Sypris Solutions, Inc.

Good day and welcome to the Cypress Solutions Incorporated conference call. Today's call is being recorded. At this time, for opening remarks, I would like to turn the call over to President and Chief Executive Officer, Mr. Jeffrey Gill.

Please go ahead, sir. Thank you, Matt, and good morning, 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 third quarter of 2021. For those of you who have access to our PowerPoint presentation this morning, please advance to slide two 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 cypress.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 three. 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. Tony will then provide you with a more detailed review of our financial results for the quarter. Now let's begin with the overview on slide four. We are pleased to report that revenue increased almost 16% year over year, driven by a 38% increase for Cypress Technologies, with revenue for the period exceeding all but one of the quarterly results reported for Cypress Technologies during the past five years. We are also pleased to note that this top line performance was achieved despite the impact of material shortages and supply chain issues that permeated across our business. Gross profit increased by more than 12% year over year, supported by a 14.5% expansion for Cypress Electronics and a 10.6% increase for Cypress Technologies. Gross margin for Cypress Electronics increased 20.8% to 20.8% of sales, up 460 basis points year-over-year, while gross margin for Cypress Technologies was negatively impacted by mix and expenses incurred during the period to further increase capacity. Orders remained robust during the quarter, with backlog up 24% year-over-year for Cypress Electronics and up 51% year-to-date. The order board from truck and all train customers for Cypress Technologies continued to remain strong, while backlog from energy-related customers increased 39% year-over-year and almost 60% year-to-date. Turning now to slide five, we have been pleased to announce several additional new contract awards since we last spoke in August. More specifically, at Cypress Electronics, We announced the award of a contract to build embedded circuit card assemblies that will perform certain cryptographic functions for the Army Key Management System, or AKMS, with production expected to start before year end. The AKMS is a fielded system that consists of three subsystems, local communications management software, automated communications engineering software, and the simple key load device. The embedded circuit card assemblies to be produced by Cypress will perform the cryptographic functions for a ruggedized, portable, handheld simple key load device that will be used to securely receive, store, and transfer data between compatible cryptographic and communications equipment. We also announced a contract award from a U.S. DOD contractor to produce and test multiple power supply modules for the upgrade of the electronic warfare suite of certain US fighter jets. According to news sources, the system will deliver fully integrated radar warning, situational awareness, geolocation, and self-protection capabilities to maximize mission effectiveness and survivability of the aircraft in highly contested environments. This advanced all-digital system enables deeper penetration against modern integrated defense systems and provides rapid response capabilities designed to protect the air crew. Further, the system will give current and future aircraft more survivability when operating near or in contested airspace. The system will allow pilots to monitor, locate, and jam enemy radars, as well as to deceive them about the aircraft's position and heading by collecting and processing electromagnetic energy and instantaneously creating a comprehensive 360-degree picture of the battle space. Production is expected to begin on this contract in the first quarter of 2022. Each of these contracts are representative of the high cost of failure applications for which Cypress is well known. We expect the momentum of new contract wins to continue during the remainder of 2021 and into 2022, and we remain very optimistic about the potential for future program and revenue growth as we move forward. Looking forward to the balance of 2021, we now believe that revenue for the year will increase 20 to 25% year over year. which is lower than our prior guidance due to the impact of short-term supply chain constraints on our business and that of our customers. Margins, on the other hand, are expected to increase 400 to 500 basis points during the fourth quarter on a year-over-year basis, while cash flow from operations is still expected to post a strong double-digit increase over the prior year's performance. We believe that this positive momentum will carry forward into 2022, with revenue forecasts to increase 25% year over year. Margins are expected to create an additional 200 basis points, while cash flow from operations is expected to once again improve materially when compared to that of the prior year. In short, we are pleased with the substantial progress that continues to be made across our business. The supply chain challenges are real and will continue to require persistence, flexibility, and a high degree of responsiveness and intimate coordination with our customers for the foreseeable future. When the supply chain issues do eventually subside, however, we should anticipate even better results. Now let's advance to slide six to review the outlook for each of our major markets. According to ACT research, all indicators we use to track the heavy-duty truck market point to extraordinarily strong market conditions, so much so that the sales metrics on the year will be determined by the supply side, by the ability of manufacturers to keep up with customer demand for the product. There are a number of factors that are having a positive influence on the demand for transportation. An increasingly strong U.S. economy, housing strength, manufacturing prosperity, carrier profitability, the acceleration of the transition to e-commerce, and fiscal stimulus are combining to drive demand for freight to high levels. In short, freight demand is currently overwhelming capacity. As a result, ACT is now forecasting a 23% increase in demand for 2021, to be followed by an additional 18% expansion in 2022, and a further 15% growth in 2023. It should be noted that this forecast represents a reduction for the current year from its previous outlook due to the inability of OEMs to ramp up production to meet demand. Shortages of semiconductor chips, steel, and other key components are serving to hold back even higher levels of production. OEM Class 8 backlog is currently up 200% to an estimated 284,000 units on a year-over-year basis. So despite these short-term issues, the outlook remains extremely healthy. Turning now to slide 7, the market for transportation and use of natural gas is key for Cypress, to be followed by the market for transportation and processing of crude oil. Oil prices have increased significantly over the past year, With a price of West Texas Intermediate up 135% from October of 2020, Brent is up 125% for the same period. The outlook for year-end 2021 is $80 per barrel, which would reflect a 67% or more increase from year-end 2020. Total rig count is up close to 100% to 533 rigs. were up 264 units over this time last year. Our sense is that the continued strong expansion of the U.S. economy will eventually result in higher prices for all forms of energy, which in turn will bode well for capital projects as providers adjust to meet increased levels of demand. Our backlog is up 39% year-over-year and is up 59% year-to-date, which is perhaps a good sign of things to come. As you'll see from the chart on slide eight, 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 high priority. Our backlog of future business is up 51% year-to-date and is up 24% year-over-year, with firm orders extending well into 2023. We are very pleased with the level of new business momentum, and we are very 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 nine, please note that while our revenue is now forecast to increase 20 to 25 percent for 2021, our market mix remains fairly well balanced despite the significant growth forecast for commercial vehicle. The mix is maintained as a result of the expected continued expansion of defense electronics and specialty automotive. We believe this to be quite an achievement and it certainly represents a big change from our increasingly distant past when commercial vehicle represented 70% of the business and these sales were concentrated with two customers. We have a much more balanced business today both in terms of market served and customer concentration. This diversification has served us well during the pandemic, both in terms of volume and margin. Looking forward, we expect margins to expand further, reflecting increased value-add and technical requirements, while continuing to move away from commodity products and services. 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 10 for a brief summary. New contract awards, when combined with the strength of our markets, is expected to fuel a 20 to 25% growth in the top line, a 400 to 500 basis point expansion in margins year over year during the fourth quarter of 2021, and strong double-digit growth in cash flow from operations for the year. We believe this possible minimum will continue into 2022, with revenue expected to increase 25% during the coming year, while margins are forecast to expand an additional 200 basis points for the year, the combination of which is expected to fuel a strong growth in cash flow from operations on a year-over-year basis. Our forecast is supported by the strength of our growing backlog and the robust outlook for the commercial vehicle and defense markets in 2022 and beyond. The wind is clearly at our back, so our focus must and will be on execution. The almost daily supply chain trials will continue, and there will be surprises and most assuredly challenges. But this is always the case, and the issues associated with growth will be much appreciated when weighed against the severity of the surprises we faced during the previous year and the pandemic. Quite simply, we are really looking forward to the task of building the business profitably during the coming year and beyond. Turning now to slide 11, Tony Allen will lead you through the balance of our presentation this morning. Tony?

Thanks, Jeff. Good morning, everyone. I'd like to discuss with you some of the highlights of our third quarter financial results. Please advance to slide 12. Q3 consolidated revenue was $25.7 million, an increase of $3.5 million, or 15.9% from the third quarter of last year. Consolidated gross profit improved to $4 million from $3.5 million a year ago, and consolidated gross margin was 15.5% for the third quarter, down 50 basis points from the prior year. Revenue for Cypress Technologies increased 38.3% to 16.7 million from 12.1 million a year ago, while gross profit increased 200,000 to 2.1 million for the quarter. The COVID pandemic initially had a severe impact on this segment in Q2 of last year. The year-over-year Q3 revenue growth highlights the turnaround in demand for our commercial vehicle, automotive, and off-road components that started in the first half of 2020 and further accelerated in the first half of 2021. More recently, although end-user demand forecasts remain high in the commercial vehicle market, production forecasts for Q4 and 2022 have been adjusted down to reflect supply chain constraints, including semiconductor shortages that are impacting the industry. Whereas three months ago, the market was expected to peak in 2022, the most recent view of the forecast now includes three consecutive years of double-digit growth starting in 2021, with the market peak taking place in 2023. Our energy product shipments posted a slight decrease in revenue year over year, As this market continues to face headwinds that originated with the COVID outbreak in the second quarter of 2020, demand has been volatile from month to month with our customers citing project delays and reduced near-term infrastructure spending as contributing factors. We expect conditions in this market to improve as crude oil and natural gas prices are up and energy demand expands. Gross profit for Cypress Technologies increased 200,000 from the prior year, primarily from increased volume from heavy truck, auto, and off-road products. However, our gross margin declined to 12.6% from 15.8% a year ago. A lower mix of energy product revenue in the period contributed to this, together with repairs, supplies, and equipment maintenance projects as we prepare for the growth in heavy truck demand in 2022 and 2023. Revenue for Cypress Electronics was 9 million in Q3, a decrease of 10.8% from the prior year. However, gross profit increased 240,000 as gross margin improved 460 basis points to 20.8% for the quarter. We experienced component shortages on a couple of programs that caused Q3 revenue to fall below our expectations. Our team is staying in front of the component availability challenge and has done an outstanding job to procure long lead and critical components for our longer term programs to mitigate supply chain risk. However, we do expect supply constraints to persist and we will continue to coordinate with our customers and vendors to minimize these risks. One of our larger programs is transitioning from limited rate to full rate production and we expect to resume shipments on this program during Q4 and continue the trend of sequential quarterly revenue growth reported for this segment from Q1 to Q3 of this year. Backlog for Cypress Electronics is up 51.3% year to date and shipments under certain of the larger programs driving the backlog increase are expected to begin in Q4 and continue during 2022. This will be a substantial component of the growth we expect in 2022 and is also the driver behind our increase in inventory sequentially and since last year end. We secured funding from customers on certain programs to purchase inventories for the life of the respective programs. The majority of the customer funding was received during the first half of the year, which was applied to inventory purchases beginning late in Q1 and continuing into Q3. As new contracts are awarded, we will continue to work with our customers to secure funding for program inventories as we mutually benefit from both pricing and material availability under these agreements. Our consolidated SG&A expense was $3 million for Q3, an increase of approximately $300,000 year over year. SG&A as a percent of revenue decreased to 11.7%. in Q3 from 12.2% a year ago. Operating income for Q3 was just short of $1 million, an increase of 15% over the prior year and 8.7% sequentially. Please advance to slide 13. Consolidated revenue for the first nine months was $71.6 million. an increase of $9.9 million, or 16% from the first nine months of last year. The year-over-year increase in revenue was followed by an increase in consolidated gross profit of $700,000 to $10.1 million from $9.4 million in the prior year. Consolidated gross margin was 14.1% for the first nine months, down 110 basis points from the prior year. Revenue for Cypress Technologies increased 41.5% to 47 million from 33.2 million a year ago, while gross profit increased 1.2 million and gross margin was down 160 basis points to 12.3%. Revenue for Cypress Electronics was 24.6 million for the first nine months, a decrease of 13.6% from the prior year, and gross profit dropped 400,000, while gross margin improved 80 basis points to 17.5% for the period. Our consolidated SG&A expense was 9.3 million for the first nine months, which is an increase of less than 200,000, or 2%, from the prior year. SG&A as a percent of revenue decreased to 13% from 14.8% a year ago. Our operating income for the first nine months is $800,000, an increase of over 200% from the comparable period of 2020. Please advance to slide 14. On this slide, we show our trend of consolidated gross margin over the most recent five years, along with the performance expected for 2021 and 2022. Our consolidated gross margin Q3 year-to-date is at 14.1%. We are now targeting 15.1% for the full year as we fell short of our expectations on revenue and margin during Q3. Revenue for Q4 is expected to increase both sequentially and year over year and include a higher mix of defense electronics and energy products, which would contribute to the margin improvement we expect during the fourth quarter. Our outlook for Q4 calls for a year-over-year increase of 400 to 500 basis points over Q4 of 2020 and lifts our full year margin expectation up approximately 50 basis points over the prior year at the midpoint of this range. As we look beyond the fourth quarter, our initial outlook for 2022 includes revenue growth in the range of 25% and margin expansion of approximately 200 basis points over our expectation for the current fiscal year. Please advance to slide 15, and I will provide summary comments of our call today. We are pleased to report increased revenue, gross profit, and operating income for the third quarter, with both segments contributing to the profit improvements. Our results for the quarter also include our continued investment in equipment repairs and maintenance projects to prepare for a strong commercial vehicle market over the next two years. Revenue increased year-over-year for the second consecutive quarter to $25.7 million, up 15.9% over Q3 of 2020. Gross profit increased 12.4% in Q3, with gross margin coming in at 15.5%, which was lower than expected as volumes, revenue mix, and variable manufacturing costs were unfavorable to our prior forecast. Cash flow from operations for the first nine months of 2021 is $2.2 million, inclusive of the working capital investments we've made to support the growth of our business, primarily for inventories of long lead and critical components on certain key programs currently in the backlog for Cypress Electronics. Backlog for Cypress Electronics increased 51.3% since the beginning of the year, and energy product backlog increased 59.6% for the same period. Industry forecasts for production in the Class 8 market indicate an increase of 18.3% in 2022 before peaking in 2023. on the strength of an additional 15.5% year-over-year growth. Our outlook for 2021 includes an expected increase in full-year revenue of 20 to 25% over the prior year. We also expect gross margin for the fourth quarter of this year will show a 400 to 500 basis point improvement over the comparable period of 2020. Our initial outlook for 2022 includes revenue growth 25% over our target for the current year and a further improvement in gross margin in the range of 200%. We also expect improved profitability and our diligence in the management of working capital will lead to a material increase in cash flow from operations in the coming year. We thank you for your continued support and interest in our business. And I'd like to turn it over to Jeff for closing remarks.

Thank you, Tony. We'd like to thank you for joining us on the call this morning. We're looking forward to another year of double-digit growth, expanding margins, and increased profitability. And please know we certainly appreciate your continued interest in our business. Thank you and have a good day. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.