Earnings Call Transcript - SYPR Q1 2023

Operator, 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, CEO

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 but 2 periods, the second of which was a 9.4% decline for the second quarter of 2020, which reflected the impact of customer shutdowns due to the onset 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 systems. 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. Shortly after the quarter ended 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 testing of electronic assemblies for an additional four systems to be supplied to a U.S. Department of Defense contractor. The modules 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 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 is expected to commence in 2023. Shortly after the quarter ended 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 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, 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 the 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 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. 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 revenue 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 a 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. When combined with improved material availability, this will 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 to 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.

Richard Davis, CFO

Thanks, Jeff. Good morning, everyone. I'd like to highlight some key points from our first quarter financial results. Q1 consolidated revenue was $32.3 million, representing a 23.4% increase from the same quarter last year and an 8.7% sequential rise, thanks to the easing of supply chain issues encountered in 2022, which allowed for increased production, especially at Sypris Electronics. Consolidated gross profit for the quarter was $4.2 million, down 7.7% year-over-year despite the revenue growth. Gross margin contracted by 430 basis points compared to the previous year due to a less favorable product mix, production ramp-up costs, raw material price pass-throughs affecting margins, and unfavorable foreign exchange rates. Revenue for Sypris Technologies rose 13.7% year-over-year to $19.5 million. The gross margin decreased by 480 basis points from last year due to raw material price hikes passed to customers without markup and negative foreign exchange impacts. However, gross margin improved by 60 basis points from Q4 due to increased shipments. Although shipment volumes dropped in Q4 as our commercial vehicle clients adjusted their inventory at year-end, they normalized in Q1. Demand for Class 8 vehicles finished 2022 up by 19.6% compared to 2021 and is projected to rise 0.9% in 2023, though a decline is anticipated in the latter half. First-quarter orders and backlog for energy products surged 26% and 61% year-over-year, respectively, suggesting higher anticipated revenue from these products in 2023. On the cost side, we continue to face inflationary pressures seen across the economy. Prices for consumables and tooling have risen, along with utility rates. We are actively working with suppliers on cost-effective solutions to manage expenses in these areas. The cost of steel has also risen compared to the previous year, and some of our contracts allow for price adjustments to pass these increases to customers. Although these adjustments preserve our gross profit, they negatively affect our gross margin percentage. Our engineering and product development teams are currently pursuing initiatives to reduce steel usage in our forging and machining processes to enhance margins and provide cost savings to customers. Revenue for Sypris Electronics hit $12.8 million for the quarter, marking a 42% year-over-year increase and a 1.9% sequential rise, as supply chain issues that hindered shipments in 2022 subsided, allowing us to ramp up production for defense and communication clients. Gross margin stood at 11.9%, a decline of 340 basis points year-over-year caused by production ramp-up expenses, unfavorable product mix, and higher material costs on specific programs. We are adopting an enhanced lean manufacturing strategy at Sypris Electronics and expanding the workforce to meet the planned increases in shipments for 2023. Additionally, we are implementing more automated production and inspection equipment to improve manufacturing efficiency. We expect these initiatives to enhance production capacity to handle the forecasted increases. As we boost production and initiate process improvements, we expect gains in labor productivity and overhead absorption to lead to better margins. As programs progress, we can also lower material costs by collaborating with suppliers and customers to qualify more cost-effective components. Consolidated operating income for Q1 reached $400,000, down 63% from the prior year mainly due to production ramp-up costs, unfavorable product mix, and foreign exchange challenges as previously mentioned. Our operations teams are focused on execution to meet customer service goals and increased volume while working to reduce unit costs. The strong backlog we have supports growth for the rest of 2023. Moving to Slide 14, we illustrate the trend of consolidated gross margins for 2021 and 2022, along with the expected performance for 2023. In 2022, our gross margin declined by 140 basis points from the previous year due to production inefficiencies caused by supply chain challenges and material costs passed on without a markup. With anticipated increases in shipment volume, backed by our record backlog, we forecast revenue growth of 25% to 30% for 2023. We expect to see year-over-year margin improvement between 150 to 200 basis points at these higher volumes, leading to a gross margin of 15.3% at the midpoint of this range in 2023. We want to acknowledge the efforts of all our team members who contributed to achieving a record backlog level, and we also extend our gratitude to the strengthened Sypris Electronics team for their dedicated efforts to meet rising shipment expectations in 2023, as well as to the Sypris Technologies team for their work on enhancing new programs for existing customers. We will continue our efforts to diversify the markets we serve and expand our customer base to provide more value-added services, which we believe will enhance our current margin levels. Please move to Slide 15 for a quick summary of our remarks. A major highlight for the quarter was the substantial increase in orders and backlog across both segments. Backlog rose by 120% year-over-year, marking the 11th consecutive quarter of growth. Orders for Sypris Electronics reached $25.8 million in Q1, up 91% year-over-year, bringing its backlog to $131.6 million. We expect significant increases in shipments each quarter of 2023 due to the growing backlog and improved production efficiency. The energy products segment for Sypris Technologies increased by 26% compared to the prior year, further supporting near-term revenue growth. Sypris Technologies has also enhanced its energy product range and distribution capabilities to strengthen its presence in Europe, Asia, and the Middle East. The outlook for Sypris Technologies is positive, given the steady forecast for Class 8 demand in 2023, which remains comparable to the high levels of 2022 and is further supported by planned expansions in new programs with existing clients. We anticipate that both segments will achieve double-digit year-over-year revenue growth in 2023, with gross margin also expected to improve this year. With a record backlog and strong order momentum, we maintain our revenue growth outlook of 25% to 30%. Nonetheless, due to unfavorable foreign currency exchange impacts on margins in the short term, we've adjusted our gross margin guidance to reflect a 150 to 200 basis point increase over the prior year. Thank you for your continued support and interest in our business. Now, I would like to hand it over to Jeff for his closing remarks.

Jeffrey Gill, CEO

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, Operator

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