Sypris Solutions, Inc. (NASDAQ:SYPR) Q1 2023 Earnings Call Transcript May 16, 2023

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 would like to turn the call over to President and Chief Executive Officer, Mr. Jeffrey Gill. Please go ahead, sir.

Jeffrey Gill: Thank you, 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 first quarter of 2023. 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 any 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 period. Now let’s begin with an overview on Slide 4. We are pleased to report that revenue for the quarter increased 23.4% year-over-year and 8.7% sequentially, reflecting continued strength across each of our business segments with revenue rising 42% for Sypris Electronics and 13.7% for Sypris Technologies on a year-over-year basis.

Orders for the quarter were up 73.6% year-over-year, driven by a 91.4% increase in Sypris Electronics and a 25.7% increase for the energy products of Sypris Technologies. Our backlog increased accordingly, raising 121% on a consolidated basis. Backlog for Sypris Electronics increased 125% to $131.6 million at the end of the quarter, up $73 million from the prior year period. In a similar fashion, backlog for the energy products of Sypris Technologies increased 61% year-over-year, reflecting positive global demand for the segment’s highly engineered products. On a consolidated basis, backlog has now increased for 11 consecutive quarters on a year-over-year basis, with an average quarterly increase of 53%. In fact, over the past 17 quarters, going back more than 4 years, backlog has increased in all of the 2 periods, the second of which was a 9.4% decline for the second quarter of 2020, which reflected the impact of customer shutdowns of the onslaught of the pandemic.

As many of you may remember, we mentioned previously that we were entering the inflection point where rapidly rising demand was intersecting with the increasing availability of material. We believe that the pace of conversion of our backlog into revenue will continue to accelerate as we now ramp up new programs to full rate production. Turning now to Slide 5. We have been pleased to announce several additional new contract awards during the quarter, more specifically at Sypris Electronics. In February, we announced an award to produce and test electronic interface modules for Department of Defense weapon system. That is an important part of the DoD’s ongoing modernization effort. The result of the program will be to increase the strategic and tactical capabilities for a variety of aircraft platforms.

Production on this program is expected to begin in late 2023. And shortly after quarter end in April, we announced the receipt of additional releases under a multiyear production contract that was first announced in 2022. The award provides for the manufacture and test of electronic assemblies for an additional 4 systems to be supplied to a U.S. Department of Defense contractor. The modules to be produced by Sypris will be integrated into an electronic warfare improvement program. 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. Production on this program is scheduled to begin later this year with deliveries expected to begin in late 2023.

Turning now to Slide 6. Sypris Technologies announced in March that it has entered into an amendment to its current supply agreement with Detroit Diesel Corporation, a subsidiary of Daimler Truck North America. Daimler Truck North America is itself a subsidiary of Daimler Truck Holding AG, one of the world’s largest commercial vehicle manufacturers. The amendment adds a new series of part numbers to the agreement with DDC for drivetrain components used in DDC’s Detroit branded drive axles. The components to be produced by Sypris will be essential to the performance of the drive axles of Freightliner’s heavy-duty vehicles. Production of these additional part numbers under the amended contract are expected to commence in 2023. And shortly after quarter end in April, we announced the award of a new program to supply drivetrain components for use in the production of a new model of side-by-side all-terrain vehicles.

The new program award provides Sypris with the opportunity for further growth in this burgeoning market. The finished components produced by Sypris to exacting specifications will be incorporated into the differentials of these vehicles. The all-terrain vehicle market is forecast to expand at a compound annual growth rate of 16.8% between 2020 and 2025, according to Technavio research. Production is expected to begin in 2024. Each of these contracts are representative of the high cost of failure applications for which Sypris is well known. We expect the momentum of new contract wins to continue during the year and we remain very optimistic about the potential for future program and revenue growth as we move forward. In summary then, we are pleased with the substantial progress that continues to be made across our business.

The supply chain challenges are continuing to abate and our focus is clearly on meeting the growing demand of our customers. Now let’s advance to Slide 7 to review the outlook for each of our major markets. According to ACT Research, the demand for the production of Class 8 heavy vehicles increased 19% in 2022 and is expected to remain essentially flat at this elevated level during 2023. There are many factors that are having a positive influence on the demand for transportation. Unfilled demand from 2022, capacity shortfalls in the supply chain, elevated carrier profitability and the continued transition to e-commerce, among other factors. Shortages of semiconductor chips, steel and other key components have served to hold OEM production levels down, pushing backlog well into 2023.

The current ACT outlook calls for medium and heavy-duty truck production to remain at elevated levels before easing somewhat in the second half of 2023. Turning now to Slide 8. The market for transportation and use of natural gas is key for Sypris and has become increasingly dynamic over this past year. European countries boosted LNG imports by 60% in 2022 to offset declining pipeline shipments from Russia. As part of the strategic response to their former dependency on Russia for the reliable supply of natural gas, Europe has embarked upon an aggressive campaign to source its needs elsewhere. The IEEFA forecast that Europe will increase its LNG import capacity by 33% by the end of 2024 and that the global LNG market will see a tidal wave of projects come online starting in mid-2025.

The outlook projects that 64 million metric tons of annual liquefaction capacity will be added by 2026. The U.S. is a major provider of LNG and became the world’s largest exporter in 2022 with plans to do even more in the future. The maps to the right depict the various projects underway in the U.S. and Europe, identifying those that are operational, under construction, approved and proposed. The 61% growth in our energy products backlog year-over-year reflects the strong and growing demand to support these infrastructure programs. We remain cautiously optimistic that this positive outlook will remain in effect for some time to come. As you will 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 now stands at $131.6 million and is up 125% or $73.1 million year-over-year, with firm orders extending into 2025. We are 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 2023 with shipments to our customers in defense-related markets expected to increase significantly. As a result, Defense Electronics forecast to represent 39% of consolidated sales in 2023, up from 28% in 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 11 for a brief summary. Revenue for the quarter increased 23.4%, while backlog grew by 121%, providing a strong platform to support future growth in 2023. Backlog at Sypris Electronics now stands at $131.6 million, reflecting 125% or $73.1 million increase from the prior year-end. In a similar fashion, backlog for our energy products is up more than 61% year-over-year. Our consolidated backlog has now increased for 11 consecutive quarters on a year-over-year basis. And when combined with improved material availability, we’ll provide important support for the launch of our new program wins and the corresponding higher levels of forecasted revenue, margin and income. Our markets are in good shape. Defense spending continues to increase, and we may yet feel some additional tailwind depending upon the future outcome of our current global geopolitical situation.

As a result, we are pleased to confirm our outlook for 2023. Revenue is expected to increase 25% to 30% year-over-year. We expect gross margin follow suit, expanding 150 to 200 basis points in 2023, while cash flow from operations is forecast to remain strong, supported by our outlook for earnings growth. Quite simply, we are looking forward to the task of building the business profitably during the coming year and beyond. Now let’s turn to Slide 12, Rich Davis will lead you through the balance of our presentation this morning. Rich?

Richard Davis: Thanks, Jeff. Good morning, everyone. I’d like to discuss with you some of our highlights of our first quarter financial results. Please advance to Slide 13. Q1 consolidated revenue was $32.3 million, an increase of 23.4% from the first quarter of last year and an increase of 8.7% sequentially as we continue to benefit from the abatement of the supply chain issues experienced in 2022, facilitating increased production, particularly at Sypris Electronics. Consolidated gross profit was $4.2 million for the quarter, a decrease of 7.7% from the prior year despite the growth in revenue over the prior year quarter. Gross margin was off 430 basis points compared to the prior year quarter due to an unfavorable shift in mix, production ramp-up costs, raw material price pass-throughs at 0 margin and unfavorable foreign exchange rates.

Revenue for Sypris Technologies increased 13.7% year-over-year to $19.5 million for the quarter. Gross margin was down 480 basis points from the prior year due to raw material price increases passed through to the customer without markup and unfavorable foreign exchange rates. However, gross margin was up 60 basis points from Q4 on increased shipments. While our shipment volume went down in Q4 at Sypris Technologies as our commercial vehicle customers rebalanced their inventory levels at year-end, shipments subsequently returned to normal levels in Q1. Class 8 demand finished 2022 with a 19.6% increase over 2021 and is expected to increase 0.9% from that high level for 2023 with some decline in the second half. First quarter orders and backlog for energy products increased 26% and 61%, respectively, year-over-year, which we expect will translate into higher revenue from these products in 2023.

On the cost side, we continue to experience 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 are working both internally and with our suppliers on cost-effective solutions to control spend in these areas. 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 cost 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 steel price adjustments preserves our gross profit, the adjustments do reduce our gross margin percentage. Our engineering and product development teams have 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 $12.8 million for the quarter, an increase of 42% year-over-year and 1.9% sequentially as the supply chain issues that impeded shipments throughout 2022 abated, and we ramped up production for defense and communication customers in the quarter. Gross margin was at 11.9%, a decrease of 340 basis points year-over-year on production ramp-up costs and unfavorable mix and higher material costs on certain programs. We’re implementing an improved approach to lean manufacturing of Sypris Electronics and we continue to expand its workforce to reinforce the team’s efforts to execute the significant planned sequential quarterly increases in shipments in 2023. We are also in the process of implementing additional automated production and inspection equipment to further improve our manufacturing efficiency.

We expect these efforts to boost manufacturing capacity to meet the planned increase. As we increase production and continue to make manufacturing process improvements, we anticipate an improvement in labor productivity and overhead absorption, resulting in an improvement in margins. As programs mature, we also have the opportunity to reduce material costs by working together with our suppliers and customers to qualify components that lower our cost per unit. Consolidated operating income for Q1 was $400,000, down 63% from the prior year due principally to production ramp-up costs, unfavorable mix and foreign exchange rates as previously discussed. Our operations teams are focused on execution and meeting our objectives for customer service and expanded volume levels while also reducing cost per unit.

The strong backlog in place provides a solid foundation to support this growth through the remainder of 2023. Please advance to Slide 14. On this slide, we show our trend of consolidated gross margin for 2021 and 2022, along with the performance expected for 2023. 2022 decreased by 140 basis points from the prior year on production inefficiencies induced by the supply chain challenges and material price pass-throughs without a markup. With the anticipated shipment volume increases, supported by our record backlog, we expect revenue growth in the range of 25% to 30% in 2023. We expect to deliver year-over-year margin improvement in the range of 150 to 200 basis points on these higher volumes, placing us at a 15.3% margin at the midpoint of this range in 2023.

We want to again recognize the efforts of all of our teammates involved in pushing our backlog to a record level, and we also want to recognize and thank our reinforced Sypris Electronics team for its intense focused efforts to meet its customers’ expectations for rising shipments in 2023 and the Sypris Technologies team for similar efforts to improve new programs for existing customers. We will continue — also continue our efforts to diversify our markets served and our customer base to deliver more value-added services to our customers, which we believe can provide further upside to our current margin levels. Please advance to Slide 15 for a quick summary of our comments. A key highlight for the quarter was the significant increase in orders and backlog in both segments.

Backlog increased 120% for the period, marking the 11th consecutive quarter of year-over-year growth. Sypris Electronics orders were $25.8 million for Q1, up 91% year-over-year, increasing its backlog to $131.6 million. We expect shipments to rise significantly in each quarter of 2023 as a function of the increase in backlog and increased production efficiency. Sypris Technologies energy products were up 26% over the prior year period, supporting continued near-term revenue expansion. Sypris Technologies has also augmented its energy product line and distribution resources to expand its energy presence in Europe, Asia and the Middle East. The outlook for Sypris Technologies remains favorable, with the current forecast for Class 8 demand in 2023, basically even with a high level of 2022 and further supported by planned increases in new programs with existing customers.

We expect both segments will generate double-digit year-over-year top line growth in 2023, with gross margin also increasing in 2023. Based on our record backlog and momentum in orders, we are holding our outlook for a 25% to 30% growth in revenue. With unfavorable foreign currency exchange rates impacting margins in the near term, we have adjusted the gross margin guidance to a 150 to 200 basis point improvement over the prior year. Thank you for your continued support and interest in our business. Now I’d like to turn it over to Jeff for closing remarks.

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

Operator: The conference has now concluded. Thank you for your participation. You may now disconnect.

End of Q&A: