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Edited Transcript of SYPR earnings conference call or presentation 15-May-19 6:00pm GMT

Q1 2019 Sypris Solutions Inc Earnings Call

LOUISVILLE May 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Sypris Solutions Inc earnings conference call or presentation Wednesday, May 15, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anthony C. Allen

Sypris Solutions, Inc. - VP & CFO

* Jeffrey T. Gill

Sypris Solutions, Inc. - Chairman, President & CEO

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Conference Call Participants

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* James Andrew Ricchiuti

Needham & Company, LLC, Research Division - Senior Analyst

* Joel Cahill

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Presentation

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Operator [1]

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Good day, and welcome to the Sypris Solutions 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. Please go ahead, sir.

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Jeffrey T. Gill, Sypris Solutions, Inc. - Chairman, President & CEO [2]

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Thank you, Kevin, and good afternoon, everyone. Tony Allen 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 2019. For those of you who have access to our PowerPoint presentation this afternoon, 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 also included in the company's filings with the Securities and Exchange Commission. And in compliance with Regulation G, you can access our website, 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 afternoon, 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. Tony will then provide you with a more detailed review of our financial results for the quarter as well as walk you through our financial guidance for 2019.

Now let's begin with the overview on Slide 4.

Revenue for the first quarter approximated that of the prior year at $19.6 million, but was down sequentially due to lower levels of shipments during the period from Sypris Electronics.

Sales in our automotive and commercial vehicle business increased 11.3% on a year-over-year basis, reflecting the positive environment for our commercial vehicle, automotive and energy markets.

Sales in our energy business in particular continued to expand on a sequential basis, reflecting the positive combination of a strong backlog and improved supply chain delivery performance.

Sales to our electronics customers on the other hand declined materially as the business confronted periodic component shortages and experienced a delay in the execution of a newly awarded contract, which had the effect of moving planned shipments out of the quarter. Our backlog remained strong systemwide, providing important support for our growth objectives for 2019.

Gross margin for the quarter was 8.1%, up from 5.9% on a sequential basis, but down from the prior year quarter due to the lower level of shipments of Sypris Electronics during the period. More specifically, gross margin for Sypris Technologies was 14.3% for the quarter, which resulted in a 9.3% increase in gross profit for the period.

Operating margin increased significantly during the quarter rising to 6.5% of sales compared to 2.1% of sales for the first quarter of 2018.

Looking forward, we expect margins for Sypris Technologies to expand further, reflecting the positive impact of additional top line growth and a reduction in the costs we have incurred to support the launch of several new programs.

Gross margin for Sypris Electronics was impacted by the short-term reduction in volume we experienced during the period. With our solid backlog, the commencement of shipments under our new contract and improved component availability, we expect margins for Sypris Electronics to improve materially throughout the balance of 2019.

In summary then, demand in each of our markets continued to be positive during the quarter, providing the company with a solid foundation for further growth and margin expansion during 2019.

Turning now to Slide 5. North American demand for heavy-duty trucks reached an all-time high during 2018, driven by strong freight growth, tight capacity and an expanding economy.

Looking forward, backlogs of most OEMs are extending out 12 months or more, while production levels appeared to have stabilized at rates that are supportable by the supply chain. Both ACT and FTR have issued a positive outlook for 2019. The North American automotive market remains solid for Sypris, where our participation is focused on supplying products for a variety of specialty vehicles. As we move into the balance of 2019, we expect new program launches in the automotive, all-terrain, agricultural, off-highway and refrigeration markets to further diversify our portfolio of business and support top line growth in 2019 and beyond. And when combined with our expanding oil and natural gas business, our customer and market profiles begin to take on a very different look from that of just a few years back.

As we discussed during previous calls, demand for oil and natural gas continues to outpace domestic consumption, thereby supporting the forecast of the U.S. will become a net exporter of energy within the next few years. The conversation of power generation to natural gas as well as the construction of pipelines and LNG terminals to support export activities is also serving to bolster the market outlook.

Production in the Permian Basin continues to outpace current pipeline capacity, while the growth in pipeline gathering systems and the aging of existing transportation infrastructure bodes well for the future demand of the company's closures, insulated joints and other such products.

Energy futures have recently stabilized in the $60 to $70 per barrel range, which if maintained will be good for the industry. In any event, an expanding economy will require an increase in energy consumption and hence the current positive outlook.

Turning to Slide 6. As we discussed during our prior call, Department of Defense spending continues to increase in encouraging manner. These positive market conditions, when combined with recent contract awards and our lower-cost profile, provides us with a solid base for optimism when looking forward.

During our last call, we mentioned that we have made significant progress in securing the electronic components that were necessary to meet our production schedules. Several large customers have joined with us to secure long-lead items and to place firm purchase orders with vendors to make certain that we receive this material. As we discussed at that time, we had expected to incur some delays in shipments during the first quarter due to late material receipts and the delays in the receipt of customer contract approvals. These issues have now been substantially resolved, and our focus is turned to making certain that we have the components available to support the second half shipments to our customers.

On the commercial front, bidding activity remains robust, both with regard to the number of potential new programs as well as the size and length of production terms with some budgeted to run for 5 years or longer.

And finally, the outlook for new Deep Sea projects for transcontinental communications systems also continues to be robust.

Turning now to Slide 7, as we resolve these issues, we expect both Sypris Technologies and Sypris Electronics to be profitable for the fiscal year 2019, reflecting the benefits of top line growth, improved mix and growing operational efficiencies.

The midpoint of our outlook for 2019 forecasts revenue growth of 19% for the year when compared to 2018 with new program launches during the second half of the year adding further momentum.

From a gross margin standpoint, we are targeting to be in the range of 14% to 16% of revenue with both business segments posting solid margin growth. Material availability will remain a focus, but otherwise the table is set for a very positive year. We simply need to make it happen. Therefore, execution will continue to be our watchword as we move forward through 2019. We have much work left to do, but we are looking forward to the challenge of this new chapter in our journey.

Turning now to Slide 8, Tony Allen will lead you through the balance of our presentation this afternoon. Tony?

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Anthony C. Allen, Sypris Solutions, Inc. - VP & CFO [3]

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Thanks, Jeff, Good afternoon, everyone. I'd like to discuss with you some of our highlights of the first quarter financial results. Q1 consolidated revenue was $19.6 million, decrease of 1.9% from the first quarter of last year. The revenue split between Sypris Technologies and Sypris Electronics was $16.1 million and $3.4 million, respectively.

Sypris Technologies reported another solid quarter in Q1. Revenue of $16.1 million is the highest quarter since Q1 of 2016 and gross profit of $2.3 million is the best of any quarters since 2014. Revenue increased 11.3% on a year-over-year basis and was up 6.7% sequentially from Q4. We continue to benefit from favorable market conditions and customer demand for our products in the commercial vehicle, automotive and energy markets. Shipments to the commercial vehicle market, which accounted for approximately 39% of consolidated revenue in 2018, are expected to be stable through the balance of the year with some upside coming from the launch of new programs.

Energy product shipments, which accounted for approximately 25% of consolidated revenue in 2018, are expected to increase over the balance of the year. Although energy product shipments increased sequentially about 10%, certain shipments slipped out of the quarter, which dampened the growth and profitability of Q1.

Gross margin of 14.3% for Sypris Technologies was in line with both the prior year and sequential quarters. We reported 12.6% gross margin for the full year 2018, and we are targeting to drive margins for this segment into the upper teens for the balance of the year. We are in the process of launching several new programs with new and existing customers and certain of the costs incurred are charged to expense as incurred.

During the first quarter, our cost of sales included items related to program launches, totaling approximately 2% of revenue for the technology segment. Production is scheduled to start on these programs over the balance of 2019 with shipments expected to further contribute to our 2020 results as they reach full run rates.

The steady improvement in gross margin for technologies over the past 2 years reflects the completion of our cost-reduction efforts as well as our operational improvements. Our labor productivity is improving, and we are concurrently reducing cycle times on some of our key assets, which is allowing us to reduce or reallocate labor to other productive areas and providing capacity for growth.

Transitioning to Sypris Electronics, Q1 has been a seasonally low quarter in each of the last 2 years, representing less than 20% of full year revenue in both 2017 and 2018. We expected to continue this trend in 2019 given the ongoing challenges with electronic component availability and revenue pulled into Q4 of '18, as we planned for an ERP system implementation and its effect on shipments early in the quarter.

The impact of component shortages is narrowed recently primarily due to the efforts of our supply chain and program management teams working closely with our customers and vendors. However, the shortage of just a single specific component impacts the timing of program shipments. The first 2 months of the quarter were the most challenging, with the flow of material and production increasing notably during March and into April. We are continuing to address component availability on a daily basis allowing our operations team to more efficiently plan and manage production on the plant floor.

We are targeting the increased shipment levels beginning in the second quarter on the majority of our active programs with revenue increasing sequentially into the second half of the year. We expect to begin shipments on a follow-on program in Q2. That has been one of our better performing programs in recent periods.

We received funding for material purchases on this program in the second half of 2018. However, negotiations on the production contract extended into the second quarter of this year, and we plan to begin shipments in May.

Our business development team has been very active in the pursuit of new program opportunities to grow our revenue base for Sypris Electronics, and we are optimistic that we will win our share of these programs to support our growth objectives later this year and into 2020.

The margin performance for Sypris Electronics in Q1 directly relates to the low shipment volume during the first quarter. Although we addressed our variable cost structure to the extent possible during the quarter, our labor productivity and overhead absorption fell well below normal levels.

With shipment volumes expected to normalize beginning in the second quarter, we are targeting sequential improvements in gross margin for Sypris Electronics on both the quarterly and half-over-half basis in 2019.

Our consolidated operating income was impacted by the lower revenue and margins from Sypris Electronics, resulting in a loss of $2 million for the quarter. Our SG&A expense for the quarter increased year-over-year by approximately $300,000, as we recognized the post-implementation fees associated with the rollout of the new ERP system for Sypris Electronics and certain of our employee benefit programs had higher claim rights in the quarter.

Although we were not pleased with our results for the first quarter, we anticipated the year was going to have a slow start, and we look forward to the second quarter and the opportunity to deliver results that further advance the ball toward the achievement of our full year outlook.

Please advance to Slide 10. Revenue for 2019 is expected to be in the range of $100 million to $110 million, with gross margin coming in between 14% to 16%. Our revenue outlook is based on a forecast that includes favorable market conditions for the automotive, heavy truck and energy markets. New programs expected to launch within Sypris Electronics as well as the order backlog and anticipated program launches for Sypris Electronics. We anticipate our margin performance will improve sequentially throughout the year, as shipment levels for Sypris Electronics steadily increase from the first quarter low point.

Our continuous improvement initiatives for Sypris Technologies are forecast to reduce costs incrementally throughout the year, which will contribute to the sequential improvement and margin performance from the first half to the second half. The program launch costs, we discussed earlier, are also expected to taper off in the second and third quarters.

We expect SG&A expense as a percent of revenue to finish within 11% to 13% for the full year, with relatively flat spend levels as compared to the prior year, as our major cost reduction actions are now complete. We believe our team is well positioned to meet these targets and report a return to profitability on a consolidated basis for 2019.

Please advance to Slide 11. This slide provides a view of our consolidated revenue and gross margin performance for the 3 most recent years and our outlook for 2019 based on the midpoint of the range we just discussed. We are forecasting revenue to increase 19% at the midpoint of the range and to drive revenue above the level reached in 2016.

The anticipated slow start in the first quarter for the electronics segment was discussed on our last earnings call and considered in our outlook. The resolution of the production contract discussed earlier and shipments on other programs and backlog are expected to keep us on track toward meeting our full year revenue target.

Sypris Electronics is also expecting to launch new programs with our existing customer base that will contribute to revenue in the second half of 2019. And as noted earlier, Sypris Technologies has preproduction activities underway on a number of new programs that have targeted start of production dates based on customer delivery schedules spread over the second half of the year. The midpoint of our gross margin outlook is 15% for 2019, which compares favorably to the trend of gross margin over the past 3 years.

The additional volume we expect in 2019 plays a role in this improvement. However, our operational improvements are a top priority for our management team. We discussed some of the initiatives noted under the margin chart on our last call, and I'm pleased to report that our progress on these initiatives is going well. As noted earlier, our metrics for labor productivity and throughput on certain of our key manufacturing cells in the technology segment have improved in the first quarter.

With the ERP system implementation complete and production levels expected to increase in the second quarter, our electronics segment is also positioned to improve its operational metrics.

Our supply chain team is making progress in both segments to meet targets that will contribute to lowering material costs and reducing inventory levels. And finally, improved controls over material and design changes for Sypris Electronics are expected to benefit our margin performance over the balance of the year.

Please advance to Slide 12 and I'll offer a few takeaways. Our first quarter revenue dipped slightly from the prior year period, but was in line with our expectations due to the low shipment levels with Sypris Electronics in the period. Sypris Technologies posted its highest quarterly revenue since the first quarter of 2016 at $16.1 million, an increase of 11.3% compared to the prior year.

Improvements in component availability and the completion of contract negotiations on the follow-on program are expected to contribute to revenue growth and margin improvement beginning in the second quarter for Sypris Electronics.

Gross margin for the first quarter of 8.1% was impacted by the expected lower shipment volumes for Sypris Electronics. While Sypris Technologies reported another quarter of solid performance with operating income at $1.1 million or 6.5% of revenue. We are confirming our outlook for revenue at $100 million to $110 million for the year and gross margin of 14% to 16%, reflecting favorable market conditions in the heavy truck, energy, and A and B markets with sequential improvement in revenue and margin from the first half to the second half. And finally, we are targeting a return to profitability for 2019.

This concludes our call today. And at this time, I'd like to turn it back over to Kevin to answer any questions you might have for us at this time. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will take our first question from Mr. Jim Ricchiuti of Needham & Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [2]

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Tony, just a point of clarification. You are anticipating growth in electronics. Is that year-over-year for Q2? Or are you just assuming that it's up from Q1 levels, which obviously was a very low level?

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Anthony C. Allen, Sypris Solutions, Inc. - VP & CFO [3]

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Yes. It's certainly going to be up from Q1 levels, Jim. And where we're looking at right now would be -- would have some year-over-year growth, as well.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [4]

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Okay. So you're actually seeing a pretty good step-up. If we think about the impact in Q1 from the component availability and the delay on the program that you alluded to, can you put -- give us a little bit more color on how big that impact was and which -- whether the component availability issue, I assume was a smaller issue than the program ramp?

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Anthony C. Allen, Sypris Solutions, Inc. - VP & CFO [5]

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Yes. The program ramp in the quarter was probably held us back up to, I would say, $2 million in total for volumes during the quarter. And the component availability given that it was on some -- a couple of specific programs had a lesser impact.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [6]

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Got it. Question on SG&A. They were some moving parts, I guess, in that. I think in the press release, you alluded to some one-time charges, severance charges. Did that $0.5 million hit the SG&A line in the quarter, the severance relocation and other costs that you alluded to?

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Anthony C. Allen, Sypris Solutions, Inc. - VP & CFO [7]

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Those...

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [8]

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Oh, I'm sorry, that was year ago.

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Anthony C. Allen, Sypris Solutions, Inc. - VP & CFO [9]

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Yes, that was the prior year number.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [10]

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Got it. So then the ERP is the only item that impacted you in Q1 because based on the way you're talking about SG&A as a percent of revenues, we should see a step down in the SG&A in absolute dollars in Q2, right, from Q1?

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Anthony C. Allen, Sypris Solutions, Inc. - VP & CFO [11]

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Yes. And from Q2 to Q1, we should see that, Jim, the number we -- year-over-year the SG&A was up about 300. The biggest element, the single largest element in that was the ERP fees. We did have, as also noted, slightly higher benefit costs on some of our claim activity, but we're expecting that to taper in the second quarter.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [12]

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Got it. And then I just had a question on technologies and I'll jump back in the queue. But looks like you're seeing some nice broad-based demand in that market. And you called out, I think, a piece of business in the energy market that slipped from Q1 into Q2, was that meaningful?

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Anthony C. Allen, Sypris Solutions, Inc. - VP & CFO [13]

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Well, in that business, even though it's -- it may be a relatively smaller top line impact of under $1 million range, the margins on that are more meaningful.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [14]

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Okay. So dollar-wise, it may not have been that meaningful, but it would have impacted you think your margins, okay.

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Anthony C. Allen, Sypris Solutions, Inc. - VP & CFO [15]

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Yes.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [16]

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Jeff, I think, in the last call, you mentioned that what you're hearing from your customers in the commercial vehicle market, it sounds like folks are pretty much booked through the year. What -- has there been any change there in terms of what you're hearing from customers? And is any of that visibility, I don't know, if extending at all into 2020, but it sounds like it's still fairly healthy.

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Jeffrey T. Gill, Sypris Solutions, Inc. - Chairman, President & CEO [17]

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Yes, Jim. It's -- I think the consensus for 2019 is that we're going to run pretty much at this level through the year. And then we're starting to hear things about 2020 and its range from, it may continue through the first half and then start cycling in the second half. But I don't think there's a consensus yet on the longer view yet.

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Operator [18]

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We will now take our next question from Mr. Joel Cahill of The Jameson Companies.

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Joel Cahill, [19]

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I don't know if we talked specifically on tariffs, but is there anything that's -- as obviously it's still influx, but are there anything, any notable concerns on the horizon for you on tariffs that would be -- that would have a meaningful effect, the Chinese tariffs specifically?

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Anthony C. Allen, Sypris Solutions, Inc. - VP & CFO [20]

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Joel, there's nothing that we're aware of today that are -- that's having a meaningful effect on our business.

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Joel Cahill, [21]

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Okay. Great. And Jim just mentioned it too, but you mentioned that 2018 was record in trucking and we're going to see cyclical things in the energy markets. Do you have any sort of contingency plans in case things do slow down? I mean, it appears that the company is still losing money and having another disappointing quarter after -- when economic activity has been strong for some time and potentially it's starting to weaken. We obviously don't know which way it goes. But is there any contingency plan? Or are there anyways that you can actually reduce overhead in any quick way because it seems that there is -- right now things could bleed very fast that there were a meaningful slowdown in the economy?

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Jeffrey T. Gill, Sypris Solutions, Inc. - Chairman, President & CEO [22]

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Well, Joel, I think, that's a good question. I think in the electronic side of our business, we see that is being barely resilient to, let's call, the industrial economy, and the programs that we're on ranging from Joint Strike Fighter to some of the others are long-term funded programs. So in terms of the electronic side, we wouldn't expect to see a short-term cycle there.

In the energy field, again, the amount of demand that's taking place, the construction of LNG pipelines from Alberta to the West Coast, pipeline is being constructed in the Permian Basin to the Gulf Coast, these types of things. Again, they're long-term projects that are related to infrastructure, and we wouldn't foresee a short-term cycle in that area either.

When it comes to the commercial vehicle market, which has traditionally been more of a leading indicator for the economy, we continue to see strong demand that the OEMs are operating at capacity. If that were to turn in the short term, we've been fortunate in that we can respond fairly quickly because most of our costs, as we've been in our cycle from 2017 on, have been of a variable nature. And so we haven't had to invest a lot of money in capital equipment to meet the demands. We've done that more through continuous improvement and other initiatives to increase output without increasing our capital base. And so I think we can cycle that pretty readily.

Separately, the 7 new programs we're launching are primarily in areas that are unrelated to the commercial vehicle industry and ranging from refrigeration to all-terrain, to off-highway. And so I think that in the near term, if we would see a cycle down in the commercial vehicle market, we would offset. I think a great piece of that would be ramp-up of the new programs that are currently in place.

So I think, there is -- the exposure that we, at Sypris, have is therefore somewhat mitigated by both the aerospace and the energy areas. And in the commercial vehicle area, I think, we both have the ability to reduce variable costs quickly if we need to, and we also have the benefit of the ramp-up with the new programs.

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Joel Cahill, [23]

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And on the -- just looking at the balance sheet, there is $700 million operating lease. I don't know if you mentioned it, but could you just give a little color on what that is?

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Anthony C. Allen, Sypris Solutions, Inc. - VP & CFO [24]

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Yes. The majority of that from the new lease accounting standard, Joel, is tied to our leases for real estate, the property that we have in Tampa and Mexico are the 2 largest components of that, and our office lease here, the corporate office. From a manufacturing equipment standpoint, the numbers are smaller and so it's primarily restate related.

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Joel Cahill, [25]

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Okay. That's nothing new. That was just the accounting change?

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Anthony C. Allen, Sypris Solutions, Inc. - VP & CFO [26]

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Yes.

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Operator [27]

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(Operator Instructions) It appears we have no further questions at this time.

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Jeffrey T. Gill, Sypris Solutions, Inc. - Chairman, President & CEO [28]

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Okay. Well, thank you, Kevin, and Tony and I would like to thank you for joining us for the call this afternoon. We welcome your continued interest and, of course, your questions about our business. Thank you and have a great day.

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Operator [29]

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Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.