Q2 2023 Sypris Solutions Inc Earnings Call

Participants

Jeffrey T. Gill; Chairman, President & CEO; Sypris Solutions, Inc.

Richard L. Davis; VP & CFO; Sypris Solutions, Inc.

Presentation

Operator

Good day, and welcome to Sypris Solutions, Inc. conference call. Today's call is being recorded.
At this time, for opening remarks, I'd like to turn the call over to the President and Chief Executive Officer, Mr. Jeffrey Gill. Please go ahead, sir.

Jeffrey T. Gill

Thank you, Nick, 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 second 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 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 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 the overview on Slide 4. We are pleased to report that revenue for the quarter increased 22.6% year-over-year and 10.3% sequentially, reflecting continued strength across each of our business segments, with revenue rising 40.2% for Sypris Electronics and 11.7% for Sypris Technologies on a year-over-year basis. Backlog for the period increased 25.5% on a consolidated basis. Backlog for Sypris Electronics increased 25% to $116.6 million at the end of the quarter, up $23 million from the prior year period. In a similar fashion, backlog for the energy products of Sypris Technologies increased 38% year-over-year, reflecting a positive global demand for the segment's highly engineered products.
EPS increased $0.04 per share from the prior year quarter rising to $0.01 per share from a loss of $0.03 per share last year. The company's financial performance was particularly notable since the [order] way to foreign currency headwinds and an unrecoverable increase in the price of raw material and an unexpected adjustment to our pension expense. In other words, from an operating standpoint, it was clearly a superior quarter.
As we mentioned previously, we have entered an inflection point. We're rapidly rising demand is 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 Technologies. 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.
In August, we announced an award for 72-inch insulated joints for use in the expansion of the Atoka Water Pipeline for the Oklahoma City Water Utilities Trust. According to new sources, the second Atoka Pipeline is being built to provide Oklahoma City and its surrounding areas with potable water. The project is the largest municipal water infrastructure project in the history of the state. It includes a new 100-mile-long 72-inch diameter pipeline that will transport raw water from Lake Atoka to Stanley Draper Lake in Oklahoma City, where it will be treated and delivered to more than 1.4 million people in Central Oklahoma. The pipeline is slated to cost $800 million and move more than 100 million gallons of water per day.
Sypris has agreed to manufacture and supply its Tube Turns-branded monolithic insulated joints for cathodic protection of the new 72-inch polyethylene-coated and cement motor line steel pipeline. These insulated joints will be 72 inches in diameter and will be rated to a pressure of 300 psi. Shipments under this award are expected to start in 2023 and finish in 2024.
In August, we also announced an award for specialty high-pressure closures to use in the Venture Global CP2 LNG Export Terminal and the Venture Global CP Express Natural Gas Pipeline project. The CP2 LNG facility will be a natural gas liquefaction export terminal with a nameplate export capacity of 20 million metric tons per annum. CP2 LNG will be the second LNG export project developed by Venture Global LNG in Cameron Parish, Louisiana, with the first being the Calcasieu Pass Project. Together, they represent more than $10 billion of direct investment in the Parish according to new sources.
CP Express will consist of approximately 85 miles of new 48-inch diameter natural gas pipeline and approximately 5.9 miles of new 24-inch diameter lateral pipeline to connect the CP2 LNG terminal to the existing natural gas pipeline grid in East Texas and Southwest Louisiana. The investment will support the objective of global venture LNG and develop clean and reliable North American energy supplies. The project is proposed to be in service by mid-2025.
Sypris has agreed to manufacture and supply its Tube Turns-branded specialty high-pressure [tool] closures for use on the filtration systems for the project. These closures will range up to 70 inches in diameter, will be rated to a pressure of 2,180 psi and weigh up to as much as 17.5 tons each. Shipments under this award are expected to be completed by year-end.
Now let's turn to Slide 6. At Sypris Electronics, 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 test of electronic assemblies for an additional 4 systems to be supplied to a U.S. Department of Defense contractor. The modules to be produced by Sypris will be integrated in its 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 for later this year with deliveries expected to begin in late 2023.
Each of these contracts are representative of the high cost of 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. As a result of these successes, we are pleased to confirm our outlook for consolidated top line growth of 25% to 30% for 2023, while recent headwinds in foreign exchange are expected to continue reducing our forecast for margin expansion to 75 to 125 basis points for the year.
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 now expected to rise an additional 7.1% during 2023, which reflects an upward revision to its previous forecast. 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, carrier profitability and the continued transition to e-commerce, among other factors. Shortages of semiconductor chips, steel and other components have served to hold down OEM production levels, 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 fourth quarter of 2023.
Turning now to Slide 8. The market for the transportation and use of natural gas is key for Sypris and it 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 38% 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 and 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 $116.6 million is up 25% year-over-year, with firm orders extending into 2025. We are pleased with the level of new business momentum, and we are 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 revenues forecast increase 25% to 30% for 2023, with shipments to our customers in defense-related markets expected to increase significantly. As a result, defense electronics is 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 22.6%, while backlog grew by 25.5%, providing a strong platform to support future growth in 2023. Backlog at Sypris Electronics now stands at $116.6 million, reflecting a 25% increase from the prior year period. In a similar fashion, backlog for our energy products is up 38% year-over-year. 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 expand 75 to 125 basis points, while cash flow from operations is forecast to remain positive. Quite simply, we are looking forward to the task of building the business profitably during the coming year and beyond.
Turning now to Slide 12. Rich Davis will lead you through the balance of our presentation this morning. Rich?

Richard L. Davis

Thanks, Jeff. Good morning, everyone. I'd like to discuss with you some of the highlights of our second quarter and first half financial results.
Please advance to Slide 13. Q2 consolidated revenue was $35.6 million, an increase of 22.6% from the second quarter of last year and an increase of 10.3% sequentially on increases in communication products at Sypris Electronics and in commercial vehicle components and energy products at Sypris Technologies. Consolidated gross profit was $4.7 million for the quarter, increasing 23.5% from the prior year quarter due to overall higher production and shipment volumes and favorable mix, offset by the $600,000 unfavorable impact of foreign exchange rates and $400,000 in nonrecurring unreimbursed steel surcharges at Sypris Technologies in Mexico. Revenue for Sypris Technologies increased 11.7% year-over-year to $20.1 million for the quarter. Gross margin was down 190 points from the prior year due to the unfavorable foreign exchange rate impact and unreimbursed steel surcharges. Gross margin was also down 350 basis points from Q1 on worsening foreign exchange rates and higher labor costs.
While our shipment volume went down in Q4 2022 at Sypris Technologies as our commercial vehicle customers rebalanced their inventory levels at year-end, shipments subsequently returned to normal in Q1 and increased slightly in Q2 with some decline expected in the fourth quarter of this year. Second quarter orders and backlog for energy products increased 10% and 38%, respectively, year-over-year, which we expect to translate into higher revenue from these products in 2023 and to support higher gross margins.
On the cost side, we continue to experience some of the inflationary pressures that are being felt across the economy. Prices of consumable supplies and tooling have increased as have utility rates. We are working on cost-effective solutions to control spend in these areas, including scheduling production in off-peak utility rate hours as much as possible. The steel surcharge increased $400,000 over the prior year. And while certain of our contract terms provide for sales price adjustments to pass the increased costs on to our consumers -- customers, these terms did not apply in Q2 but will resume in Q3. The impact of the steel surcharges reduced our gross profit and gross margin percentage. Our engineering and product development teams also have initiatives underway to reduce steel consumption, both in our forging and machining processes to improve our margins and deliver cost savings to our customers.
Revenue for Sypris Electronics was $15.6 million for the quarter, an increase of 40% year-over-year and 21.6% sequentially as we ramped up production for communications product customers in the quarter. Gross margin was at 17.1%, an increase of 220 basis points year-over-year on higher production and shipment volume, favorable mix and material cost savings on certain programs. We are implementing an improved approach to lean manufacturing of Sypris Electronics, and we continue to expand its workforce to reinforce the team's efforts to execute significant sequential quarterly increases in shipments in 2023. We are also in the process of implementing additional automated production and inspection equipment to further improve our manufacturing efficiency. We expect these efforts to cost effectively boost manufacturing output to meet the planned shipment increases. As we increase production and continue to make manufacturing process improvements, we anticipate an improvement in labor productivity, and overhead absorption resulting in improved margins.
Consolidated operating income for Q2 weighed down by the $600,000 unfavorable foreign exchange rate impact and $400,000 steel charge -- steel surcharge noted earlier, was $1 million compared to breakeven in the prior year due principally to the increase in gross profit. Our operations teams are focused on execution and meeting our objectives for customer service at expanded volumes while also reducing cost per unit. The strong backlog in place provides a solid foundation to support this growth through the remainder of 2023.
Please advance to Slide 14. Consolidated revenue for the first half was $67.9 million, an increase of $12.7 million or 23% from the first half of last year. Consistent with Q2, both segments contributed to the year-over-year revenue growth. Consolidated gross profit for the first half increased 6.5% to $8.8 million, while gross margin decreased year-over-year by 200 basis points to 13%. Revenue for Sypris Electronics was $28.3 million, an increase of 41% from the prior year and its gross profit increased 38.3% to $4.2 million. Gross margin saw a slight decline of 60 basis points to 14.8%.
In addition to the factors previously noted for Q2, the comparison of revenue and gross margin for Sypris Electronics for the first half period reflects the significant increase in revenue volume resulting from the very high level of bookings achieved in the preceding 5 quarters and the significant progress made by our integrated manufacturing and continuous improvement teams to deliver on the steeply increased backlog.
Revenue for Sypris Technologies increased 12.7% to $39.6 million. Gross profit decreased 11.7% to $4.6 million on the unfavorable foreign exchange rate and steel surcharge impacts while gross margin decreased 330 basis points to 11.7% for the period. The revenue mix for the first half period for Sypris Technologies was unfavorable compared to the prior year period. While revenue from our proprietary energy products increased year-over-year, the mix within commercial vehicle components was unfavorable.
Our consolidated SG&A was $7.4 million for the first half, an increase of 4.5% over the prior year. [Merit] pay increases and limited additions to business development and program management personnel contributed to the increase. SG&A as a percentage of revenue decreased to 11% from 12.9% a year ago as our revenue increases, we expect further reductions in SG&A as a percent of revenue as operating leverage improves. Our operating income was $1.4 million for the first half, an increase of 18.8% over the same period a year ago.
Please advance to Slide 15. On this slide, we show our trend of consolidated gross margin for 2021 and 2022, along with the performance expected for 2023. 2022 decreased by 140 basis points from the prior year on production inefficiencies induced by the supply chain challenges and material price pass-throughs without markup. With the anticipated shipment volume increases supported by our strong backlog, we expect revenue growth in the range of 25% to 30% in 2023. Despite the impact of unfavorable foreign exchange rates, we expect to deliver year-over-year margin improvement in the range of 75 to 125 basis points on these higher volumes, placing us at a 14.5% margin at the midpoint of this range in 2023. As noted in the 2023 pro forma bar on the graph, absent the unfavorable foreign exchange impact, our forecast and full year gross margin would be approximately 16.1% or 160 basis points higher than the current estimate.
We want to recognize once again the efforts of all of our teammates involved in pushing our backlog to its current high level and we also want to recognize and thank our reinforced Sypris Electronics team for its intense focused efforts to meet its customers' expectations for rising shipments in 2023 and Sypris Technologies team for similar efforts to implement new programs for existing customers. We will strive to continuously improve manufacturing output and productivity while maintaining excellent quality. We will also continue our efforts to diversify our markets served and our customer base and to deliver more value-added services to our customers, which we believe can provide further upside to our current margin levels.
Please advance to Slide 16 for a quick summary of our comments. A key highlight for the quarter was the significant increase in backlog in both segments. Backlog increased 25.5% for the period, marking the 12th consecutive quarter of year-over-year growth. Sypris Electronics orders were consistently high throughout 2022 and into the first quarter of 2023, increasing its backlog to $116.6 million at the end of the first half of 2023. We expect shipments to rise significantly each quarter in 2023 as a function of the increase in backlog and increased production capacity and efficiency. Sypris Technologies energy products orders and backlog were up 10.3% and 38%, respectively, over the prior year period, supporting continued near-term revenue expansion. Sypris Technologies has also augmented its energy product line and distribution resources to expand its energy products presence in Europe, Asia, the Middle East and Mexico. And it has booked its first order for insulated joints and a waterline expansion application.
The outlook for Sypris Technologies remains favorable, with the current forecast for Class 8 demand in 2023 falling slightly in the fourth quarter, but supported by planned increases in new programs with existing customers and currently strong demand for its energy products. We expect both segments will generate double-digit year-over-year top line growth with gross profit also increasing in 2023. Based on our strong backlog and momentum in orders, we are holding our outlook for a 25% to 30% growth in revenue with unfavorable foreign currency exchange rates impacting margin in the near term, we have adjusted the gross margin guidance to a 75 to 125 basis point improvement over the prior year.
Thank you for your continued support and interest in our business. Now I'd like to turn it back over to Jeff for closing remarks.

Jeffrey T. Gill

Thank you, Rich, and thank you, everyone, 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 great day.

Operator

Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.