Sypris Solutions, Inc. (NASDAQ:SYPR) Q3 2023 Earnings Call Transcript

Sypris Solutions, Inc. (NASDAQ:SYPR) Q3 2023 Earnings Call Transcript November 17, 2023

Operator: Good day and welcome to Sypris Solutions Incorporated Conference Call. Today’s call is being recorded. At this time for opening remarks, I’d like to turn the call over to the President and Chief Executive Officer, Mr. Jeffrey Gill. Please go ahead, sir.

Jeffrey Gill: Thank you, Nick 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 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.

An engineer studying the blueprints of a large mechanical construction near a busy city skyline.

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 period. Now, let’s begin with the overview on Slide 4. We are pleased to report that revenue for the quarter increased 33% year-over-year, reflecting continued strength across each of our business segments, with revenue rising 73.5% for Sypris Electronics and 13.8% for Sypris Technologies on a year-over-year basis.

Gross profit increased 105% for the period, reflecting an increase of 186.8% at Sypris Electronics and 36.2% at Sypris Technologies. Gross margin for the company followed suit, rising by 420 basis points for the quarter, driven by an increase of 710 basis points for Sypris Electronics and by 120 basis points for Sypris Technologies. Backlog for the period increased 8.4% on a consolidated basis which was an important accomplishment following the 33% increase in sales during the period. Backlog for Sypris Electronics increased 9% to $109.5 million at the end of the quarter, up $9 million from the prior year period. The company’s financial performance was particularly notable since we bore the negative weight of $800,000 in the form of foreign currency headwinds when compared to the prior year period.

In other words, from an operating standpoint, it was another very positive quarter. As we mentioned previously, we have entered an inflection point, where rapidly rising demand is intersecting with the increasingly availability of material. We believe that the pace of conversion of our backlog in the revenue will continue to accelerate as we now ramp up new programs to full rate production. Turning now to Slide 5. We’ve been pleased to announce several additional new contract awards during the quarter, more specifically, at Sypris Technologies. In August, we announced an award for 72-inch insulated joints for use in the expansion of the Atoka Water Pipeline for the Oklahoma City Water Utilities Trust. According to new sources, the second Atoka Pipeline is being built to provide Oklahoma City and its surrounding areas with potable water.

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The project is the largest municipal water infrastructure project in the history of the state and includes a new 100-mile-long 72-inch diameter pipeline that will transport raw water from Lake Atoka to Lake Stanley Draper in Oklahoma City, where it will then be treated and delivered to more than 1.4 million people in Central Oklahoma. The pipeline is slated to cost $800 million and move more than 100 million gallons of water per day. Sypris has agreed to manufacture and supply its Tube Turns-branded monolithic insulated joints for cathodic protection of the new 72-inch polyethylene-coated and cement mortar-lined steel pipeline. These insulated joints will be 72 inches in diameter and will be rated to a pressure of 300 psi. Shipments under this contract are expected to start in 2023 and finish in 2024.

In August, we announced an award for specialty high-pressure closures for use in the Venture Global CP2 LNG Export Terminal and the Venture Global CP Express Natural Gas Pipeline Project. The CP2 LNG facility will be a natural gas liquefaction export terminal, with a nameplate export capacity of 20 million metric tons per annum. CP2 LNG will be the second LNG export project developed by Venture Global LNG in Cameron Parish, Louisiana, with the first being the Calcasieu Pass Project. Together, they represent more than $10 billion of direct investment in the Parish, according to new sources. CP Express will consist of approximately 85 miles of new 48-inch diameter natural gas pipeline, an approximately 5.9 miles of new 24-inch diameter lateral pipeline to connect the CP2 LNG terminal to the existing natural gas pipeline grid in East Texas and Southwest Louisiana.

The investment will support the objective of Global Venture LNG to develop clean and reliable North American energy supply. The project is proposed to be in service by mid-2025. Sypris has agreed to manufacture and supply its Tube Turns-branded specialty high-pressure TOOL-LESS closures for use on the filtration systems for the project. These closures will range up to 70 inches in diameter, will be rated to a pressure of 2,180 psi and will weigh up to as much as 17.5 tons each. Shipments under this award are expected to be completed by year-end. Turning now to Slide 6. At Sypris Electronics, we recently announced the receipt of 2 multimillion-dollar follow-on contract awards from a U.S. global defense contractor to produce modules to be incorporated into an advanced integrated electronic warfare and communications avionics 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 capability. According to news sources, the U.S. plans to purchase versions of the aircraft through the year 2044 and the aircraft is expected to operate until 2070. Sypris will produce and test the advanced integrated electronic avionics system modules for the communications, navigation and identification suite of the aircraft. The 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 2023. We also 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 3 subsystems: local communication security management software, automated communications engineering software and the simple key load device. Under the umbrella of our nation’s electronic key management system, the AKMS provides tactical units at sustaining basis, with an organic key generation capability and an efficient secure electronic key distribution means. 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 to provide for the streamlined management of communication security key, electronic protection data and signal operation instructions. Production is expected to begin in 2023. 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 into the coming year and we remain very optimistic about the potential for future program and revenue growth as we move forward. We expect full year revenue growth for 2023 to approximate 25%, with gross profit rising by a similar percentage despite the drag associated with the continued strength of the Mexican peso on a year-over-year basis. Our initial outlook for 2024 is positive, reflecting our strong backlog and the continued momentum of new contract awards across many of our markets.

Revenue is forecast to increase 15% to 20%, with gross profit rising 25% to 30% while gross margins are expected to expand 150 to 200 basis points. 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 commercial vehicles is now expected to rise 7.3% to 625,000 vehicles during 2023 and for a softening of demand to occur in 2024, with production forecast to decline by 13.4% for the year before rising sequentially in each of the following 2 years. We believe that the potential exists to grow through the cycles, with momentum continuing to favor the reshoring of production to North America and within North America to Mexico. Turning now to Slide 8. The market for the 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 forecasts 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 coming online starting in mid-2025. The outlook projects — projects at the 64 million metric tons of annual liquidation — 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.

By way of illustration, the U.S. exported 10.6 billion cubic feet per day in 2022 and is forecast to export 13.3 billion cubic feet per day in 2024 and 22.5 billion cubic feet per day by 2027. The maps to the right depict the various projects underway in the U.S. and Europe, identifying those that are proposed, approved, under construction and in operation. The continued 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 of defense spending remains positive. And within the overall budgetary allocations, spending for technology upgrades at strategic platforms continues to be a very high priority.

Our backlog of business now stands at $109.5 million; that’s up 9% year-over-year with firm orders 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 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 revenue is forecast to increase 15% to 20% for 2024, with shipments to our customers and defense-related markets expected to increase significantly. As a result, defense electronics is forecast to represent 46% of consolidated sales in 2024, up from 33% in 2023. 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 33% while gross profit increased 105% and gross margins expanded 420 basis points despite the negative drag of the Mexican peso on our year-over-year results. The defense market should benefit from increased spending in fiscal 2024, with discretionary and emergency funding combining to exceed $1 trillion for the year. And within this overall expected spend, investments in electronic warfare, avionics and communications are forecast to rise disproportionately. As a result, we are pleased to issue our initial outlook for 2024, with revenue expected to increase 15% to 20% year-over-year. We expect gross profit to rise 25% to 30% while gross margin is forecast to expand 150 to 200 basis points for the year.

Turning now to Slide 12. Rich Davis will lead you through the balance of our presentations. Rich?

Rich Davis: Thanks, Jeff. Good morning, everyone. I’d like to discuss a few — some of the highlights of our third quarter and year-to-date financial results. Please advance to Slide 13. Q3 consolidated revenue was $33.6 million, an increase of 33% from the third quarter of last year. Consolidated gross profit was $4 million for the quarter, increasing 105% from the prior year quarter due to overall higher production and shipment volumes in both segments and favorable mix, offset by the impact of $0.8 million in unfavorable peso-to-dollar exchange rates. Revenue for Sypris Technologies increased 13.8% year-over-year to $19.3 million for the quarter. Gross margin was up 120 basis points from the prior year quarter due to the favorable mix, offset by the unfavorable peso-to-dollar exchange rate impact.

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 continue to do daily management of spend in these areas, including scheduling production in off-peak utility rate hours as much as possible. Our engineering and product development teams have also 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 $14.2 million for the quarter, an increase of 73% year-over-year. Gross margin was at 18.1%, an increase of 710 basis points year-over-year on higher production and shipment volumes, favorable mix, material cost savings on certain programs and the impact of our continuous improvement initiatives.

We continue to implement a comprehensive approach to continuous improvement in lean manufacturing at Sypris Electronics and to expand its workforce to reinforce the team’s efforts to effectively serve its customers and the execution of significant sequential quarterly increases in shipments in 2023 and on into 2024. We also continue to implement additional automated production and inspection equipment to further improve our manufacturing efficiency. We expect these efforts to cost effectively further boost manufacturing output to meet the planned shipment increases. 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.

Consolidated operating income for Q3 was $0.1 million loss due to the $0.8 million unfavorable peso-to-dollar exchange rate impact noted earlier, up from a loss of $1.6 million in the prior year, due principally to the increase in gross profit. Our operations teams are focused on execution and meeting our objectives for customer service at 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 and into 2024. Please advance to Slide 14. Year-to-date consolidated revenue was $101.5 million, an increase of $21.1 million or 26% from the 9 months of last year. Both segments contributed to this year-over-year revenue growth. Year-to-date consolidated gross profit increased 25% to $12.9 million.

Excluding the impact of $1.8 million in year-to-date unfavorable peso-to-dollar exchange rates, gross profit would have increased by 43% to $14.7 million. Year-to-date revenue for Sypris Electronics was $42.6 million, an increase of 50% from the prior year and gross profit increased 72% to $6.8 million. Gross margin improved 202 basis points to 15.9%. In addition to the factors previously noted for Q3, the comparison of year-to-date revenue and gross margin for Sypris Electronics to the prior year periods reflects a significant increase in revenue volume resulting from a very high level of bookings achieved in 2022 and continuing into 2023 and the significant progress our integrated manufacturing and continuous improvement team has made in delivering on the steeply increased backlog.

Year-to-date revenue for Sypris Technologies increased 13% to $58.9 million. Gross profit decreased 3.6% to $6.1 million, mainly due to the $1.8 million year-to-date unfavorable peso-to-dollar exchange rate impact. Excluding the impact of the unfavorable exchange rates, gross profit would have increased by 25% to $7.9 million. Gross margin decreased 180 basis points to 10.4% for the period. Excluding the impact of the unfavorable exchange rates, gross margin would have improved 125 basis points to 13.4%. The Mexican peso strengthened significantly against the U.S. dollar in 2023 to levels not seen since before the pandemic. In 2019, the rate varied from MXN18.76 per dollar to MXN19.91 per dollar. After the disruption of the pandemic, the rate moved to MXN19.47 per dollar on December 29, 2022, after having varied in a range above that from early 2020 to that date.

Since that date, the rate has fallen to MXN17.32 as of this morning, a rate not seen in the previous 5 years. Forecasts of the future rates vary widely. We are evaluating currency hedging options at this time under a variety of scenarios. Our year-to-date consolidated SG&A expense was $11.6 million, an increase of 8.6% over the prior year. Merit pay increases and limited additions to business development and program management personnel contributed to the increase. SG&A as a percent of revenue decreased to 11.4% from 13.3% a year ago. As our revenue increases, we expect further reductions in SG&A as a percent of revenue as operating leverage improves. Our year-to-date operating income was $1.3 million, an increase of over 3.5x the operating loss of $0.4 million for the same period in 2022.

Please advance to Slide 15. On this slide, we show our trend of consolidated gross margin for 2022 and 2023, along with the performance expected for 2024. 2023 is expected to approximate the prior year as the impact of negative peso — of the negative peso-to-dollar exchange rate more than offset the positive impact of higher volumes on production efficiencies, favorable mix, material savings on certain programs and the positive impact of our continuous improvement initiatives. As noted in the 2023 pro forma bar on the graph, our gross margin would have been 14.4% or 90 basis points higher, had it not been subject to the full year estimate of $1.9 million with the unfavorable peso-to-dollar exchange rate impact. With our 2024 outlook for a revenue increase of 15% to 20% and a more limited impact of the peso-to-dollar exchange rate, our 2024 gross margin outlook is 14.8% on higher volumes at the expected mix.

We will strive to continuously improve manufacturing output and productivity while maintaining excellent quality. We will also continue our efforts to diversify our markets served and our customer base and 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 16 for a quick summary of our comments. Key highlights for the quarter and year-to-date include the continued strong backlog position and a significant increase in gross profit both for the third quarter and the year-to-date periods despite the unfavorable impact of the Mexican peso relative to the U.S. dollar. We expect rapid growth in Sypris Electronics defense market, supplemented by additional funding to meet the defense needs of our allies.

This market will likely exceed $1 trillion for the fiscal year 2024. We also expect significant growth in its communications and space markets. The outlook for Sypris Technologies remains positive, though the current forecast for commercial vehicles in 2024 is for a year-over-year decline of 13.4%. That decline is expected to be offset by planned increases in new programs with existing commercial and other vehicle customers and currently strong demands for its energy products for use in the rapidly growing LNG export markets, among others. Sypris Technologies, in addition to expanding its energy product line to include pig signalers, augmenting its distribution resources to expand its energy products presence in Europe, Asia, the Middle East and Mexico, has booked its first order for insulated joints in a water line expansion application.

Based on our strong backlog, growing new business funnel and growing market potential, we offer our initial guidance for 2024 at 15% to 20% growth in revenue, 25% to 30% growth in gross profit and 150 [ph] to 200 basis point increase in gross margin. We look forward to the opportunity to continue the positive momentum of growth and continuous improvement in 2023 into a bigger and more profitable 2024. 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 and thank you for joining us on this call this morning. We are looking forward to another year of double-digit growth, expanding margins and increased profitability. And please know, we appreciate your continued interest in our business. Thank you and have a good day.

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

End of Q&A: