Sypris Solutions, Inc.
Q3 2013 Earnings Call Transcript

Published: 12 Nov 2013

[Operator:]

Good day, and welcome to the Sypris Solutions Incorporated 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.

[Jeffrey T. Gill:]

Thank you, Noel, 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 third 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 be 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. Revenue for the third quarter declined 7% sequentially from the second quarter of this year to $76.3 million, driven primarily by inventory rebalancing at our commercial vehicle customers and the somewhat lower than expected production of heavy-duty trucks. This decline was softened by increased shipments from our A&D segment and continued strength from the sale of our branded products to customers in the global oil and gas industry. Gross profit for the quarter decreased to $7.3 million or 9.5% of sales, reflecting the decline in quarterly revenue. Downward conversion was minimized by the sequential improvement in results from our A&D segment, and the increasingly visible impact of Lean initiatives on efficiencies in our Industrial Group. The company's earnings were a negative $0.10 per share for the quarter, reflecting lower than expected shipments in both of our operating segments and the continued impact of sequestration and other federal budgetary funding issues on our A&D segment. As we look to the future, you can rest assured that our team is focused on improving the company's financial results without having to rely upon the return of A&D funding to pre-sequestration levels. A number of initiatives are underway in both segments that are expected to lead to improved cost performance and operating efficiencies as we move forward. We will be pleased to keep you abreast of our progress as we proceed. Turning now to Slide 5. During the last couple of quarters, we have mentioned that the impacts of sequestration and other DoD funding related issues have turned out to be more far reaching and expedient than we'd ever imagined. The impact has taken many forms. Plant shipments have been delayed. Funding for product purchases have moved out of the fiscal year. Approvals have been withheld, and in one case, some long-standing commercial satellite 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. Now 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. They have worked diligently to gain customer approvals for delayed programs and to pull in business that was otherwise slated for later delivery. As we previously mentioned, 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. This morning, I'm pleased to report that our efforts have met with some success as we recently entered into a new customer funded contract to bring a new secured communications technology to market. In summary, the market continues to be a challenge for our A&D segment. In our view, the team continues to perform well and is doing a nice job of balancing the short-term requirements of the business and its customers while maintaining much-needed support for key long-term initiatives. 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 additional customer funding for specific research and development opportunities. If successful, these funds will help us to accelerate the introduction of several new promising technologies into the marketplace. And we will 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 have been targeting additional prospective customers in the NATO countries, Japan and India with the expectation that we will close on new business opportunities in Norway, Luxembourg, Canada and the Philippines in the not-too-distant future. We will continue to partner with national universities, such as Purdue and Carnegie Mellon, to develop new technologies to combat the exploding cyber threat both for our country and for nations around the world. And we will pursue synergistic acquisitions as a means to both supplement our existing capabilities and to accelerate the 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 2% from the prior-year period, but declined 10% sequentially to $66.7 million from the second quarter of this year, reflecting the combined impact of a 4% to 5% reduction in the production of commercial vehicles during the period and some inventory rebalancing by our customers. Gross profit increased 13% to $7.4 million from the third quarter of last year, reflecting a 100 basis point improvement in gross margin, while our sequential results reflect the impact of the pullback in shipments during the period. Year-to-date numbers, when compared to the final 9 months of 2012, reflect some of the recent softness in shipments while increased efficiencies and improved cost profiles have helped to limit the impact of the softer revenue on margins. As we mentioned on our previous calls, we have engaged Toyota to accelerate the development of Lean tools in our factories through the introduction of the Toyota Production System with the objective of further improving our processes and eliminating inefficiencies, thereby, increasing our competitiveness and margins. Solid progress is made during the quarter and we are now beginning to see some of the initial results of these efforts in our margins. And finally, 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 global oil, gas and petrochemical markets. Turning now to Slide 8. The outlooks for our markets served by our Industrial Group appear to be shaping up fairly nicely for the coming year. The commercial vehicle market for Class 8 trucks remains stable with the components that produce freight still fairly solid, while demand for Class 4 through 7 medium-duty trucks continues to recover along with the housing markets. In any event, it appears that the fundamentals and orders are holding up to support a solid commercial vehicle market for 2014. 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 for the coming year. 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 will begin to contribute to the company's topline in the near future and help us to diversify our customer and market concentration. As we enter 2014, you can expect that we will continue to focus our efforts on 3 key strategic initiatives

[Brian A. Lutes:]

I'd like to take you through the highlights of our third quarter financial results, and let me begin with our consolidated and then I'll touch briefly on the financial highlights of both segments. So on Slide 10, you'll see that Q3 consolidated revenue totaled $76.3 million. This was down $2.5 million or 3.2%. As Jeff mentioned, Industrial Group revenue remained stable with the prior-year period while A&D declined. The Industrial performance continued its strength, but lower revenue and changing product mix within A&D impacted our consolidated gross margin -- that came in at 9.5% or down 240 basis points from the prior-year period. Earnings per diluted share for the quarter came in at a $0.10 loss, this versus a $0.29 loss in the third quarter of 2012, driven by the lower A&D revenue and the changing product mix. One important footnote is the prior-year period did include a loss of $0.32 per diluted share from the discontinued operations resulting from the settlement associated with the sale of our Sypris Test & Measurement business. With respect to our consolidated performance on a sequential basis, please advance to Slide 11. You'll see there that the consolidated revenue declined $5.9 million or 7.2% from the prior quarter, again, driven primarily by lower Industrial Group revenue resulting from the inventory rebalancing that is most often common as we get towards the back end of the year. On a positive note, A&D revenue which I'll talk about in a moment, increased during the quarter. Despite the sequential decline in revenue, consolidated gross margin contracted only 60 basis points, to 9.5% and that clearly reflects the strength of the operational execution by our Industrial Group, and certainly by the team in Tampa, to manage the headwinds that they've been experiencing. Finally, earnings per diluted share for Q3, as Jeff mentioned, came in at a $0.10 loss, this was versus an $0.08 loss in Q2, again reflecting the lower -- the impact of lower revenue. As we shift to the A&D segment, let me touch on that with Slide 12. You'll see on the left side, A&D Q3 revenue came in at $9.6 million or 29% below the prior-year period, but did improve on a sequential basis, increasing nearly 25% to $9.6 million from Q2. Obviously, the year-over-year revenue decline highlights the magnitude of the ongoing defense uncertainty in the sequestration we've been discussing for some time. And as you know, this causes the funding for purchases to be either moved out or permanently delayed in some cases. As you shift to the right side of the page, the A&D gross margin for the third quarter was negative to all the things we've discussed, that came in at a negative 1.6%, down substantially from the prior-year period. However, on a sequential basis, gross margin improved, and the revenue increase, and came in with a 24% -- as a result of the 24% sequential revenue increase, but still fell slightly below break-even at 1.6% negative. Shifting to our industrial segment on Slide 13. You'll see that the third quarter revenue came in at $66.7 million, up $1.5 million or 2.3% from the prior-year period, reflecting overall, rather stable demand year-over-year. The revenue decreased 10% sequentially from the second quarter, again reflecting the normal inventory rebalancing that we tend to see towards the back end of the year. Overall, I think we're pleased with the Industrial Group's third quarter revenue, given that last year, the first half revenue levels peaked at a level not seen since before the September 2008 economic crisis. In addition, in a very important note, demand remained very strong for our oil and gas product offerings as well. Covering the gross margin, shifting to the right side of page, the gross margin did increase 100 basis points on a 2.3% revenue increase, reflecting strength in their operational execution. On a sequential basis, gross margins decreased 80 basis points to 11.1% on lower revenue. Again, attributable to the revenue -- to the inventory rebalancing we've talked to. In terms of summarizing Q3 and some of our key takeaways, if you will, please advance to Slide 14. Overall, commercial vehicle demand was relatively stable, with inventory rebalancing driving lower shipments in the quarter, while demand for our products serving the oil and gas markets remained very strong. As a result, our Industrial revenue increased 2% year-over-year, but decreased 10% on a sequential basis. Overall, their gross margin improved 100 basis points year-over-year to 11.1%, reflecting the benefit of our efforts with the Lean and continuous improvement efforts. In addition, as you heard Jeff mention earlier, our journey with the Toyota Production System implementation is having a positive impact and is expected to drive meaningful improvement on our future earnings. And in this regard, as you'll see, we made the announcement this morning of Gary Convis joining our Board of Directors. And as you will see from the distinguished background that Gary possesses, will be a key strategic tenant as we drive the TPS journey over the foreseeable future. Secondly, the market indicators suggest we are well-positioned for a very strong start and further improvement in 2014. Truck and trailer demand is expected to strengthen in '14; demand within the oil and gas markets remain strong and should position our Industrial segment for yet another solid year. As you heard Jeff mention and as we've talked for some time now, we continue with some of the critical R&D fundings across a number of the key development platforms within our A&D segment as a means to both reinvigorate and replenish our product offerings. Finally, as a result of the many efforts that we've undertaken since the economic crisis, our balance sheet remains a great asset and continues to allow us to remain focused on opportunities in both segments that will diversify and grow earnings and cash flow. In addition, as we spoke to earlier, it enables us to maintain and make choices about funding critical R&D investments, despite continued defense spending uncertainty and the resulting headwinds that continue to impact our results. This concludes our presentation. And as always, we thank you for your time and interest in Sypris. And at this time, I'll turn the call back over to Noah for us to answer any questions you might have.

[Operator:]

[Operator Instructions] And we'll take our first question from Jim Ricchiuti with Needham & Company.

[James Ricchiuti:]

Maybe we could start with the A&D business. I'm trying to reconcile the commentary around improved visibility, just with the overall environment. Jeff, maybe you could just talk a little bit about where you see that improved visibility? I think you touched on some of it, but perhaps you could elaborate a little bit more on that?

[Jeffrey T. Gill:]

That's a good question, Jim. I guess it's all relative, isn't it? The -- I think the easiest way to say it is that, at the moment, we believe that the second quarter reflected the low point for this business. And so we see incremental improvements in shipments as we go forward and it's still going to be a long slug, I think, as we go into 2014. But we do see some increased visibility that way. I'll tell you that as we look at it, there still ends up being a wide range of potential outcomes when we look at it from an internal planning standpoint. And so all of us here have moved towards the conservative end of the distribution in terms of expectations because of the variability that we have in the customer side. So I think it's a relative term. I think it's based upon coming out of what we believe to be the low point in Q2. And the team is just working hard to build it back.

[James Ricchiuti:]

Okay, that's helpful. And just looking at some of the newer opportunities in that business, you kind of alluded to what sounds like customer funded R&D. Not readily apparent, just given the sequential decline in R&D, is this something -- I know you did -- it's customer funded, but I assume you are also funding it separately. So what's happening within the R&D line? Is there anything you can say about the timing of potential -- this new secured communications technology, when this might be brought to market and perhaps the revenue potential relative to what you've done in the past in this area?

[Jeffrey T. Gill:]

Well the initial impact in '14 will be a reduction in our expenses. The funding from the customer will now start to take over starting with what we've been doing. The revenue potential will be in '15 and beyond, I believe. And the technology that they're being funded, while the initial focused revenue impact will not be huge, it does have some applications across a number of areas that, if we're successful, could be pretty interesting. So -- but it's not a '14 revenue impact situation, it's a '14 cost impact.

[James Ricchiuti:]

Got it, and then I'll jump back in the queue, but just one more final question on the A&D business, is the international part of the business. Any way to size what it is now and perhaps where you think it could go in the next 1 to 2 years, as a percent of the revenues of the business?

[Jeffrey T. Gill:]

Let us get back to you on that one. I mean it's another good question, but let us not kind of swag on that. Let us get you something more specific.

[Operator:]

We'll take our next question from Alan Weber with Robotti & Company.

[Alan W. Weber:]

In your comments, you talked about some initiatives to reduce costs in the Toyota Production. Can you quantify, in terms of absolute dollars, how much reduced cost you expect to see in both segments?

[Jeffrey T. Gill:]

To this point, the belief is that we've accumulated roughly $2 million of savings through these various activities. And with regard to TPS specifically, at this point, TPS is contributing a small percentage of that, but we certainly expect it to grow in size, particularly as it takes root in 3 different industrial plants that are not as mature in their adaptation of these lean techniques as we are in our Aerospace and Defense operation.

[Alan W. Weber:]

Okay. And then do you have for the quarter the breakdown by operating income for both of the segments?

[Brian A. Lutes:]

That would be in our filing this afternoon, Alan.

[Alan W. Weber:]

Okay. And I guess my final question is, can you talk about the A&D businesses? Is there a certain level of revenue or what will it have to happen for it to become profitable after corporate overhead?

[Jeffrey T. Gill:]

At the moment, we're just tracking below breakeven, quite frankly. And so we've maintained R&D spending because we believe that there's some real potential in some of the technology that we've been working on. Otherwise, that would've been reduced prior to this. So we're continuing to spend on R&D from a revenue standpoint and the current mix, we're operating below breakeven. And so it's our plan, as we move through 2014, and with any luck from our customer base, to get it back to a sustaining level, if you will, where we're not funding these losses.

[Operator:]

We'll take our next question from Jim Ricchiuti with Needham & Company.

[James Ricchiuti:]

Jeff, on the Industrial business. So we usually see some seasonality in Q4 in that business, not always, but it seems like there's been some pattern of that the last couple of years. Any way should we be thinking about it in the current quarter?

[Jeffrey T. Gill:]

Jim, I think our current outlook is that Q4 is going to be relatively consistent with Q3 and that the current forecast from ACT, FTR, all of the independent researchers, is that we'll see some lift, of 8% to 10%, in 2014, maybe 7% to 10%. That type of thing.

[James Ricchiuti:]

Is that -- is your sense in that, that is more weighted towards the back half of 2014?

[Jeffrey T. Gill:]

If I am making a forecast, I'd say it's all going to be in December of next year. It does vary, Jim. Typically, if you will look at the seasonality, Q2 is typically one of the stronger quarters. So...

[James Ricchiuti:]

Is that now -- the view that you're hearing from some of the guys -- the folks who track the market, is that also consistent with what you're hearing from your customers? As they look -- as your customers look at the market, has there been any change in their perspective over the last, say, 3 months in terms of how they are viewing 2014?

[Jeffrey T. Gill:]

No, I don't think so. And in fact, the October orders were just released and they came in at 26,000 for heavy truck and I think that was -- it wasn't surprising, people were pleased with the order rate, because that was substantially higher than what we've been tracking in the previous months.

[James Ricchiuti:]

Okay. And one final question on the industrial business. Again, you may not be able to necessarily quantify this, but it's -- I assume it's part of the more profitable part of this business, the oil and gas area. Can you give us some sense as to what it represents of revenues right now?

[Jeffrey T. Gill:]

Let us again get back to you on that one. It is growing. It's growing nicely and yes, the margins in that business are certainly attractive relative to some of our other businesses. But I'm sure when you talk with Brian and Tony, they can help you with that.

[James Ricchiuti:]

Okay. And as a look at the 2014 business, that part of the business, Jeff, oil and gas, is that an area that you guys feel reasonably good about, that you continue to show some decent growth there?

[Jeffrey T. Gill:]

Yes. We think 2014 is going to be a good year for that part of the business.

[Operator:]

We'll take our next question from Alan Weber with Robotti & Company.

[Alan W. Weber:]

I may have missed something. Did you give in Industrial what percent is oil and gas?

[Brian A. Lutes:]

No, we did not. What we were telling Jim, within our Industrial segment, we have a product line and this product line, as Jeff referenced, serves oil and gas. It is growing, but we have not in any of our filings segregated or provided visibility to those revenues, because again, we consider it another product line within our Industrial Group segment.

[Alan W. Weber:]

Right. And I heard you talk about you expect 2014 to improve. Can you talk about actually what you do there that is enable you to get the growth and good margins?

[Jeffrey T. Gill:]

Sure. Alan, we have a line of branded products, it's under the 2 Turns brand, which is a 50-plus-year old brand of things. So we've been participating in this industry for a long period of time. We make high-pressure closures, insulated joints, different types of components that are used in natural gas pipelines, refining operations, some offshore and so, as frac-ing and other means of exploration and transportation have been growing, we've been benefiting by this industry. And if you look back, historically, you can find our products in all sorts of major infrastructure initiatives around the world, quite frankly, from the Alaska Pipeline to Pakistan to the United Arab Emirates. And so it's been a business where our team has been developing new products and that has been helping as we've expanded our market share. So it's been very active. The bookings rate remains quite solid and so, we're anticipating another positive year of growth for this business in '14 as these markets remain very dynamic.

[Alan W. Weber:]

And did you say the brand has been there for 50 years? Or 15 years?

[Jeffrey T. Gill:]

Fifty. 5-0. And just quite frankly, there are a number of instances where our brand is actually spec-ed in to the work by companies such as Exxon Mobil, Shell and others.

[Alan W. Weber:]

Okay. And then my other question is, on the A&D side, can you just talk about given your issues -- as you said, you do have a strong balance sheet, so that you're able to support the losses. Can you talk about the competitive landscape and if you've seen any changes given what's impacting your business should be impacting the competitors also?

[Jeffrey T. Gill:]

Yes, I think as you look across the various product lines that we have on that side of our business, the lack of funding by key agencies and customers is very consistent. And so, in many cases, we don't see ourselves as losing business. We see the business as not being awarded or being delayed, things of that nature.

[Brian A. Lutes:]

Hey, Alan, 1 footnote to that and we didn't talk about this with you during the first quarter, but as we released the first quarter earnings, if you were to go back, Jeff gave a great example in the case of Lockheed Martin New Town, which we serve as a significant customer, which ended up resourcing that business back internally because they see and are feeling many of the same challenges, the entire Aerospace and Defense industry are feeling. And as a result, as we look at 2013, and as we planned our year, obviously, that was a sizable program, over $10 million a year, that was inevitably resourced internally back. So as Jeff mentioned, it's not so much that we are losing customers in as much as the business is simply not being awarded, because of the dynamic nature of the industry that we've watch for the better part of the 3 years now.

[Jeffrey T. Gill:]

And Brian makes a good point because this is one of the, I don't want to say unintended consequences, but certainly one of the unanticipated, because the work we were doing for this customer actually stretched across a number of programs and were primarily have a commercial satellite basis. But the decision was made to in-source this work to offset losses in more of the defense-related business that the customer was experiencing.

[Operator:]

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

[Jeffrey T. Gill:]

Well, thank you, Noah, and we want thank all of you for joining us this morning. It's a pleasure to have this opportunity to talk to you about our business and we appreciate your questions. So thank you, and have a great day.

[Operator:]

And this does conclude today's conference. Thank you for your participation.