Sypris Solutions, Inc.
Q2 2013 Earnings Call Transcript

Published: 6 Aug 2013

[Operator:]

Good day, and welcome to the Sypris Solutions Incorporated Earnings 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 T. Gill:]

Thank you, Cynthia, and good morning, everyone. Brian Lutes and I would like to welcome you to this call. The purpose of which is to review the trends reflected in the company's financial results for the second quarter of 2013. 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 to the first half of our presentation this morning, starting with an overview of the highlights for the quarter, to be followed by a brief discussion of each of our 2 business segments. Brian 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 increased 5% sequentially from the first quarter of this year, rising to $82.2 million, driven primarily by solid top line growth in our Industrial Group. Gross profit for the quarter increased to $8.3 million or 10.1% of sales, driven by the strong performance of our Industrial Group. Unfortunately, the 9% sequential increase in profit from this group was offset by the breakeven performance of our A&D segment, as a result of the lower sales volume reported for the period. The company's earnings were a negative $0.08 per share for the quarter, reflecting what we now believe to be the bottom of the cycle for our A&D segment. It should also be noted that the earnings for the quarter reflect both the short-term increase in R&D spending and an increase in inventory reserves, which combined to impact earnings by $0.06 to $0.07 per share. Neither of these items is expected to be repeated during the coming quarters. So in summary, the performance of our business during the second quarter can best be summed up as a tale of two cities. One in which 90% of our business performed exceedingly well; while the other, with smaller segment of our business, is forced to deal with the residual impacts of sequestration. Turning to Slide 5. Last quarter, we mentioned the impact of secular sequestration and the other DoD funding issues on our business, turned out to be more far reaching and expedient than we'd ever imagined. The impact has taken many forms. Client shipments have been delayed. Funding for product purchases have been moved out of the fiscal year. Approvals have been withheld. And in one case, some long-standing programs were identified for in-sourcing by our customer. It has been, as most of you can well imagine, a pretty hectic time for our team in charge of running this business. Having said this, they have done a nice job in responding to the challenge. The business has been rightsized, and all nonessential capital projects have been eliminated. We have worked diligently to gain customer approvals for delayed programs and to pull in business that was otherwise slated for later delivery. We also made a nontraditional decision, that is we agreed to accelerate our investment in R&D with the objective of increasing the probability of early customer adoption for one of our new growth platforms. The 60% increase in funding occurred during the quarter [indiscernible] was not expected to be repeated doing coming periods. In summary, the quarter was certainly a challenge for our A&D segment. In our view, the team performed well and did a nice job of balancing the short-term requirements of the business while maintaining much-needed support for key long-term objectives. Turning to Slide 6. We expect the impact of sequestration and other DoD funding-related issues to continue to affect our business until such times as new programs, products and cyber-related services achieve sufficient traction to offset the issues described a moment ago. We are making important progress with our efforts to secure customer funding for specific research and development opportunities. If successful, these funds will help to accelerate the introduction of several new promising technologies into the marketplace. And while we continue to focus on EDMS sales for end-use applications that exhibit a high cost of failure, and therefore, require the unique pedigree, certifications and traceability standards that have long been an important part of our heritage. As many of you may recall, we made significant progress during 2012 in our efforts to expand international sales to customers in Australia, New Zealand and other Five Eye countries. The objective was and is to diversify our customer, product and service mix. For 2013, we are targeting additional prospective customers in the NATO countries, Japan and India. We will partner with national universities, such as Perdue and Carnegie Mellon, to develop new technologies to combat the exploding cyber threat both for our country and for nations around the world. Then we will pursue synergistic acquisitions as a means to both supplement our existing capabilities and to accelerate replacement of revenue that has been lost or delayed due to the issues we mentioned earlier. We remained focused on the future prospects for this business, despite our most recent challenges. We have a great team in place and a number of new opportunities under development. We will manage it closely until such time as we exit the current turbulence, always striving to strike the right balance between short-term needs and long-term objectives. Now let's take a quick look at our Industrial Group, beginning with Slide 7. Revenue increased 5% sequentially to $74.4 million from the first quarter of this year, commercial vehicle and trailer markets. Gross profit increased 9% sequentially to $8.9 million, up from $8.1 million for the first quarter of 2013, while gross margin increased by 50 basis points to 11.9%, up from 11.4% for the first quarter of 2013. Year-to-date numbers, when compared to the final 6 months of 2012, reflect the strength of the business' performance. Sales were up 21%, while gross profit is up 40%. In addition to the positive financial results, quality and delivery remained at world-class levels, while quoting activity for new business programs remained at risk. As we mentioned in our last call, we have engaged Toyota to accelerate the deployment of Lean tools in our factories through the introduction of the Toyota Production System with the objective of further improving our processes in eliminating inefficiencies, thereby, increasing our competitiveness and margins. Solid profit [indiscernible] quarter with over 100 employees now having completed training. We continue to increase our investment in engineering and operational capability during the quarter to make certain that we will be in a position to support the growth opportunities inherent in today's oil, gas and petrochemical markets. In summary, the team responsible for our Industrial Group simply did an excellent job. The combination of positive financial results and strong operational performance came together nicely during the period. And it is our pleasure to recognize them once again. Thank you, one and all. Turning now to Slide 8. The outlooks for the markets served by our Industrial Group appear to be shaping up fairly positively. The commercial vehicle market for Class 8 trucks remained stable with the components that produce freight still fairly solid while the demand for Class 4 through 7 medium-duty trucks continues to recover along with the housing market. In any event, it appears that the fundamentals and orders are holding up to support a solid commercial vehicle market for 2013. The outlooks for our light truck and trailer markets, as well as our off-highway and agricultural markets also appear to be in good shape. We are looking forward to another year of profitable growth from our natural gas, oil and petrochemical markets, where global demand for our highly engineered closures, insulated joints and other specialty piping components continues to be quite strong. As we mentioned during our last call, the new business development pipeline remains quite active. If successful, many of these new programs would begin to contribute to the company's top line as early as 2014 and help to diversify our customer and market concentration. During the balance of the year, you can expect that we will continue to focus our efforts on 3 key strategic initiatives

[Brian A. Lutes:]

Great. Thank you, Jeff. Good morning, everyone. I'd like to take you through the highlights of our second quarter financial results, and I'll begin with our consolidated view and then I'll briefly discuss some of the highlights for each of the segments. So in advancing to Slide 10, we'll start at the revenue line. Q2 consolidated revenue totaled $82.2 million. This was down 17% to -- or roughly $16.7 million, but attributable primarily to the much higher commercial vehicle volume in the prior year period. So very much in line with our internal expectations for the quarter. Despite the year-over-year revenue and the changing product mix within A&D, we brought gross margin in at 10.1%, again, driven very much by the strength and performance of our Industrial Group. On the earnings per diluted share, we came in at $0.08 loss. This was versus a $0.22 positive in Q2 of '12, and clearly, a result of the lower A&D revenue and the unfavorable mix. In addition, as you heard Jeff mention earlier, we did accelerate the pace of R&D investment during the quarter, and we also made the decision to increase our inventory reserve on a certain end-of-life program, when combined, impacted our earnings there at approximately $0.06 to $0.07. If we move to our consolidated results in context of sequential, please advance to Slide 11. Once again, you'll see that consolidated revenue was up 5% from the prior quarter, again, in line with our expectations and driven clearly by the continued strength in demand for light truck commercial vehicles and the trailer markets in general. Gross margin remained essentially stable there. Despite the shift in mix and the increase in inventory reserves, we came in at 10.1%, only down about 30 basis points. Obviously, our Industrial Group continued to help us weather the storm and made critical investments to the product portfolio in our A&D segment. Finally, again, on the earnings per share. Looking at it from a sequential basis, just as a reminder, it did come in at $0.08 loss versus $0.34 loss in Q1. But as you will recall, the first quarter did include the $6.9 million noncash goodwill write-off for approximately $0.36. Shifting now to our segment view, let me begin with the A&D business on Slide 12. On the left side, you'll see, as we've discussed, the challenge in budget cuts and program delays impacted their quarter resulting in A&D revenue of $7.7 million, down considerably from the prior year period, but it did improve on a sequential basis. You'll see there increasing 5.5% to $7.7 million from Q1. Obviously, the year-over-year revenue decline really does highlight the impact of delayed shipments, funding for purchases that either moved out or permanently delayed and its impact on the team and certainly, as it was challenged in managing these tough conditions. Shifting to the right side, you'll see the gross margin for the second quarter, again, negatively impacted by the things we've already discussed, down substantially from the prior year period. On a sequential basis, gross margin declined slightly due to those same challenges. And while our results here truly depict the challenging environment, as you heard Jeff mention, I think we do see some signs that the budgetary funding delays might be easing, and as so, suggest that Q2 was the bottom of the cycle and that revenue in margins should improve as we move through the second half of the year. Let me round out now with some commentary on our Industrial segment and talk about their performance on Slide 13. There, second quarter revenue, again, came in at $74.4 million. This is down 10% from the prior year quarter, very much in line with our internal projections. If you will recall, last year, the first half revenue levels peaked at a level not seen since a few years before the economic crisis. So again, we did see, while strength in the quarter, down from the prior year period, but again we were at volume levels back, if you will recall, in the roughly $82 million range back in those quarters. However, when viewed sequentially, revenue continued its pace. It increased nearly 5% sequentially from the first quarter, reflecting the continuing market demand and we expect it, as we look forward, to remain essentially flat for the balance of this year. Shifting over to the right, our Industrial Group gross margin increased 120 basis points despite the 10% decrease in revenue year-over-year, again reflecting the continued operating improvement this business has been working so hard to advance. Likewise, on a sequential basis, you see, like revenue, gross margin expanded 50 basis points, coming in just under 12% for the second quarter. So as Jeff mentioned earlier, I think it's also important to reiterate for those of you that have followed the company for quite some time, that this is really reflective of the team's efforts to embrace and engage continuous improvement in Lean, and frankly, a myriad of other tools deployed for quality, to drive improvements in their operations and is truly reflective of the transformational change made in executing customer demand requirements at world-class quality levels, yet profitably. And clearly, this is not the case during the last upturn, particularly in 2004 and 2005. So let me bring closure to our call with you today and ask you to advance to Slide 14, and I'll summarize some of the highlights. Obviously, as Jeff mentioned, commercial vehicle demand continued its rebound from the second half of 2012 downturn. And as a result, we were fortunate in that our Industrial Group revenue continue to improve coming in at $74.4 million for the quarter. Gross margin was up 120 basis points year-over-year to 11.9%. And finally, EBITDA of $9 million was generated by the Industrial segment as well. We are positioned further -- for further improvement during the second half of the year for a number of reasons

[Operator:]

[Operator Instructions] Our first question will come from Jim Ricchiuti with Needham & Company.

[James Ricchiuti:]

Jeff, Brian, with the cash [ph] in the industrial business in the second half are clearly more favorable or easier versus a year ago. But I'm curious, can you talk a little bit about how the second half for the industrial business might look versus the first half? It sounds like you've got pretty good visibility into what your customers are seeing from a build standpoint.

[Jeffrey T. Gill:]

Certainly, Jim. As we look into the second half of the year, our customers are basically telling us that we should expect the third quarter to be within the relevant range of where we've been in the first 2 quarters. And then pretty much across-the-board, they're expecting the fourth quarter to have some potential for some upside because they're seeing at least the first half of 2014 as being up 10% to 12% from 2013. So whether that hits right in the fourth quarter, which typically has far fewer workdays than the other quarters of the year, we'll wait to see. But at the moment, nobody is indicating that there is, let's say, downside to the outlook.

[James Ricchiuti:]

Okay. And just on the A&D business, can you expand or elaborate at all on the R&D spend? You indicate that primarily it's for a new growth opportunity that you're focusing on. Can you talk a little bit about what that might be? And when you might be able to see some orders coming from that? And then just as a follow-up, would we expect R&D then to go back more towards Q1 levels in Q3?

[Jeffrey T. Gill:]

So let me answer your questions starting with the last. Yes, we would expect R&D to fall back to more traditional levels as we move into the balance of the year. And so I would say, the first quarter would be a very good baseline for purposes of your outlook for the second half. With regard to the timing of revenue, we're hoping that the recent efforts will generate some orders here in the latter part of 2013, which would then begin to contribute to the business in 2014. And probably the more important aspect of the efforts that our team is making in this area is that the impact on the top line would not be nearly as material as the impact would be on our profit. Because the work that they've been doing, the patents that they've been filing all are to create a much more attractive mix of revenue and profit, if you will.

[Operator:]

And next we'll move on to Tristan Thomas with Sidoti & Company.

[Tristan Thomas:]

2 quick questions. Inventory reserves, is that primarily tied to the A&D business?

[Brian A. Lutes:]

Yes, it was.

[Tristan Thomas:]

Okay. And then second question, in terms of CapEx, it's running at about 1% of revenue. Is that what you project moving forward or...

[Brian A. Lutes:]

When we looked at CapEx in turn -- no, because we certainly curtailed some of the spending in the second quarter. And we would see that, that would be somewhere in the 2.5% as we've called out in the prior quarter, roughly 3% in terms of a range of revenue because we'll see that pick up in the third and fourth quarter.

[Operator:]

[Operator Instructions] Gentlemen, we have no further questions at this time.

[Jeffrey T. Gill:]

Okay. Well, thank you, Cynthia. Brian and I would like to thank all of you for joining us this morning. We certainly welcome your continued interest, and of course, your questions about our business. So thank you and have a great day.

[Operator:]

This does conclude our conference call for today. We'd like to thank you for your participation.