Item
2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a diversified provider of truck components, oil and gas pipeline components and aerospace and defense electronics. We offer a wide range of manufactured products, with a preference for multi-year sole-source contracts.
We are organized into two business segments, Sypris Technologies and Sypris Electronics. Sypris Technologies, which is comprised of Sypris Technologies, Inc. and its subsidiaries, generates revenue primarily from the sale of forged, machined, welded and heat-treated steel components and subassemblies including commercial vehicle component parts, high-pressure closures and other fabricated products. Sypris Electronics, which is primarily comprised of Sypris Electronics, LLC, generates revenue primarily through circuit card and full box build manufacturing, high reliability manufacturing, systems assembly and integration, design for manufacturability and design to specification work.
We target those markets where we have the expertise, qualifications and leadership position to sustain a competitive advantage. We focus our resources to support the needs of industry leaders that embrace technological innovation and flexibility, coupled with multi-year contractual relationships where possible, as a strategic component of their supply chain management. Our leading-edge processes and technologies help our customers remain competitive, and the resulting productivity and flexibility offer an important opportunity for differentiating ourselves from our competitors when it comes to cost, quality, reliability and customer service.
Sypris Technologies Outlook
The Sypris Technologies segment continues to migrate from its traditional, concentrated dependence upon the commercial vehicle markets to a more diversified base of customers who place value on our innovation, flexibility and lean manufacturing capabilities. The continued strength of the U.S. dollar, the tightening of margins in certain sectors of the commercial vehicle markets and the generally softening markets led the Company to reevaluate the strategic importance of each of its customers to the Company’s long-term success. In connection with this reevaluation process, the Company and Meritor determined not to renew their supply agreement for certain of Meritor’s domestic, forged axle shafts beginning in 2017. The Company has had a similar reduction in its business with Eaton. However, the Company continues to supply component parts to Sistemas Automotrices de Mexico, S.A de C.V. (“Sisamex”), Meritor’s joint venture in Mexico, and continues to supply axle shafts to Meritor’s Brazilian subsidiary. Subsequent to the end of the third quarter of 2018, the Company entered into a new three-year agreement to supply axle shafts to Sisamex, as well as a number of other product lines for periods of up to six years from the commencement of production.
The oil and gas markets, served by our Tube Turns® brand of engineered product lines, have strengthened along with the overall economy, and domestic pipeline projects continue to be active with U.S. domestic gas and oil production increasing in 2017 and the first nine months of 2018.
We are pursuing new business in a wide variety of markets from light automotive to refrigeration valves to new energy related product lines to achieve a more balanced portfolio across our customers, markets and products. We have recently announced new program awards in each of these markets that have contributed to revenue growth for Sypris Technologies in 2018. We believe these opportunities provide a solid multi-year foundation for growth and that additional prospective business will result in increased revenue in 2018 and 2019.
Sypris Electronics Outlook
We have faced challenges within Sypris Electronics, such as the uncertainty in the worldwide macroeconomic climate and its impact on aerospace and defense spending patterns globally over the last several years, the emergence of new competitors to our manufacturing capabilities, as well as federal government spending uncertainties in the U.S. and the allocation of funds by the U.S. Department of Defense. More recently, we have begun to generate revenue from the ramp-up of new electronic manufacturing programs.
We announced new program awards for Sypris Electronics that contributed to revenue in 2017 and 2018, with certain programs continuing into 2019. In addition to program awards related to weapons systems, electronic warfare and infrared countermeasures in our traditional aerospace and defense markets, we have also been awarded programs related to the communication and navigation markets which align with our unique capabilities for delivering products for complex, high cost of failure platforms. The National Defense Authorization Act for Fiscal Year 2019 provides nearly $700 billion in funding for the U.S. Department of Defense, which is expected to support program growth and market expansion during the coming year for aerospace and defense participants. We expect to compete favorably for follow-on business opportunities on future builds of these programs, as our competitiveness is enhanced by the reduction in our overhead structure following our relocation into a new manufacturing facility as of the beginning of 2017.
In the near term, certain electronic component shortages and extensive lead-time issues are becoming prevalent in many of the segments in the electronic manufacturing industry that we serve. We are working with our customers to qualify alternative components or suppliers to mitigate the impact on our business. The majority of our aerospace and defense programs require specific components that are sole-sourced to specific suppliers; therefore, the resolution of supplier constraints requires coordination with our customers or the end-users of the products.
Strategic Actions
The Company completed a number of strategic actions during the past three years in response to the nonrenewal of its supply agreement with certain Tier I automotive customers primarily due to global pricing constraints, the downturn in the commercial vehicle market beginning in the fourth quarter of 2015 and other market and economic factors impacting the Company during this period. Strategic actions taken included: (i) the initiation of the exit of the Broadway Plant (see discussion below), (ii) the sale of the Company’s CSS business in 2016, (iii) the sale and leaseback of the Company’s facility in Toluca, Mexico in 2016, (iv) the sale of the Company’s manufacturing facility in Morganton, North Carolina in 2015, (v) the capacity reallocation of certain oil and gas industry components to Mexico, (vi) the relocation of its Sypris Electronics operation to a new facility, and (vii) reductions in employment costs through reduced work schedules, senior management pay reductions, deferral of merit increases and certain benefit payments. Using a portion of the proceeds generated from asset sales noted above, the Company paid off all of its most senior, secured debt consisting of a “Term Loan” and “Revolving Credit Facility” in August 2016. During this period, the Company also received the benefit of cash infusions from Gill Family Capital Management, Inc. (“GFCM”) in the form of secured promissory note obligations totaling $6.5 million in principal, scheduled to mature in part in 2021, 2023 and 2025 (see Note 13 to the consolidated financial statements in this Form 10-Q).
The Company has embraced a strategic change in its business by repositioning away from certain of its traditional Tier 1 customers that represent the primary suppliers to the original equipment manufacturers (“OEMs”) in the commercial vehicle markets, while targeting to replace these customers with longer-term relationships, especially among the OEMs and others who place a higher value on the Company’s innovation, flexibility and core commitment to lean manufacturing principles. Among the customer programs not being renewed was a supply agreement with Meritor Inc. (“Meritor”) that expired on January 1, 2017, which utilized production at the Company’s Broadway Plant, and the Company has had a similar reduction in certain portions of its business with Eaton. As a result of these decisions, the Company experienced a significant reduction in its commercial vehicle revenues in 2017 (see Note 6 to the consolidated financial statements in this Form 10-Q).
On November 22, 2016, the Board of Directors of the Company approved moving forward with the exploration of a range of strategic options for the Broadway Plant, including the divestiture of the plant, the transitional reduction in its operations to accommodate lower volumes, the relocation of production to other Company facilities as needed, and/or the closure of the plant. Accordingly, management explored various exit or disposal options for the Broadway Plant with the input of our salaried and unionized employees, our customers and others within the industry. On February 21, 2017, with the benefit of management’s analysis, the Board of Directors approved a modified exit or disposal plan with respect to the Broadway Plant, which was substantially complete as of the end of 2017. The Company has relocated certain assets from the Broadway Plant to other manufacturing facilities as needed to serve its existing and targeted customer base and identified underutilized or non-core assets for disposal. Management expects to use the proceeds from the sale of any underutilized or non-core assets to help fund costs of transferring any additional equipment from the Broadway Plant. Management is currently evaluating options for the real estate and any remaining assets in the Broadway Plant.
Our failure or inability to realize our key financial objectives could materially and adversely impair the Company’s ability to operate, its cash flows, financial condition and ongoing results.
Results of Operations
The tables below compare our segment and consolidated results for the three and nine month periods of operations of 2018 to the three and nine month periods of operations of 2017. The tables present the results for each period, the change in those results from 2017 to 2018 in both dollars and percentage change and the results for each period as a percentage of net revenue.
|
●
|
The first two columns in each table show the absolute results for each period presented.
|
|
●
|
The columns entitled “Year Over Year Change” and “Year Over Year Percentage Change” show the change in results, both in dollars and percentages. These two columns show favorable changes as positive and unfavorable changes as negative. For example, when our net revenue increases from one period to the next, that change is shown as a positive number in both columns. Conversely, when expenses increase from one period to the next, that change is shown as a negative number in both columns.
|
|
●
|
The last two columns in each table show the results for each period as a percentage of net revenue. In these two columns, the cost of sales and gross profit for each are given as a percentage of that segment’s net revenue. These amounts are shown in italics.
|
In addition, as used in the table, “NM” means “not meaningful.”
Three Months Ended September 30, 2018 Compared to Three Months Ended October 1, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Over
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Over
|
|
|
Year
|
|
|
Results as Percentage of
|
|
|
|
|
|
|
|
|
|
|
|
Year
|
|
|
Percentage
|
|
|
Net Revenue for the Three
|
|
|
|
Three Months Ended,
|
|
|
Change
|
|
|
Change
|
|
|
Months Ended
|
|
|
|
September 30,
|
|
|
October 1,
|
|
|
Favorable
|
|
|
Favorable
|
|
|
September 30,
|
|
|
October 1,
|
|
|
|
2018
|
|
|
2017
|
|
|
(Unfavorable)
|
|
|
(Unfavorable)
|
|
|
2018
|
|
|
2017
|
|
|
|
(in thousands, except percentage data)
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sypris Technologies
|
|
$
|
14,852
|
|
|
$
|
13,547
|
|
|
$
|
1,305
|
|
|
|
9.6
|
%
|
|
|
70.3
|
%
|
|
|
63.4
|
%
|
Sypris Electronics
|
|
|
6,249
|
|
|
|
7,824
|
|
|
|
(1,575
|
)
|
|
|
(20.1
|
)
|
|
|
29.6
|
|
|
|
36.6
|
|
Total
|
|
|
21,101
|
|
|
|
21,371
|
|
|
|
(270
|
)
|
|
|
(1.3
|
)
|
|
|
100.0
|
|
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sypris Technologies
|
|
|
13,523
|
|
|
|
14,121
|
|
|
|
598
|
|
|
|
4.2
|
|
|
|
91.1
|
|
|
|
104.2
|
|
Sypris Electronics
|
|
|
6,376
|
|
|
|
6,509
|
|
|
|
133
|
|
|
|
2.0
|
|
|
|
102.0
|
|
|
|
83.2
|
|
Total
|
|
|
19,899
|
|
|
|
20,630
|
|
|
|
731
|
|
|
|
3.5
|
|
|
|
94.3
|
|
|
|
96.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sypris Technologies
|
|
|
1,329
|
|
|
|
(574
|
)
|
|
|
1,903
|
|
|
|
NM
|
|
|
|
8.9
|
|
|
|
(4.2
|
)
|
Sypris Electronics
|
|
|
(127
|
)
|
|
|
1,315
|
|
|
|
(1,442
|
)
|
|
|
NM
|
|
|
|
(2.0
|
)
|
|
|
16.8
|
|
Total
|
|
|
1,202
|
|
|
|
741
|
|
|
|
461
|
|
|
|
62.2
|
|
|
|
5.7
|
|
|
|
3.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
2,942
|
|
|
|
3,134
|
|
|
|
192
|
|
|
|
6.1
|
|
|
|
13.9
|
|
|
|
14.7
|
|
Research and development
|
|
|
—
|
|
|
|
5
|
|
|
|
5
|
|
|
|
100.0
|
|
|
|
—
|
|
|
|
0.0
|
|
Severance, relocation and other costs
|
|
|
274
|
|
|
|
357
|
|
|
|
83
|
|
|
|
23.2
|
|
|
|
1.3
|
|
|
|
1.7
|
|
Operating loss
|
|
|
(2,014
|
)
|
|
|
(2,755
|
)
|
|
|
741
|
|
|
|
26.9
|
|
|
|
(9.5
|
)
|
|
|
(12.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
|
231
|
|
|
|
208
|
|
|
|
(23
|
)
|
|
|
(11.1
|
)
|
|
|
1.1
|
|
|
|
1.0
|
|
Other expense, net
|
|
|
56
|
|
|
|
115
|
|
|
|
59
|
|
|
|
51.3
|
|
|
|
0.3
|
|
|
|
0.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before taxes
|
|
|
(2,301
|
)
|
|
|
(3,078
|
)
|
|
|
777
|
|
|
|
25.2
|
|
|
|
(10.9
|
)
|
|
|
(14.4
|
)
|
Income tax expense, net
|
|
|
35
|
|
|
|
55
|
|
|
|
20
|
|
|
|
36.4
|
|
|
|
0.2
|
|
|
|
0.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(2,336
|
)
|
|
$
|
(3,133
|
)
|
|
$
|
797
|
|
|
|
25.4
|
|
|
|
(11.1
|
)%
|
|
|
(14.7
|
)%
|
Nine Months Ended September 30, 2018 Compared to Nine Months Ended October 1, 2017.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Over
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Over
|
|
|
Year
|
|
|
Results as Percentage of
|
|
|
|
|
|
|
|
|
|
|
|
Year
|
|
|
Percentage
|
|
|
Net Revenue for the Nine
|
|
|
|
Nine Months Ended,
|
|
|
Change
|
|
|
Change
|
|
|
Months Ended
|
|
|
|
September 30,
|
|
|
October 1,
|
|
|
Favorable
|
|
|
Favorable
|
|
|
September 30,
|
|
|
October 1,
|
|
|
|
2018
|
|
|
2017
|
|
|
(Unfavorable)
|
|
|
(Unfavorable)
|
|
|
2018
|
|
|
2017
|
|
|
|
(in thousands, except percentage data)
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sypris Technologies
|
|
$
|
44,686
|
|
|
$
|
40,366
|
|
|
$
|
4,320
|
|
|
|
10.7
|
%
|
|
|
69.8
|
%
|
|
|
66.4
|
%
|
Sypris Electronics
|
|
|
19,328
|
|
|
|
20,439
|
|
|
|
(1,111
|
)
|
|
|
(5.4
|
)
|
|
|
30.2
|
|
|
|
33.6
|
|
Total
|
|
|
64,014
|
|
|
|
60,805
|
|
|
|
3,209
|
|
|
|
5.3
|
|
|
|
100.0
|
|
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sypris Technologies
|
|
|
39,320
|
|
|
|
41,261
|
|
|
|
1,941
|
|
|
|
4.7
|
|
|
|
88.0
|
|
|
|
102.2
|
|
Sypris Electronics
|
|
|
18,527
|
|
|
|
17,727
|
|
|
|
(800
|
)
|
|
|
(4.5
|
)
|
|
|
95.9
|
|
|
|
86.7
|
|
Total
|
|
|
57,847
|
|
|
|
58,988
|
|
|
|
1,141
|
|
|
|
1.9
|
|
|
|
90.4
|
|
|
|
97.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sypris Technologies
|
|
|
5,366
|
|
|
|
(895
|
)
|
|
|
6,261
|
|
|
|
NM
|
|
|
|
12.0
|
|
|
|
(2.2
|
)
|
Sypris Electronics
|
|
|
801
|
|
|
|
2,712
|
|
|
|
(1,911
|
)
|
|
|
(70.5
|
)
|
|
|
4.1
|
|
|
|
13.3
|
|
Total
|
|
|
6,167
|
|
|
|
1,817
|
|
|
|
4,350
|
|
|
|
239.4
|
|
|
|
9.6
|
|
|
|
3.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
9,261
|
|
|
|
10,125
|
|
|
|
864
|
|
|
|
8.5
|
|
|
|
14.5
|
|
|
|
16.6
|
|
Research and development
|
|
|
—
|
|
|
|
36
|
|
|
|
36
|
|
|
|
100.0
|
|
|
|
—
|
|
|
|
0.1
|
|
Severance, relocation and other costs
|
|
|
1,088
|
|
|
|
2,235
|
|
|
|
1,147
|
|
|
|
51.3
|
|
|
|
1.7
|
|
|
|
3.7
|
|
Operating loss
|
|
|
(4,182
|
)
|
|
|
(10,579
|
)
|
|
|
6,397
|
|
|
|
60.5
|
|
|
|
(6.5
|
)
|
|
|
(17.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
|
665
|
|
|
|
602
|
|
|
|
(63
|
)
|
|
|
(10.5
|
)
|
|
|
1.0
|
|
|
|
1.0
|
|
Other (income), net
|
|
|
(1,651
|
)
|
|
|
(1,663
|
)
|
|
|
(12
|
)
|
|
|
(0.7
|
)
|
|
|
(2.5
|
)
|
|
|
(2.7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before taxes
|
|
|
(3,196
|
)
|
|
|
(9,518
|
)
|
|
|
6,322
|
|
|
|
66.4
|
|
|
|
(5.0
|
)
|
|
|
(15.7
|
)
|
Income tax expense, net
|
|
|
121
|
|
|
|
70
|
|
|
|
(51
|
)
|
|
|
(72.9
|
)
|
|
|
0.2
|
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,317
|
)
|
|
$
|
(9,588
|
)
|
|
$
|
6,271
|
|
|
|
65.4
|
|
|
|
(5.2
|
)%
|
|
|
(15.8
|
)%
|
Net Revenue
. Sypris Technologies derives its revenue from the sale of forged and finished steel components and subassemblies and high-pressure closures and other fabricated products. Net revenue for Sypris Technologies for the three and nine-month periods ended September 30, 2018 increased $1.3 million and $4.3 million from the prior year comparable periods, respectively. The net revenue growth for the comparable three-month period was primarily attributable to increased sales volume of $1.6 million with customers in the commercial vehicle market, partially offset by lower energy related product sales of $0.2 million. The net revenue growth for the comparable nine-month period was primarily attributable to increased sales volume of $4.1 million with customers in the commercial vehicle market and increased energy related product sales of $1.9 million. The growth for the three and nine-month periods was partially offset by the nonrenewal of the Eaton supply agreement, which accounted for $0.1 million and $1.7 million of revenue in the respective prior year periods.
Sypris Electronics derives its revenue primarily from circuit card and full box build manufacturing, high reliability manufacturing and systems assembly and integration. Net revenue for Sypris Electronics decreased $1.6 million and $1.1 million for the three and nine months ended September 30, 2018, respectively, from the prior year comparable periods. Revenue for the three and nine-month periods of 2018 was affected by shortages of certain electronic components and extensive lead-time issues in the electronic manufacturing industry. Program delays associated with changes to the complex designs of certain circuit cards and the qualification and ramp-up of production on new programs further contributed to the decrease in revenue for the comparable periods.
Gross Profit.
Sypris Technologies’ gross profit increased $1.9 million and $6.3 million for the three and nine months ended September 30, 2018. The net increase in volumes contributed to an increase in gross profit of $0.2 million and $1.3 million for the three and nine months ended September 30, 2018. Additionally, gross profit for the three and nine months ended September 30, 2018 was positively impacted by cost improvements following the transfer of production from our Broadway Plant, which was completed as of the end of 2017.
Sypris Electronics’ gross profit decreased $1.4 million and $1.9 million for the three and nine months ended September 30, 2018, respectively. The decrease in gross profit was primarily attributable to an unfavorable revenue mix, which included the start-up of new programs and shortages of certain electronic components. Certain higher volume, higher margin programs were replaced with the start-up of new programs during the period. The Company expects the component shortages to continue during the fourth quarter of 2018 and into 2019, however recent actions by the Company, our customers and vendors to mitigate the impact of the shortages on our production are expected to yield improvements in component availability for our programs. The adoption of ASC 606 decreased our gross profit by $0.1 million and increased our gross profit by $0.1 million for the three and nine months ended September 30, 2018, respectively.
Selling, General and Administrative.
Selling, general and administrative expense decreased by $0.2 million and $0.9 million for the three and nine month periods ended September 30, 2018, respectively, as compared to the same periods in 2017, primarily as a result of lower employment costs during the period as compared to the prior year.
Severance
, Relocation and Other Costs
.
Severance, relocation and other costs were $0.3 million and $1.1 million for the three and nine months ended September 30, 2018, respectively, as compared to $0.4 million and $2.2 million for the three and nine months ended October 1, 2017. The charges for the first nine months of 2018 included $0.1 million in equipment relocation costs and $0.2 million primarily related to mothball costs associated with the closure of the Broadway Plant. Severance costs in 2017 are comprised of charges related to the headcount reductions associated with the closure of the Broadway Plant and equipment relocation costs incurred during the period (see Note 6 to the consolidated financial statements in this Form 10-Q).
Other
Expense
(Income)
, Net.
The Company recognized other income, net of $1.7 million for the nine months ended September 30, 2018 compared to $1.7 million for the nine months ended October 1, 2017. As described in Note 3 and Note 17 to the consolidated financial statements, in the first quarter of 2018, the Company adopted ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (ASU 2017-07). The ASU requires the Company to disaggregate the service cost component from the other components of net periodic benefit costs and requires application on a retrospective basis. As such, the other components of net periodic benefit costs included in other income for the nine months ended September 30, 2018 and October 1, 2017 were $0.5 million and $0.3 million, respectively.
During the nine months ended September 30, 2018, the Company recognized an insurance recovery gain of $2.3 million related to proceeds received for damage sustained at one of its plants (see Note 7 to the consolidated financial statements in this Form 10-Q). Additionally, the Company recognized foreign currency related translation gains of $0.1 million in the first nine months of 2017 related to the net U.S. dollar denominated monetary asset position of our Mexican subsidiaries for which the Mexican peso is the functional currency. The gains were partially offset by a loss of $0.2 million related to the sale or disposal of idle assets.
The Company recognized other income, net of $1.7 million for the nine months ended October 1, 2017. Other income, net for the nine months ended October 1, 2017 includes $2.7 million related to the gain recognized on the sale of idle assets within Sypris Technologies. The gain was partially offset by foreign currency related translation losses of $0.8 million recognized in the first nine months of 2017 related to the net U.S. dollar denominated monetary asset position of our Mexican subsidiaries for which the Mexican peso is the functional currency.
Liquidity, Capital Resources
As a result of Sypris Technologies’ nonrenewal of certain supply agreements, the Company experienced substantially reduced levels of revenue and cash flows beginning in 2015. Additionally, revenue declined due to softness in the commercial vehicle market, which began in the fourth quarter of 2015 and continued through 2016. These developments prompted us to re-examine our strategies, develop recovery plans and cut our costs significantly. Reductions in our available liquidity have also required closer monitoring of the timing of our capital expenditures and cash flows in order to manage our business operations.
During 2017, the Company completed the transfer of production and the relocation of certain manufacturing assets from its Broadway Plant to other manufacturing facilities, as needed, to serve its existing and targeted customer base. During the fourth quarter of 2017, the Company terminated all production at the Broadway Plant. As a result of the closure of the Broadway Plant and the transfer of production, the Company is incurring lower employment costs, occupancy and related facility fixed costs and depreciation expense, which is expected to contribute to higher levels of gross profit and operating income for Sypris Technologies.
Gill Family Capital Management
Note
. The Company has received the benefit of cash infusions from GFCM in the form of secured promissory note obligations totaling $6.5 million in principal as of December 31, 2017 and September 30, 2018. GFCM is an entity controlled by the Company’s chairman, president and chief executive officer, Jeffrey T. Gill and one of our directors, R. Scott Gill. GFCM, Jeffrey T. Gill and R. Scott Gill are significant beneficial stockholders of the Company.
During 2017, the Company amended its secured promissory note obligation with GFCM to, among other things: (i) extend the maturity dates for $2.5 million of the obligation to April 1, 2021, $2.0 million to April 1, 2023 and the balance to April 1, 2025, (ii) adjust the interest rate beginning on April 1, 2019 and on each April 1 thereafter, to reflect the greater of 8.0% or 500 basis points above the five-year Treasury note average during the previous 90-day period, (iii) allow for up to an 18-month deferral of payment for up to 60% of the interest due on the notes maturing in April of 2021 and 2023, and (iv) provide for a first security interest in substantially all assets, including those in Mexico.
Capital Lease Obligations.
On March 9, 2016, the Company completed the sale of its 24-acre Toluca property for 215 million Mexican Pesos, or approximately $12.2 million in U.S. dollars. Simultaneously, the Company entered into a ten-year lease of the 9 acres and buildings currently occupied by the Company and needed for its ongoing business in Toluca. As a result of the Toluca Sale-Leaseback, the Company has a capital lease obligation of $2.8 million for the building as of September 30, 2018.
In January 2018, the Company entered into a capital lease for $1.3 million for new production equipment installed at its Sypris Electronics facility during 2017. The balance of the lease obligation as of September 30, 2018 was $0.8 million.
Cash Balance.
At September 30, 2018, we had approximately $8.6 million of cash and cash equivalents, of which $1.2 million was held in jurisdictions outside of the U.S. that, if repatriated, could result in withholding taxes.
We have projected that our cash and cash equivalents will be sufficient to allow us to continue operations for the next 12 months. Significant changes from our current forecasts, including, but not limited to: (i) meaningful shortfalls in projected revenue or sales proceeds from underutilized or non-core equipment, (ii) unexpected costs or expenses, and/or (iii) operating difficulties which cause unexpected delays in scheduled shipments, could require us to seek additional funding or force us to make further reductions in spending, extend payment terms with suppliers, liquidate assets where possible and/or suspend or curtail planned programs. Any of these actions could materially harm our business, results of operations and future prospects.
Cash Flows
Operating Activities.
Net cash used by operating activities was $1.1 million in the first nine months of 2018 as compared to $8.5 million in the same period of 2017. Cash of $2.2 million was used to finance increased accounts receivables in the first nine months of 2018 as a result of the increase in revenue within Sypris Technologies and the timing of revenue being weighted toward the last month of the period. The investment in inventory in the first nine months of 2018 resulted in a use of cash of $2.2 million. There was a corresponding increase in accounts payable during the first nine months of 2018, which resulted in a source of cash of $4.0 million. Additionally, accrued and other liabilities increased during the first nine months of 2018 primarily as a result of prepayments from customers within Sypris Electronics, resulting in a source of cash of $4.9 million.
Investing Activities.
Net cash provided by investing activities was $2.3 million for the first nine months of 2018 as compared to $2.8 million for the first nine months of 2017. Net cash provided by investing activities for the first nine months of 2018 includes $2.3 million from insurance proceeds related to damage sustained at one of its plants (See Note 7 to the consolidated financial statements in this Form 10-Q). Additionally, the Company received proceeds of $1.4 million from the sale of idle assets by Sypris Technologies during the period.
Net cash provided by investing activities for the first nine months of 2017 includes proceeds of $2.8 million from the sale of idle assets by Sypris Technologies during the period. Additionally, $1.5 million of the escrow balance from the CSS sale was released to the Company during the third quarter of 2017. Capital expenditures in both periods represented maintenance levels of investment.
Financing Activities.
Net cash used in financing activities was $0.8 million for the first nine months of 2018 as compared to $0.3 million for the first nine months of 2017. Net cash used in financing activities in the first nine months of 2018 included capital lease payments of $0.7 million and payments of $0.1 million for minimum statutory tax withholdings on stock-based compensation.
Net cash used in financing activities in the first nine months of 2017 included payments of $0.1 million for minimum statutory tax withholdings on stock-based compensation and capital lease payments of $0.2 million.
Critical Accounting Policies
See the information concerning our critical accounting policies included under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation - Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. Except as set forth below in connection with the adoption of ASC 606, there have been no significant changes in our critical accounting policies during the nine months ended September 30, 2018.
Revenue Recognition.
Refer to Note 4 to the accompanying consolidated financial statements for a description of the Company’s revenue recognition policies.
The Company recognizes revenue when it satisfies a performance obligation by transferring control of a promised product or rendering a service to a customer. The amount of revenue recognized reflects the consideration the Company expects to be entitled to in exchange for the product or service (the “transaction price”). The Company’s transaction price in its contracts with customers is generally fixed; no payment discounts, rebates or refunds are included within its contracts. The Company does not provide service-type warranties either via written agreement or customary business practice, nor does it allow customer returns. In connection with the sale of various parts to customers, the Company is subject to typical assurance warranty obligations covering the compliance of the electronics parts produced to agreed-upon specifications (See Note 14). Customer returns, when they occur, relate to quality rework issues and are not connected to any repurchase obligation of the Company.
A performance obligation is a promise in a contract to transfer a distinct product or render a service to a customer and is the unit of account to which the transaction price is allocated under ASC 606. When a contract contains multiple performance obligations, we allocate the transaction price to the individual performance obligations using the price at which the promised goods or services would be sold to customers on a standalone basis. For most sales within our Sypris Technologies segment and a portion of sales within Sypris Electronics, control transfers to the customer at a point in time. Indicators that control has transferred include the Company having a present right to payment, the customer obtaining legal title and the customer having the significant risks and rewards of ownership. The Company’s principal terms of sale are FOB Shipping Point, or equivalent, and, as such, the Company primarily transfers control and records revenue for product sales upon shipment.
For contracts where Sypris Electronics serves as a contractor for aerospace and defense companies under federally funded programs, we generally recognize revenue over time as we perform because of continuous transfer of control to the customer. This continuous transfer of control to the customer is supported by clauses in the contracts that allow the customer to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. Because of control transferring over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. We use labor hours incurred as a measure of progress for these contracts because it best depicts the Company’s performance of the obligation to the customer, which occurs as we incur labor on our contracts. Under this measure of progress, the extent of progress towards completion is measured based on the ratio of labor hours incurred to date to the total estimated labor hours at completion of the performance obligation.
Our contract profit margins may include estimates of revenues for goods or services on which the customer and the Company have not reached final agreements, such as contract changes, settlements of disputed claims, and the final amounts of requested equitable adjustments permitted under the contract. These estimates are based upon management's best assessment of the totality of the circumstances and are included in our contract profit based upon contractual provisions and our relationships with each customer.
Forward-looking Statements
This Quarterly Report on Form 10-Q, and our other oral or written communications, may contain “forward-looking” statements. These statements may include our expectations or projections about the future of our business, industries, business strategies, prospects, potential acquisitions, liquidity, financial condition or financial results and our views about developments beyond our control, including domestic or global economic conditions, trends and market developments. These statements, including those outlined in management’s recovery plan, are based on management’s views and assumptions at the time originally made, and, except as required by law, we undertake no obligation to update these statements, even if, for example, they remain available on our website after those views and assumptions have changed. There can be no assurance that our expectations, projections or views will come to pass, and undue reliance should not be placed on these forward-looking statements.
A number of significant factors could materially affect our specific business operations and cause our performance to differ materially from any future results projected or implied by our prior statements. Many of these factors are identified in connection with the more specific descriptions contained throughout this report. Other factors which could also materially affect such future results currently include: our failure to achieve targeted gains and cash proceeds from the anticipated sale of certain equipment; our failure to return to profitability on a timely basis, which would cause us to continue to use existing cash resources or other assets to fund operating losses; the cost, quality, timeliness, efficiency and yield of our operations and capital investments, including the impact of tariffs, product recalls or related liabilities, working capital, production schedules, cycle times, scrap rates, injuries, wages, overtime costs, freight or expediting costs; cost, quality and availability of raw materials such as steel, component parts (especially electronic components), natural gas or utilities; inventory valuation risks including excessive or obsolescent valuations or price erosions of raw materials or component parts on hand or other potential impairments, non-recoverability or write-offs of assets or deferred costs; potential weaknesses in internal controls over financial reporting and enterprise risk management; breakdowns, relocations or major repairs of machinery and equipment, especially in our Toluca Plant; our failure to successfully complete final contract negotiations with regard to our announced contract “orders”, “wins” or “awards”; dependence on, retention or recruitment of key employees; disputes or litigation involving governmental, supplier, customer, employee, creditor, stockholder, product liability or environmental claims; volatility of our customers’ forecasts, scheduling demands and production levels which negatively impact our operational capacity and our effectiveness to integrate new customers or suppliers, and in turn cause increases in our inventory and working capital levels; the fees, costs and supply of, or access to, debt, equity capital, or other sources of liquidity; the costs of compliance with our auditing, regulatory or contractual obligations; changes in licenses, security clearances, or other legal rights to operate, manage our work force or import and export as needed; labor relations; strikes; union negotiations; pension valuation, health care or other benefit costs; our inability to patent or otherwise protect our inventions or other intellectual property from potential competitors; our reliance on third party vendors and sub-suppliers; adverse impacts of new technologies or other competitive pressures which increase our costs or erode our margins; U.S. government spending on products and services that Sypris Electronics provides, including the timing of budgetary decisions; risks of foreign operations; currency exchange rates; war, terrorism, or political uncertainty; cyber security threats and disruptions; failure to adequately insure or to identify environmental or other insurable risks; unanticipated or uninsured disasters, losses or business risks; inaccurate data about markets, customers or business conditions; or unknown risks and uncertainties and the risk factors disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.