Q2 of 2021, primarily on the strength of the Sypris Electronics orders.
The outlook for Sypris Technologies remains favorable, as the current forecast for Class 8 production in 2022 shows a 17.2% increase from the last year, and OEM daily build rates are expected to increase 11% in the second half, over the first six months of the year. We expect both segments will generate double-digit year-over-year topline growth in the second half of this year, with quarterly revenue increasing sequentially in Q3, and more significantly in Q4. As we move closer to full-rate production on our higher volume programs at Sypris Electronics going into the fourth quarter, we expect the productivity initiatives we are executing will gain traction, and we will realize the benefit of more efficient production scheduling in our operation. Productivity on the recently expanded second shift at this location, is also expected to improve over the next few months, and contribute to our margin improvement target. We expect some of the headwinds that contributed to our margin performance in the second quarter, will limit our margin improvement during Q3. However, we expect certain of these factors to subside over the next few months. When combined with the volume increase and a more favorable revenue mix, we expect to generate an increase in consolidated gross margin in Q4 of 400 to 500 basis points from the current level, which will put our margin performance back in line with Q4 of ’21, and Q1 of this year. We are updating our outlook for 2022, with our revenue gross target remaining at 25% to 30%, while adjusting our full-rate gross margin increase to 25 to 50 basis points over the prior year. Our cash flow from operations is still expected to show solid double-digit growth from last year, reflecting increased profit and cash generated by working capital improvements.
Thank you for your continued support and interest in our business. And I’d like to turn it over to Jeff for closing remarks.
Question-and-Answer Session
End of Q&A
Tony and I would like to thank you for joining us on the call this morning. We are looking forward to a year of double-digit growth, expanding margins, and increased profitability. And please know, we certainly appreciate your continued interest in our business. Thank you, and have a great day
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
Be the first to comment