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Edited Transcript of SYPR earnings conference call or presentation 14-Aug-18 1:00pm GMT

Q2 2018 Sypris Solutions Inc Earnings Call

LOUISVILLE Aug 30, 2018 (Thomson StreetEvents) -- Edited Transcript of Sypris Solutions Inc earnings conference call or presentation Tuesday, August 14, 2018 at 1:00:00pm 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

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Presentation

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Operator [1]

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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 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, Sebastian, and good morning, everyone. Tony Allen and I would like to welcome you this call. The purpose of which is to review the company's financial results for the second quarter of 2018.

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 the 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 this 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 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 2018.

Now let's begin with the overview on Slide 4. We're pleased to report that revenue for the quarter came in at just under $23 million, which represented a 15.2% increase from the first quarter of this year and an 8.1% increase from the prior year period. Sypris Electronics led the way, with shipments during the quarter up 40.6% sequentially and up 6.3% on a year-over-year basis, reflecting the positive impact of its strong backlog, coupled with the timely receipts of certain electronic components.

Our ability to secure these components is greatly improved with the help and participation of our customers who have used their scale and financial leverage to apply a positive influence on the supply chain. As a result, we expect to see higher levels of shipments going forward absent any surprises.

And as a special note, we would like to thank those who were instrumental in working to improve the availability of these parts, both inside and outside of the company. We simply could not have achieved these results without your dedication and support. Thank you.

The top line at Sypris Technologies also increased on both the sequential and year-over-year basis, rising 5.7% and 9%, respectively, as a result of new contract awards and favorable market conditions.

Gross margin on a consolidated basis increased to 12.8%, up 520 basis points from 7.6% for the prior year period and up 260 basis points sequentially from the first quarter of this year. The improvement in gross margin on both the sequential and year-over-year basis was driven by positive results in both business segments. For Sypris Electronics' gross margin increased to 13.1% for the quarter, up sequentially from a loss of 1.4% for the first quarter of 2018, reflecting the positive conversion on its 40.6% increase in sales for the period.

For Sypris Technologies, gross margin increased to 12.6%, up from 2.3% for the prior year period, reflecting the positive impact of higher revenue and significantly lower operating costs.

Our improved cost profile and operating performance, when combined with an expanding top line and improved mix, is expected to result in further margin expansion during the balance of the year.

And finally, the company reported earnings of $0.04 per share, which was a positive improvement from both the first quarter of 2018 and from the prior year's performance.

Turning now to Slide 5. The outlook remains positive as we head into the second half of 2018. In the case of Sypris Technologies, the business is expected to benefit from the cost improvement activities that were completed in the second half of 2017 as well as from higher sales during the second half of 2018.

Demand for heavy trucks continues at record levels and fleets are still attempting to add capacity as fast as possible in this market. North American Class 8 orders for the past 12 months have now totaled 445,000 units. Orders for Class 8 trucks in July were up 187% on a year-over-year basis and up 25% sequentially to over 52,000 units, the highest monthly total ever recorded. The positive outlook for the economy and freight demand, coupled with rising freight rates, appears to be underlying increase in orders.

We expect the rate of comparable period growth to cool as we move forward through the year, with build slots for 2018 reaching capacity, thereby pushing the production of any additional orders into 2019.

The outlook for the automotive and light truck markets remains solid, while you will note on Slide 6 that the price of oil has risen approximately 40% over the past year. Demand for oil and natural gas continues to outpace domestic consumption, thereby supporting the forecast that the U.S. will become a net exporter of energy within the next 4 to 5 years.

The conversion of power generation used 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. And should we happen to see a positive resolution to the discussions regarding NAFTA and other trade related issues, the environment for energy-related products would likely improve further.

Turning to Slide 7. The increase in the availability of electronic components during the quarter was instrumental to the 40.6% sequential growth reported by Sypris Electronics. As we mentioned earlier, several of our customers have worked in close partnership with Sypris to secure components, to identify and qualify alternative components and sources and to enter into and fund long-term purchase commitments to help ensure future deliveries.

Department of Defense spending is also on the rise, with the recent approval of the National Defense Authorization Act for Fiscal Year 2018 providing nearly $700 billion in funding for the Department of Defense. Within this budget, spending has been increased for missile defense, weapons programs and the Joint Strike Fighter which should bode well for our business.

Even more importantly, the bill should provide for the continuity in funding of major multiyear programs that have been disrupted in the past by continuing resolutions and other short-term budgetary issues. 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.

Turning now to Slide 8. We expect both Sypris Technologies and Sypris Electronics to be solidly profitable for 2018, reflecting the benefits of top line growth, improved mix and growing operational efficiencies.

As a result, we are pleased to confirm our outlook for the balance of 2018 with revenue forecast to increase 14% at the midpoint of our guidance on a year-over-year basis, while our gross margin is expected to increase to 17% at the midpoint, up from a 11.6% for the first half of 2018 and up from 5.3% for the second half of 2017. The effective reduction of our cost profile by $26 million since 2016 has certainly played an important role in this transformation.

As we look to the future, however, the acceleration of top line growth will be the key factor that carries us forward. Much work certainly remains. We must make certain that we have the materials we need in order to meet customer commitments. But by working in close partnership with our customers, we will have a much better chance of navigating these issues successfully.

In summary, the combination of revenue growth, improved mix and the significant reduction in our expense profile is expected to open up a new, very positive chapter in our journey here at Sypris with a return to profitability for 2018.

Turning now to Slide 9. Tony Allen will lead you to the balance of our presentation this morning. Tony?

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

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Thanks, Jeff. Good morning, everyone. I'd like to discuss with you some of the highlights of our second quarter financial results. Please advance to Slide 10.

Q2 consolidated revenue was $23 million, an increase of 8.1% from the first quarter of last year. The revenue split between Sypris Technologies and Sypris Electronics was $15.3 million and $7.6 million, respectively. This represents an increase over the prior year period of 9% for Sypris Technologies and 6.3% for Sypris Electronics. The primary demand driver for Sypris Technologies continues to be the strong market conditions for our customers serving the commercial vehicle, automotive and energy markets.

Our revenue for Q2 was up sequentially by 5.7% from Q1 and we see further upside in these markets as we enter the third quarter. Revenue for Sypris Electronics increased 40.6% sequentially as component availability improved during the second quarter.

The supply-chain team for Sypris Electronics continues to work closely with our customer base to resolve the challenges of component availability in the market that could impact our programs. We are making progress with these initiatives as evidenced by the increase in revenue for the period, but much work remains. We will continue to pursue a variety of solutions, including identifying alternative sources of supply and qualifying alternative components. While the component shortages are expected to continue in the industry for the near term, we expect to maintain our position in the market, which should allow us to more efficiently balance production during the second half of the year.

Consolidated gross margin improved 520 basis points to 12.8% compared with 7.6% in Q2 of '17.

In early 2017, we announced our plans for transferring production from our Broadway facility and the actions to reduce our costs by an estimated $26 million in 2018 compared to 2016. These actions were completed over the course of 2017 and the benefits are now being reflected in a more material way in our cost of sales following the closure of the Broadway Plant in December.

Sypris Technologies reported gross margin of 12.6% for Q2 compared to 2.3% in the prior year, reflecting a significant reduction in the fixed overhead structure for this segment.

Given the strength of the Class 8 heavy truck market this year and the product transfers from Broadway, the production volume at our Toluca facility in 2018 is expected to be nearly double the volume produced there during 2017, and our team is working diligently to meet the rising demand and maintain our high standards for quality and on-time delivery.

As we've increased production in our Toluca facility, we've continued to identify equipment modernization and upgrade opportunities as well as increasing our training for the growing workforce at this location. The additional cost incurred for these activities pressured our margin performance during the second quarter, but the operational improvements related to these actions are expected to contribute to our ability to achieve our margin targets in the second half of the year.

Additionally, our revenue mix for Q2 included lower volumes for certain of our energy products compared with the prior year and sequential quarterly periods, which dampened our margin performance for the quarter.

Sypris Electronics reported gross margin of 13.1% for Q2, up sequentially from negative 1.4% in the first quarter. The rebound in revenue attributable to improved electronic component availability is the primary factor for our margin improvement. Our labor productivity improved as we had a more continuous flow of production during the quarter contributing to the expected conversion on our revenue growth. We are partnering with our customers to resolve certain technical challenges that are typical with the launch of new programs, which are expected to contribute to revenue and margin growth during the second half. We are also working proactively with our customers to mitigate supply chain risk as we launch new programs. This includes actions for the procurement of long lead time and the other high-demand components during the initial phase of a program launch on a basis that neutralizes our working capital investment over the life of the program.

Our SG&A expense for Q2 declined 11.4% from the prior year, which also drove SG&A as a percent of revenue to 13.8% compared with 16.9% a year ago.

At the adjusted operating income line, we were just below breakeven at a $200,000 loss, which represents an improvement of 88% compared to Q2 of '17.

We settled a property insurance claim for $2.4 million during the second quarter related to water supply and sprinkler pipe freeze damage that occurred following the end of production at our Broadway facility and recognized a gain in other income of $2.3 million net of expenses incurred for claim-related expenses.

We are currently evaluating options related to the disposition of the Broadway real estate, including the extent to which repairs, if any, are made to the facility. We expect to complete our evaluation and implement a disposition plan during the second half of the year.

We also completed the auction of certain excess manufacturing equipment at the Broadway facility during June, for which we received net proceeds totaling $1 million and we reported a noncash loss on disposal of the equipment during the second quarter of approximately $500,000. We are continuing to market or relocate certain of the larger high-value manufacturing assets that were excluded from the auction.

Please advance to Slide 11. First half consolidated revenue was $42.9 million, an increase of 8.8% from the first half of last year. The revenue split between Sypris Technologies and Sypris Electronics was $29.8 million and $13.1 million, respectively. This represents an increase over the prior year of 11.2% for Sypris Technologies and 3.7% for Sypris Electronics.

Gross margin for the first half increased by 890 basis points to 11.6%, reflecting the increase in volume and the impact of cost-reduction actions completed at the end of 2017.

Over the past 4 quarters, our gross margin has improved from 3.5% in Q3 of '17 to 7% in Q4 to 10.2% in Q1 of '18 and to 12.8% in the current period. With volumes expected to increase during the second half, we expect profitability to continue to improve on both the sequential and year-over-year basis.

Our SG&A expense for the first half was $6.3 million, a decrease of 9.6% or $700,000 from the prior year, which also drives SG&A as a percent of revenue to 14.7% compared with 17.7% a year ago.

Adjusted operating income for the first half improved by $4.6 million or 77% from the prior year to a loss of $1.4 million, reflecting both the increase in gross margin and the reduction in SG&A expense.

Please advance to Slide 12. Our outlook for the second half of 2018 is consistent with the view we discussed on our Q1 earnings call. We expect to see revenue grow sequentially from the first half to the second half of the year, increasing from $42.9 million in the first half to $47 million to $51 million in the second half. At the midpoint of the range, this represents a sequential and year-over-year increase of approximately 14%. For the full year, the midpoint of our outlook range represents an increase of nearly 12% over 2017.

We are maintaining our margin target at 16% to 18% for the second half of the year, placing full year margin in the range of 14% to 15.5%.

SG&A is expected to fall within 12% to 13.5% of revenue for the second half and finish lower in both absolute dollars and as a percentage of revenue compared with the prior year. The net result is top line growth for the first time in 4 years and most importantly, a return to profitability.

Please advance to Slide 13. On this slide, we summarize the first and second half year-over-year comparative data for revenue and gross margin. On the left side, we see our first half revenue increase 8.8% from $39.4 million to $42.9 million, while our gross margin increased by a multiple of over 4x from 2.7% to 11.6%. The first half improvement was driven by strong market conditions in the commercial vehicle market, coupled with the impact of cost reductions from the consolidation of operations for Sypris Technologies.

On the right side, we compare the actual results for the second half of '17 with the midpoint of our outlook range for revenue and gross margin for the second half of '18.

We expect strong market conditions will prevail during the second half of the year and that electronic component availability will improve, in particular as compared with the shortage experienced in the first quarter of '18. This is expected to drive revenue up approximately 14% for the comparable periods and gross margin up by a multiple of over 3x.

Please advance to Slide 14. This slide highlights the improvement in gross margin performance for periods back to 2014 when our annual revenue was over $350 million, with approximately 70% generated from sales to the heavy truck market.

As we managed through the last 3 years of change, we experienced a significant drop in margin performance as we realigned our cost -- cost profile to meet our new top line. But we started to see an up upward trend in our performance beginning in the first half of 2017.

Our gross margin of 11.6% for the first half of this year is more than double the gross margin from the second half of '17 and another step toward meeting our target range of 16% to 18% for the second half of 2018.

I'd also note that our first half margin performance exceeds the 2014 level of 10.9%.

As we look beyond 2018, we expect to leverage our lower cost profile with new business awards and follow-on business opportunities to create further margin expansion opportunities.

Please advance to Slide 15, and I will offer a few takeaways. Our second quarter revenue increased 15.2% sequentially from the first quarter and was up 8.1% over Q2 '17. Gross margin improved to 12.8% in the second quarter compared to 7.6% in the prior year, an improvement of 520 basis points and up sequentially from 10.2% in Q1.

SG&A declined 11.4% from Q2 of '17 and represented 13.8% of revenue for the quarter. The revenue growth and lower cost structure have enabled Sypris Technologies to generate positive operating income for the third consecutive quarter. We are confirming our outlook for revenue for the second half of the year at $47 million to $51 million and gross margin of 16% to 18%, and we continue to expect SG&A to decrease to 12% to 13.5% of revenue in the second half. The revenue outlook is supported by our current backlog and the strong market conditions for our heavy truck, energy and aerospace and defense programs. We expect to be cash flow positive for the year, and we have the opportunity to generate upside to our forecast from the sale of excess assets. And finally, we expect to report positive adjusted operating income for 2018.

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

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Questions and Answers

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Operator [1]

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

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

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Congrats on the gross margin improvement. Looks like you got there a little differently than we were expecting. So I'm wondering is the -- some of the additional costs that you incurred in scaling the Toluca business just to meet the demand, is that anticipating that's going to ease in the second half? It sounds like you think that may be behind you.

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

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Yes, Jim, we do. We expect it to -- and we're beginning to see that as we enter the third quarter and look at our July numbers and as we maintained our guidance as we have for the second half of the year. In order to get to that number, we are going to need to see those costs come out of the technologies business, and we're starting to see that in the performance for Q3.

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

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Got it. And just with respect to the outlook in that business. Just given the demand trends and maybe this is even looking beyond the second half, how confident are you in the ability to scale the business, to ramp that business to meet what looks like still to be a pretty healthy market environment entering next year?

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Jeffrey T. Gill, Sypris Solutions, Inc. - Chairman, President & CEO [5]

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Jim, this is Jeff. We feel very good about it actually. During the first half of this year, we ended up increasing employment in Toluca by 160 people and those people are now onboard and trained and that type of thing. And so we have the direct and indirect labor in place to handle the higher volumes and we're through much of the training costs and the associated things of bringing those people on. So to Tony's point, from a performance we expect to see much better performance in the second half of the year. And from a standpoint of capacity and being able to meet the demand, we feel we have the resources in place.

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

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Got it. And then just switching to the electronics side of the business. It sounds like you're more optimistic that these component shortages may be also behind you. It sounds like you got some help from your customers as well.

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Jeffrey T. Gill, Sypris Solutions, Inc. - Chairman, President & CEO [7]

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Yes. The key thing for us was getting some of our customers who are very significant in size to join with us to either help us gain access to a larger allocation of components or to help us requalify different components or substitute components and/or sources. And then the final piece that's been very, very helpful is their willingness to use their financial resources with the supply base to go out and secure long lead funding to ensure the delivery of the components.

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

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And, Jeff, are we talking mainly about the ceramic capacitors?

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Jeffrey T. Gill, Sypris Solutions, Inc. - Chairman, President & CEO [9]

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Yes.

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Operator [10]

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(Operator Instructions) We now take again a question from Jim Ricchiuti from Needham and Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [11]

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Again, going back to the electronics business, are you seeing any signs yet -- this is early, but any signs yet of a stronger funnel of opportunities as it relates to the new defense bill? Or is that something you might see later in the early -- in 2019?

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Jeffrey T. Gill, Sypris Solutions, Inc. - Chairman, President & CEO [12]

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What we've seen is a pretty material increase in the funnel of opportunities. It appears that our customers both are growing and there appears to be an interest in longer-term commitments, meaning that on an annual basis some going out 2 or 3 years. And so while the conversion of that hasn't taken place yet, the activity is certainly up materially. And as we look into 2019, absent some form of surprise, we would think that, that would continue to push our top line during the coming year.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [13]

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Okay. And, Jeff, are you seeing the pick up yet in your energy vertical? I mean, clearly, we're seeing oil prices at significantly higher levels. Has that started to translate into bookings for you?

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Jeffrey T. Gill, Sypris Solutions, Inc. - Chairman, President & CEO [14]

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We went through the period back in the first half of the year, Jim, as you know, where the impact of tariffs and all those things kind of put everybody into neutral. And recently, we've seen a lot more demand in that side of the business. And our conclusion, I don't know how well-founded, but kind of the internal belief is that, that the amount of pent-up demand out there finally just overcame the uncertainty as to what was going to happen with steel prices and some of these other things and so the outlook at the moment looks pretty positive.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [15]

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Good. And that also provides a nice tailwind, doesn't it, to your gross margins in that part of the business, it's typically at higher margin?

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Jeffrey T. Gill, Sypris Solutions, Inc. - Chairman, President & CEO [16]

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Yes. It is typically because of the proprietary products.

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Operator [17]

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It appears there are no further question at this time. Mr. Gill, I'd like to turn the conference back to you for any additional or closing remarks.

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Jeffrey T. Gill, Sypris Solutions, Inc. - Chairman, President & CEO [18]

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Okay. Well, thank you, Sebastian. Tony and I'd like to thank you for joining us on the call. We welcome your continued interest and, of course, your questions about our business. Well, thank you, and have a great day.

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Operator [19]

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This concludes today's call. Thank you for your participation. You may now disconnect.