Sypris Solutions
Annual Report 2003

Plain-text annual report

Investing in the future 2003 Annual Report 101 Bullitt Lane Suite 450 Louisville, Kentucky 40222 Phone (502) 329-2000 Fax (502) 329-2050 www.sypris.com 3 7 2 $ 7 7 2 $ 5 5 2 $ 7 1 2 $ 4 8 . 0 $ 3 6 . 0 $ 6 5 . 0 $ 2 3 . 0 $ 3 . 7 2 $ 6 . 3 1 $ 1 . 8 $ 5 . 8 $ 00 01 02 03 00 01 02 03 00 01 02 03 Net Revenue (in millions) Diluted Earnings Per Share Cash Flow From Operations (in millions) 9 9 1 $ 1 6 1 $ 2 6 1 $ 4 5 1 $ 5 8 1 $ 7 7 1 $ 4 5 1 $ 4 3 1 $ 9 3 2 $ 8 2 1 $ 4 3 1 $ 7 6 $ 00 01 02 03 00 01 02 03 00 01 02 03 Order Backlog (in millions) Revenue Per Employee (in thousands) Market Capitalization (in millions) Performance 2003 Revenue Continued to Grow: Up 1.1% Driven by a 10% increase for the Industrial Group, revenue increased for the fourth consecutive year. Operating Income Declined: Down 21.2% Third quarter issues across the business had a negative impact. Earnings per Share Followed Suit: Down 33.3% EPS was affected by the decline in operating income, a 25% increase in marginal tax rates and a 7% increase in diluted shares. Cash Flow from Operations Soared: Up 100.5% Cash flow from operations reached a record $27 million. Market Capitalization Continued to Rise: Up 78.0% Market capitalization increased to $239 million. Revenue per Employee Hit a New Record: Up 4.5% This important measure of productivity increased for the fourth consecutive year to $185,000 per employee. Total Long-Term Debt Remained Low: $56 million Even after spending $46 million in investing activities, total long-term debt increased by only 19% due to the 100% increase in cash flow from operations. Total Assets Reached a New Record: $263 million Total assets increased 17.8%, driven by investments in technology, capacity and new capabilities. Orders Reached Record Levels: $322 million Firm orders with specified shipment dates increased 21% for the year. Backlog Climbed to Record Heights: $199 million Backlog climbed 29%, driven by strong orders and new multi-year contracts. Sypris Solutions is a diversified provider of technology-based outsourced services and specialty products. We perform a wide range of manufacturing and technical services, typically under multi-year, sole-source contracts with corporations and government agencies in the markets for aerospace & defense electronics, truck components & assemblies, and for users of test & measurement equipment. Contents Letter to Stockholders 3 Corporate Officers 6 Investing in the Future 7 Sypris at a Glance 22 Board of Directors 24 Financial Summary 26 Financial Review 27 Common Stock Information 58 Corporate Directory 59 Company Locations 60 Investor Information IBC Letter to Stockholders FELLOW STOCKHOLDERS: position of strong financial and operational health, but is poised as never before to expand and grow profitably in This past year turned out to be one of the most the future. important, exciting and challenging periods in the 20-year history of Sypris. While we were successful in FINANCIAL RESULTS continuing to execute our long-term strategy, we were Revenue increased slightly during 2003, climbing to challenged by a difficult third quarter. Despite this $277 million from $273 million for the prior year, thereby temporary setback, 2003 marked one of the most marking the fourth consecutive year of top line growth transformational periods in the Company’s history, one for the Company. The increase was supported by a 10% that will have a significant impact on the future of Sypris increase in revenue from the Industrial Group, which for some time to come. benefited from increased shipments to Dana and 2003 was a year that was remarkable for the amount Visteon despite the difficult market for commercial and and range of the investments that your company made light-truck vehicles during the year. in its future. We invested $46 million during the year in Operating income decreased 21% to $15 million new state-of-the-art manufacturing technologies, during the year from $19 million for 2002, primarily as a processes, capabilities and services. We also invested result of the shortfall we experienced during the third to advance the introduction of new, leading-edge quarter of 2003. During this period, the Company products successfully to market, while continuing to struggled through effects of the electrical blackout that devote resources to support the development of our resulted in plant closures, production delays and single most important asset – our people. overtime charges we incurred to meet our customers’ The results were as you might expect. Orders from schedules. The period was also notable for reduced customers increased 21% during the year to a record deliveries to two customers as they rebalanced $322 million. Firm, shippable backlog increased 29% inventories as well as the delay of shipments to another during the year, reaching a record $199 million at year customer as it completed the redesign of key circuit card end. And perhaps most importantly, the award of new, assemblies for a new missile guidance system. long-term contracts, the life blood of the Company’s Earnings per share declined 33% to $0.56 from future, soared 111% to a record $639 million as a result $0.84 in 2002, reflecting the effects of the third quarter of new contracts with Dana, Nokia, Motorola, Siemens on the Company’s profitability, as well as a 25% and a variety of government agencies tasked with increase in our marginal tax rate and a 7% increase in maintaining the security of our nation. the number of diluted shares outstanding. We are pleased to highlight some of our people and Cash flow from operations increased 100% to $27 the investments that we made during 2003 in this year’s million during 2003 following a 61% increase during annual report. Please join us in thanking these 2002. This record level of cash flow enabled Sypris to individuals, as well as their 1,700 fellow employees, increase capital expenditures 14% to $23 million and who have been instrumental in building the strength and invest an additional $23 million to support the capacity organizational vitality of Sypris. As a result of their hard requirements and growth opportunities tied to new work and dedication, your company is not only in a contracts while incurring only $19 million of debt to do so. ROBERT E. GILL, Chairman of the Board and JEFFREY T. GILL, President & CEO 3 Sypris Solutions Net book value continued to increase, rising 6% to Morganton who is featured on our cover this year and medium and heavy-duty trucks, including those expected to approximate $500 million over the term of $145 million, while the value of the Company’s total elsewhere in this annual report, we believe that we have manufactured by Freightliner, Navistar and Paccar. The the agreements. assets increased 18% to $263 million from $224 million made an investment in the future that will benefit the contract also calls for Sypris to produce certain drive Should we prove to be successful in closing these for the prior year. And finally, the market capitalization of Company for years to come. train components for use in light trucks manufactured by two proposed transactions, we will significantly increase Sypris increased 78% to $239 million from $134 million We invested in the purchase and installation of new Ford and General Motors. The agreement runs through the breadth and depth of our relationship with both for the prior year, reflecting a positive response by our automated inventory towers in our plant in Tampa, 2011 and has a projected value of $440 million over the customers, as well as add vital new production investors to the announcement of new contract awards Florida. These towers, which can hold over 13,000 part term of the contract based upon current market capabilities to our rapidly growing manufacturing base. and their expected impact on our future financial results. numbers, resulted in a vast increase in inventory INVESTMENTS accuracy and reduced the amount of square footage required to house these parts to 5,000 square feet from conditions. THE FUTURE CLOSING In November of 2003, Sypris celebrated its 20th During 2003, we committed a record level of capital, 35,000 square feet prior to the purchase of the The prospect for additional growth in the future anniversary as a company. While we are proud of our investing $46 million, or 16% of revenue, for the future equipment. The project, which was the focus of one of remains bright, with two contracts currently under letter longevity, staying power alone is not enough. We want of your company. our Six Sigma teams, is an excellent example of the of intent with Dana and ArvinMeritor. We expect to to move forward. We want to generate the kind of value To give you a sense of potential scale and impact of dedication to continuous improvement that exists complete these proposed transactions during 2004, that will delight our stockholders, motivate our these investments, we dedicated over $8 million to a throughout your company. subject to the completion of our due diligence and the employees and consistently outperform that of our new machining operation in our plant in Marion, Ohio. We also invested in a range of products to serve the satisfaction of certain conditions to closing. competitors. That is our goal and we are determined to This cell can handle a wide variety of part numbers, needs of certain government agencies that are involved The proposed transaction with Dana involves the reach it. With your continued support, we are confident requires only 10 minutes to change over from the with ensuring our nation’s security. Of particular note is purchase of a major portion of Dana’s manufacturing we will. production of one part number to another, and is our new, patent-pending Silver Phoenix technology, campus in Toluca, Mexico and certain production In closing, we wish to call your attention to the operated by just four people per shift. The operation is which incorporates real-time storage area network equipment located at other Dana plants in the United outstanding performance of our employees in already running 24/7 and is expected to make a material architecture. When embedded in systems used by States. In return, we plan to enter into an eight-year overcoming the many challenges of 2003 and in making contribution to the Company’s productivity and customers in national security and weapons testing supply agreement to provide Dana with a variety of the most of the opportunities that arose during the past profitability during 2004. In fact, the early results have applications, it enables users to simultaneously gather, forged and machined drive train components for use in twelve months that were both trying and stimulating. been so positive that we have already placed an order process and disseminate diverse types of information medium and heavy-duty trucks. When completed and at Their performance and dedication enabled us to for a second cell, which we hope to have up and running from a variety of sources with unprecedented speed and full production, the projected value of the contract is continue operating profitably, to expand our operations in time to meet the growing needs of our customers in accuracy. We plan to build upon this architecture in the expected to approximate $500 million over the term of efficiently and effectively, and to successfully position early 2005. future and believe the number of potential applications the agreement. our company for a future that can only be described as We invested $22 million for the purchase of an to be highly scalable. award-winning manufacturing operation located in Morganton, North Carolina from Dana at year-end. This CONTRACTS plant, which features over 100 pieces of CNC controlled During 2003, we secured a record level of new The proposed transaction with ArvinMeritor involves exciting. Please join us in thanking them for doing an the purchase of its plant in Kenton, Ohio that specializes outstanding job. in the manufacture of trailer axle beams. In return, we plan to enter into a multi-year supply agreement to machining equipment, boasts a very talented and contract awards bringing the total estimated value of provide ArvinMeritor with trailer axle beams and a /s/ Jeffrey T. Gill /s/ Robert E. Gill dedicated workforce, and is expected to serve as a key these awards to $639 million for the year. variety of drive train components for use in medium and President & CEO Chairman of the Board manufacturing base from which we plan to serve a The Dana contract is particularly noteworthy. Under variety of customers in the commercial and light-truck this supply agreement, which began in January of 2004, markets in the future. In fact, with the addition of people Sypris is providing machining operations for a variety of like Robert McCracken, a long-time CNC machinist in drive train components that are produced for use in heavy-duty trucks. The proposed transaction also includes the five-year extension of an existing supply agreement with ArvinMeritor. When completed and at full production, the projected value of the contracts is Sypris Solutions 4 5 Sypris Solutions Corporate Officers John R. McGeeney, Anthony C. Allen, James G. Cocke, Kathy Smith Boyd, Richard L. Davis, David D. Johnson, G. Darrell Robertson, John M. Kramer Sypris Solutions 6 During 2003, Sypris invested $46 million in new technology, capacity, processes and capabilities. The result: Orders increased 21% to $322 million. Backlog increased 29% to $199 million. New contract awards increased 111% to $639 million. 2003 Investing in the Future We thought you might like to learn more about the investments that will impact Sypris for years to come. 9 Sypris Solutions People Our team of encryption software specialists and hardware engineers developed this technologically advanced secure host for use by our Armed Forces and certain government agencies tasked with maintaining our national security. Technology Our team designed and installed the most advanced machining cell in the world for finishing axle shafts for use by medium and heavy-duty truck customers. Capabilities Our purchase of the plant in Morganton, North Carolina added much needed experience and talent to our manufacturing base. We expect to build on this critical base for many years to come. Processes Six Sigma techniques were applied to develop a solution for storing electronic components that resulted in vastly improved inventory accuracy and a reduction of 30,000 square feet in storage space. Products We developed the high-speed Silver Phoenix architecture to ease the burden It has the capability to record the entire of intelligence gathering operations. Encyclopædia Britannica in less than five one-hundredths of a second. Services We offer specialized on-site services for our customers, including Bose, Delphi and Siemens, using our extensive knowledge and best practices to manage their instrument calibration and repair needs at a significant cost savings. Sypris At A Glance Sypris Solutions is a diversified provider of technology-based outsourced services and specialty products. We perform a wide range of manufacturing and technical services, typically under multi-year, sole-source contracts with corporations and government agencies in the markets for aerospace & defense electronics, truck components & assemblies, and for users of test & measurement equipment. s c i n o r t c e l E e s n e f e D d n a e c a p s o r e A s t n e n o p m o C k c u r T s e i l b m e s s A d n a s e c i v r e S t n e m e r u s a e M d n a t s e T Market-Focused Businesses Business Summary Applications and Uses Select Customers Manufacturing Services Engineering Services Products Integrated design and engineering services, component selection, sourcing and procurement, automated assembly, design and implementation of product testing, systems assembly, and repair and warranty services. Software design services for data and communications security products and contract design services. Encryption devices and real-time network- centric analog and digital data acquisition and storage systems. Electronic assemblies and subsystems for use in military cockpit control and display systems, missile guidance systems, commercial avionics, satellite communications systems, ruggedized hand-held computers, and secure communications networks and products. Boeing, Eaton, General Dynamics, Honeywell, L3, Lockheed Martin, National Security Agency, Northrop Grumman, Raytheon and U.S. Army. Secured transmission of voice and data for intelligence and surveillance applications. General Services Administration, National Security Agency and U.S. Army. Network and communications security, collection and storage of data for aerospace applications, weapons test and evaluation, and acquisition of signal data from targets of interest for the intelligence gathering community. General Dynamics, Government of Israel, Johnson Space Center, Lockheed Martin, NASA, National Security Agency, Northrop Grumman, Raytheon, Titan Corporation, TRW, U.S. Air Force, U.S. Army and U.S. Navy. Manufacturing Services Automated forging, machining, induction hardening, cold extrusion, heat-treating, testing and fabrication of products, production tooling and prototypes. Axle shafts, steer axles, carriers, full-float tubes, ring gears, pinions, input shafts, helical gears and other drive train components for use in light, medium and heavy-duty trucks, SUVs, pickup trucks and automobiles. Jet engine shafts and construction vehicle components. ArvinMeritor, Dana, DaimlerChrysler, John Deere, Pratt & Whitney and Visteon. Products High-pressure closures, transition joints and insulated joints. Pipeline and chemical systems in the energy and chemical industries. Chevron, ExxonMobil and Shell Oil. Calibration and Repair Testing Products Calibration, repair and certification of electrical, electronic, physical and dimensional test equipment, diagnostic and process control equipment. Testing of digital, linear, discrete, passive and hybrid components, RF devices, environmental testing, dynamics testing, failure analysis and transportation testing on products, systems and subassemblies. Hall generators, current sensors, autoprobes and gaussmeters. Telecommunications systems, air traffic control systems, electronic component manufacturing, automotive, process control, weather radar systems, aerospace and defense, medical equipment manufacturing and power generation and distribution. Anadigics, AT&T, Bose, Delphi Automotive, FAA, General Dynamics, Honeywell, ITT, Lucent Technologies, Maxtor, Motorola, National Weather Service, Nokia, Siemens, Spirent, Square D, Tyco Electronics and TRW Automotive. Military, semiconductor manufacturing, aerospace, satellite and launch systems, avionics, medical, telecommunications and transportation. Arrow-Zeus, BAE Systems, Boeing, Bose, Eldec, General Dynamics, Goodrich, Hamilton-Sundstrand, Honeywell, JPL, L-3, Lockheed Martin, NASA, Northrop Grumman, Raytheon, Sawtek and Suntron. Current measurement applications in mass transit systems, elevators, automotive diagnostic systems and laboratory diagnostic systems. Magnetic measurement of components used in military, aerospace and medical applications, and for research and development and quality control. General Motors, Hamilton-Sundstrand, Lockheed Martin, Miltope, Snap-on, Toyo, Ithaco and SPX. Sypris Solutions 22 23 Sypris Solutions Board of Directors Robert E. Gill (top photo) has served as Chairman of the Board of Sypris and its predecessor since 1983, and as President and Chief Executive Officer of its predecessor from 1983 to 1992. Prior to 1983, Mr. Gill served in a number of senior executive positions, including Chairman, President and Chief Executive Officer of Armor Elevator Company, Vice President of A. O. Smith Corporation and President and Chief Executive Officer of Elevator Electric Company. Mr. Gill holds a BS degree in Electrical Engineering from the University of Washington and an MBA from the University of California at Berkeley. He is Chairman of the Executive Committee. Robert E. Gill is the father of Jeffrey T. Gill and R. Scott Gill. Jeffrey T. Gill (bottom photo) has served as President and Chief Executive Officer of Sypris and its predecessor since 1992, and as Executive Vice President of its predecessor from 1983 to 1992. Mr. Gill holds a BS degree in Business Administration from the University of Southern California and an MBA from Dartmouth College. A director of Sypris and its predecessor since 1983, Mr. Gill is a member of the Executive Committee. Jeffrey T. Gill is the son of Robert E. Gill and the brother of R. Scott Gill. Henry F. Frigon (top photo) has served as a private investor and business consultant since 1994. Mr. Frigon served as Chairman of CARSTAR, a national provider of collision repair services, from 2000 to 2001, and as its President and Chief Executive Officer from 1998 to 2000. Prior to 1994, Mr. Frigon served in a number of senior executive positions, including Executive Vice President-Corporate Development and Strategy, and Chief Financial Officer of Hallmark Cards, and President and Chief Executive Officer of BATUS. A director of Sypris since 1997 and of Sypris Electronics from 1994 until its merger with Sypris in 1998, Mr. Frigon also serves as a director of H&R Block, Buckeye Technologies, Dimon, Tuesday Morning and Packaging Corporation of America. He is Chairman of the Compensation Committee and a member of the Executive and Nominating and Governance Committees. R. Scott Gill (bottom photo) has served as a Managing Broker with Coldwell Banker Residential Brokerage since 2003. Mr. Gill served as a Managing Broker and Associate with Koenig & Strey GMAC Real Estate, a residential real estate firm from 1999 to 2003. Mr. Gill served as Project Manager for IA Chicago, an architectural design firm, from 1998 to 1999, as Senior Vice President and Secretary of Sypris from 1997 to 1998, and as Vice President and Secretary of its predecessor from 1983 to 1998. A director of Sypris and its predecessor since 1983, Mr. Gill is a member of the Executive Committee. R. Scott Gill is the son of Robert E. Gill and the brother of Jeffrey T. Gill. William L. Healey (top photo) has served as President and Chief Executive Officer of Cal Quality Electronics, an electronics manufacturing company, since 2002. Mr. Healey served as a private investor and consultant from 1999 to 2002, as Chairman of the Board of Smartflex Systems, an electronics manufacturing company, from 1996 to 1999 and as its President and Chief Executive Officer from 1989 to 1999. Prior to 1989, Mr. Healey served in a number of senior executive positions with Silicon Systems, including Senior Vice President of Operations. A director of Sypris since 1997, Mr. Healey also serves as a director of Microsemi Corporation. He is Chairman of the Nominating and Governance Committee. Roger W. Johnson (bottom photo) is currently a private investor, educator and business consultant. Mr. Johnson served as Chairman of the Board and Chief Executive Officer of Collectors Universe, a provider of services to dealers and collectors of high-end collectibles, from 2001 to 2002. Mr. Johnson served as Chief Executive Officer of YPO International (Young Presidents Organization) from 1998 to 2000 and as Administrator of the General Services Administration from 1993 to 1996. Prior to 1993, Mr. Johnson served in a number of senior executive positions, including Chairman of the Board and Chief Executive Officer of Western Digital Corporation. A director of Sypris since 1997 and of Sypris Electronics from 1996 until its merger with Sypris in 1998, Mr. Johnson also serves as a director of the Needham Funds, Insulectro, Maxtor Corporation and Computer Access Technology Corporation. He is Chairman of the Audit and Finance Committee and a member of the Nominating and Governance Committee. Sidney R. Petersen (top photo) retired as Chairman of the Board and Chief Executive Officer of Getty Oil in 1984, where he served in a variety of increasingly responsible management positions since 1955. A director of Sypris since 1997 and of Sypris Electronics from 1994 until its merger with Sypris in 1998, Mr. Petersen is a member of the Compensation and Audit and Finance Committees. Robert Sroka (bottom photo) has served as Managing Director of Corporate Solutions Group, an investment banking firm, since December 2003, and as Managing Partner of Lighthouse Partners, a private investment and business consulting company, since 1998. Mr. Sroka served as Managing Director of Investment Banking- Mergers and Acquisitions for J.P. Morgan from 1994 to 1998. Prior to 1994, Mr. Sroka served in a variety of senior executive positions with J.P. Morgan, including Vice President-Investment Banking and Vice President-Corporate Finance. A director of Sypris since 1997, Mr. Sroka also serves as non-executive Chairman of the Board of Avado Brands. He is a member of the Compensation and Audit and Finance Committees. Sypris Solutions 24 25 Sypris Solutions Financial Summary Financial Review (In thousands, except per share data) 2003 2002(1) 2001(2) 2000 1999 Years ended December 31, Consolidated Income Statement Data: Net revenue Gross profit Operating income Net income Earnings per common share: Basic Diluted $ 276,605 $ 273,477 $ 254,640 $ 216,571 $ 202,130 46,012 49,521 43,547 40,313 44,949 14,941 18,956 13,030 5,477 14,166 8,135 11,439 6,367 3,184 9,556 $ $ 0.57 $ 0.56 $ 0.87 $ 0.84 $ 0.65 $ 0.63 $ 0.33 $ 0.32 $ 1.00 0.97 (In thousands) 2003(3) 2002 2001 2000 1999 December 31, Consolidated Balance Sheet Data: Working capital Total assets $ 80,516 $ 77,593 $ 67,325 $ 58,602 $ 53,705 263,495 223,605 211,444 179,122 148,564 Long-term debt, net of current portion 53,000 30,000 80,000 62,500 49,000 Total stockholders’ equity 144,781 137,035 70,120 64,205 60,820 (1) On January 1, 2002, we adopted Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets" which required us to discontinue the amortization of goodwill. See Note 1 of our consolidated financial statements for the year ended December 31, 2003 included elsewhere in this annual report. (2) On May 31, 2001, we completed the acquisition of the net assets of Dana’s Marion, Ohio facility and its results of operations are included from that date forward. (3) On December 31, 2003, we completed the acquisition of the net assets of Dana’s Morganton, North Carolina facility. Management’s Discussion and Analysis 28 Report of Management 38 Report of Independent Auditors 39 Consolidated Income Statements 40 Consolidated Balance Sheets 41 Consolidated Statements of Cash Flows 42 Consolidated Statements of Stockholders’ Equity 43 Notes to Consolidated Financial Statements 44 Sypris Solutions 26 27 Sypris Solutions Management’s Discussion and Analysis The following discussion of our results of operations and financial condition should be read together with the other As part of the proposed transaction, we plan to acquire ArvinMeritor's Kenton, Ohio plant that specializes in the manufacture financial information and consolidated financial statements included in this annual report. This discussion contains forward- of trailer axle beams. In addition, the proposed transaction provides for a five-year extension of an existing five-year supply looking statements that involve risks and uncertainties. Our actual results could differ materially from the results anticipated agreement that is otherwise expected to expire on December 31, 2004 under which we supply ArvinMeritor with axle shafts in the forward-looking statements as a result of a variety of factors, including those discussed in "Forward-Looking for medium and heavy-duty trucks. Should we complete the proposed transaction with ArvinMeritor successfully, the total Statements" and elsewhere in this annual report. outsourcing arrangement is expected to generate approximately $75 million of revenue per year, based upon current market conditions. OVERVIEW The proposed second phase of the Dana transaction and the proposed ArvinMeritor transaction remain subject to due We are a diversified provider of outsourced services and specialty products. We perform a wide range of manufacturing, diligence, negotiation and execution of definitive agreements and board approvals among other contingencies, and in the engineering, design, testing and other technical services, typically under multi-year, sole-source contracts with major case of ArvinMeritor's Kenton plant, the negotiation and approval of a new union collective bargaining agreement. companies and government agencies in the markets for aerospace & defense electronics, truck components & assemblies, The expected revenue from these transactions are based upon current market volumes and neither Dana nor and for users of test & measurement equipment. Revenue from our three core markets accounted for approximately 94% of ArvinMeritor have an obligation to purchase a particular level of services under either the recently executed or proposed our revenue for the year ended December 31, 2003, while revenue from our outsourced services accounted for approximately contracts and there can be no assurance that the expected revenue will be realized. The prices contained in these 83% of our revenue. We expect these percentages to increase in the future. agreements for our services are fixed for an initial term and generally reduced thereafter in accordance with schedules We have four major operating subsidiaries that are grouped into two reportable segments, the Electronics Group and contained in the agreements. We believe these price reductions will not materially affect our profitability. We purchase raw the Industrial Group. The Electronics Group is comprised of Sypris Data Systems, Inc., Sypris Electronics, LLC and Sypris steel and fabricated steel parts for these agreements at the direction of our customers, with any periodic changes in the price Test & Measurement, Inc. Revenue from this group is derived primarily from the sale of manufacturing services, technical of steel being reflected in the prices we are paid for our services, such that we neither benefit from nor are harmed by any services and products to customers in the markets for aerospace & defense electronics and test & measurement services. future changes in the price of steel. The agreements also provide for us to share in the benefits of any cost reduction The Industrial Group consists solely of Sypris Technologies, Inc., which generates revenue primarily from the sale of suggestions that we make that are accepted by our customers. manufacturing services to customers in the market for truck components & assemblies and from the sale of products to the Accounting Policies. Our significant accounting policies are described in Note 1 to the consolidated financial energy and chemical markets. statements included elsewhere in this annual report. We believe our most critical accounting policies include revenue Our objective is to become the leading outsourcing specialist in each of our core markets for aerospace & defense recognition and cost estimation on certain contracts for which we use percentage of completion methods of accounting, as electronics, truck components & assemblies, and for users of test & measurement equipment. We have focused our efforts described immediately below. on establishing long-term relationships with industry leaders who embrace multi-year contractual relationships as a strategic The complexity of the estimation process and all issues related to the assumptions, risks and uncertainties inherent with component of their supply chain management. the application of the percentage of completion methodologies affect the amounts reported in our financial statements. A Recent Contract Awards. The pursuit of multi-year contractual relationships with industry leaders in each of our core number of internal and external factors affect our cost of sales estimates, including labor rate and efficiency variances, revised market segments is a key component of our strategy. We focus primarily on those candidates that will enable us to estimates of warranty costs, estimated future material prices and customer specification and testing requirement changes. If consolidate positions of leadership in our existing markets, further develop strategic partnerships with leading companies, our business conditions were different, or if we used different assumptions in the application of this and other accounting and expand our capability and capacity to increase our value-added service offerings. The quality of these contracts has policies, it is likely that materially different amounts would be reported in our financial statements. enabled us to invest in leading-edge technologies that we believe will serve as an important means for differentiating Net Revenue. The majority of our outsourced services revenue is derived from manufacturing services contracts under ourselves in the future from the competition when it comes to cost, quality, reliability and customer service. which we supply products to our customers according to specifications provided under our contracts. We generally recognize We recently announced the closing of a transaction with Dana as well as letters of intent for transactions we expect to revenue for these outsourced services, as well as our product sales, when we ship the products, at which time title generally close in 2004 with Dana and ArvinMeritor. passes to the customer. On December 31, 2003, we completed the first phase of a proposed two-phase transaction with Dana in which we Contract revenue in our Electronics Group is recognized using the percentage of completion method, generally using entered into a new eight-year agreement to supply a wide range of drive train components for the light, medium and heavy- units-of-delivery as the basis to measure progress toward completing the contract. Revenue is recognized on these contracts duty truck markets to Dana. In connection with this agreement, we acquired the property, plant, and equipment and certain when units are delivered to the customer, with unit revenue based upon unit prices as set forth in the applicable contracts. component inventories associated with Dana’s manufacturing plant in Morganton, North Carolina for a purchase price of The costs attributed to contract revenue are based upon the estimated average costs of all units to be shipped. The approximately $22 million. In addition, the parties agreed to a three-year extension of an existing seven-year supply cumulative average costs of units shipped to date are adjusted through current operations as estimates of future costs to agreement that we originally entered into on May 31, 2001. In the proposed second phase of the transaction, which is complete change. Revenue under certain other multi-year fixed price contracts is recorded using achievement of performance evidenced by a letter of intent signed on August 25, 2003, we expect to enter into an eight-year agreement with Dana for the milestones or cost-to-cost as the basis to measure progress toward completing the contract. The basis for the measurement supply of forged and machined components for use in the medium and heavy-duty truck markets effective as of the closing, of progress toward completion is applied consistently to contracts with similar performance characteristics. Amounts which is expected to occur during 2004. As part of the proposed transaction, we plan to acquire a portion of Dana’s representing contract change orders or claims are included in revenue when these costs are reliably estimated and realization manufacturing campus in Toluca, Mexico and certain production equipment located at other Dana facilities in the U.S. The is probable. We recognize all other revenue as product is shipped and title passes, or when the service is provided to the first phase of the transaction with Dana is expected to generate approximately $55 to $60 million of revenue per year, or customer. Our net revenue includes adjustments for estimated product warranty and allowances for returns by our customers. approximately $440 million over the term of the contract while the three-year contract extension currently represents Generally, the percentage of completion method based on units of delivery is applied by our Electronics Group for outsourced approximately $50 million of revenue per year, or $150 million over the new period. Should we complete the second phase services provided under multi-year contracts with aerospace & defense customers. Approximately 35%, 44% and 53% of total of the transaction with Dana successfully, the total outsourcing arrangement excluding the contract extension is expected to net revenue was recognized under the percentage of completion method based on units of delivery during 2003, 2002 and result in revenue of approximately $130 million per year, based upon current market conditions. 2001, respectively. Approximately 5% of total net revenue was recognized under the percentage of completion method based On January 13, 2004, we signed a letter of intent with ArvinMeritor to supply trailer axle beams and a variety of drive on milestones or cost-to-cost during 2003. train components to ArvinMeritor under a series of multi-year agreements, the first of which is expected to close during 2004, with the balance scheduled to occur during the next two to three years in accordance with a predetermined transition plan. Sypris Solutions 28 29 Sypris Solutions Cost of Sales. Cost of sales consists primarily of our payments to our suppliers, compensation, payroll taxes and RESULTS OF OPERATIONS employee benefits for service and manufacturing personnel, and purchasing and manufacturing overhead costs. The The tables presented below, which compare our results of operations from one year to another, present the results for contracts for which our Electronics Group recognizes net revenue under the percentage of completion method involve the each year, the change in those results from one year to another in both dollars and percentage change and the results for use of estimates for cost of sales. We compare estimated costs to complete an entire contract to total net revenue for the each year as a percentage of net revenue. The columns present the following: term of the contract to arrive at an estimated gross margin percentage for each contract. Each month, the estimated gross • The first two data columns in each table show the absolute results for each year presented. margin percentage is applied to the cumulative net revenue recognized on the contract to arrive at cost of sales for the period. • The columns entitled "Year Over Year Change" and "Year Over Year Percentage Change" show the change in results, These estimates require judgment relative to assessing risks, estimating contract revenues and costs, and making assumptions for schedule and technical issues. These estimates are complicated and subject to many variables. Contract costs include material, labor and subcontract costs, as well as an allocation of indirect costs. For contract change orders, 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 year to the next, that change is shown as a positive number in both columns. Conversely, when expenses increase from one year to the next, that change is shown as a claims or similar items, we apply judgment in estimating the amounts and assessing the potential for realization. These negative number in both columns. amounts are only included in contract value when they can be reliably estimated and realization is considered probable. Management reviews these estimates monthly and the effect of any change in the estimated gross margin percentage • 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 for a contract is reflected in cost of sales in the period in which the change is known. If increases in projected costs-to- amounts are shown in italics. complete are sufficient to create a loss contract, the entire estimated loss is charged to operations in the period the loss first In addition, as used in these tables, "NM" means "not meaningful." becomes known. Additionally, our reserve for excess and obsolete inventory is primarily based upon forecasted demand for our products and any change to the reserve arising from forecast revisions is reflected in cost of sales in the period the Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 revision is made. Impairments. Consistent with Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," goodwill is tested at least annually for impairment by calculating the estimated fair value of each business with which goodwill is associated. The estimated fair value is based on a discounted cash flow analysis that requires judgment in our evaluation of the business and establishing an appropriate discount rate and terminal value to apply in the calculations. In selecting these and other assumptions, for each business we consider historical performance, forecasted operating results, general market conditions and industry considerations specific to the business. We likely would compute a materially different fair value for a business if different assumptions were used or if circumstances were to change. We evaluate long-lived assets for impairment and assess their recoverability based upon our estimate of future cash flows. If facts and circumstances lead us to believe that the cost of one of our assets may be impaired, we will write down that carrying amount to fair value to the extent necessary. In determining an estimate of future cash flows, we consider historical performance, forecasted operating results, general market conditions and industry considerations specific to the assets. We likely would compute a materially different estimate of future cash flows if different assumptions were used or if circumstances were to change. Year Over Year Over Year Years Ended December 31, Year Change Percentage Results as Percentage of Change Net Revenue for the Years Favorable Favorable Ended December 31, (In thousands, except percentage data) 2003 2002 (Unfavorable) (Unfavorable) 2003 2002 $ 180,733 95,872 276,605 $ 186,562 86,915 273,477 $ (5,829) 8,957 3,128 (3.1)% 10.3 1.1 65.3% 34.7 100.0 68.2% 31.8 100.0 Net revenue: Electronics Group Industrial Group Total Cost of sales: Electronics Group Industrial Group Total Gross profit: Electronics Group Industrial Group Total Selling, general and administrative Research and development Amortization of intangible assets 144,467 86,126 230,593 148,766 75,190 223,956 4,299 (10,936) (6,637) 36,266 9,746 46,012 26,711 4,166 194 37,796 11,725 49,521 27,114 3,354 97 (1,530) (1,979) (3,509) 403 (812) (97) 2.9 (14.5) (3.0) (4.0) (16.9) (7.1) 1.5 (24.2) (100.0) 79.9 89.8 83.4 20.1 10.2 16.6 9.7 1.5 0.0 5.4 0.6 0.1 4.7 1.8 79.7 86.5 81.9 20.3 13.5 18.1 9.9 1.3 0.0 6.9 1.0 (0.1) 6.0 1.8 Operating income 14,941 18,956 (4,015) (21.2) Interest expense, net Other expense (income), net 1,693 230 2,742 (159) 1,049 38.3 (389) NM Income before income taxes 13,018 16,373 (3,355) (20.5) Income taxes Net income 4,883 4,934 51 1.0 $ 8,135 $ 11,439 $ (3,304) (28.9)% 2.9% 4.2% Sypris Solutions 30 31 Sypris Solutions Net Revenue. Our backlog increased $44.8 million to $199.0 million at December 31, 2003, on $321.7 million in net Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 orders in 2003 compared to $265.8 million in 2002. We expect to convert approximately 80% of the backlog at December 31, 2003 to revenue during 2004. Net revenue decreased in the Electronics Group due to lower revenue from manufacturing services, partially offset by higher revenue from other outsourced services and product sales. Manufacturing services decreased $10.3 million because certain contracts with aerospace & defense customers were completed during 2002 which more than offset the revenue earned from new contract awards in 2003 and increased demand on certain other contracts. Net revenue from other outsourced services increased $3.9 million in 2003 due to an increase in engineering services. Net revenue from product sales increased $0.6 million in 2003 driven by higher quantities of data systems products, which benefited from higher spending by intelligence agencies. Backlog for our Electronics Group increased $10.4 million to $125.8 million at December 31, 2003, on $191.5 million in net orders in 2003 compared to $183.8 million in 2002. We expect to convert approximately 69% of the backlog at December 31, 2003 to revenue during 2004. Net revenue in the Industrial Group increased due to higher sales of light axle shafts and new components for medium and heavy-duty trucks. We began full production of light axle shafts under our contract with Visteon during the second quarter of 2002 so 2003 benefited from the full year effect of this contract. In 2003, we began shipping to Dana additional drive train components parts for medium and heavy-duty trucks. Backlog for our Industrial Group increased $34.4 million to $73.2 million at December 31, 2003, on $130.2 million in net orders in 2003 compared to $82.0 million in 2002. Backlog and net orders in 2003 increased primarily due to the Dana contract that closed on December 31, 2003. We expect to convert substantially all this backlog at December 31, 2003 to revenue during 2004. Gross Profit. Our Electronics Group experienced lower gross profit from manufacturing services and other outsourced services, partially offset by higher gross profit from products sales. Gross profit from manufacturing services decreased due to lower revenue and lower gross margins. Gross margins were lower primarily due to costs recognized during the third quarter related to warranty costs on an end-of-life program, expenses related to resolving technical problems on a custom manufacturing program and write-off of program costs related to the termination of an unprofitable contract. Gross profit from other outsourced services decreased due to lower gross margins in our test & measurement services business. Gross profit from product sales was higher due to the mix of higher value products and programs. Gross profit for our Industrial Group decreased due to lower gross margins. Gross margins were lower due to equipment maintenance and efficiency issues for certain automated equipment and a higher concentration of lower-margin Class 5-7 truck components. The Industrial Group experienced a difficult third quarter in 2003 during which gross profit decreased $2.3 Year Over Year Over Year Years Ended December 31, Year Change Percentage Results as Percentage of Change Net Revenue for the Years Favorable Favorable Ended December 31, (In thousands, except percentage data) 2002 2001 (Unfavorable) (Unfavorable) 2002 2001 Net revenue: Electronics Group Industrial Group Total Cost of sales: Electronics Group Industrial Group Total Gross profit: Electronics Group Industrial Group Total Selling, general and administrative Research and development Amortization of intangible assets Interest expense, net Other (income) expense, net Income before income taxes Income taxes Net income $ 186,562 86,915 273,477 $ 207,282 47,358 254,640 $ (20,720) 39,557 18,837 (10.0)% 83.5 7.4 68.2% 31.8 100.0 81.4% 18.6 100.0 148,766 75,190 223,956 169,897 41,196 211,093 21,131 (33,994) (12,863) 37,796 11,725 49,521 27,114 3,354 97 37,385 6,162 43,547 26,134 3,054 1,329 2,742 (159) 16,373 4,934 4,111 (358) 9,277 2,910 411 5,563 5,974 (980) (300) 1,232 5,926 1,369 (199) 7,096 12.4 (82.5) (6.1) 1.1 90.3 13.7 (3.7) (9.8) 92.7 45.5 33.3 (55.6) 76.5 79.7 86.5 81.9 20.3 13.5 18.1 9.9 1.3 0.0 6.9 1.0 (0.1) 6.0 1.8 82.0 87.0 82.9 18.0 13.0 17.1 10.3 1.2 0.5 5.1 1.6 (0.1) 3.6 1.1 $ 11,439 $ 6,367 $ 5,072 79.7% 4.2% 2.5% (2,024) (69.6) Operating income 18,956 13,030 million as compared to the third quarter of 2002. During the third quarter of 2003, productivity for the Industrial Group Net Revenue. Our backlog decreased $8.1 million to $154.2 million at December 31, 2002, on $265.8 million in net decreased primarily as a result of the Northeast electricity blackout in August 2003 and lower sales quantities to Visteon and orders in 2002 compared to $242.1 million in 2001. Dana. These lower sales quantities were driven by Visteon’s longer than normal annual plant shutdown and Dana’s Net revenue decreased in the Electronics Group due to lower revenue from manufacturing services and other rebalancing of inventory levels in anticipation of a potential labor-related work stoppage. outsourced services. Manufacturing services decreased $14.7 million due to lower aerospace & defense shipments during Selling, General and Administrative. Selling, general and administrative expense decreased $0.4 million in 2003 and 2002 and the completion of a commercial contract in the fourth quarter of 2001. Net revenue from other outsourced services decreased as a percentage of net revenue to 9.7% from 9.9% in 2002. We controlled our spending on selling, general and decreased $5.4 million in 2002 due to a 16% decline in revenue for test & measurement services. Weak economic conditions administrative in consideration of the 1.1% increase in net revenue from 2002 to 2003. and a slowdown in the telecommunications, semiconductor, and commercial avionics markets negatively affected demand for Research and Development. The increase in research and development costs is driven by development of a new data test & measurement services from our customers. Net revenue from product sales decreased $0.6 million in 2002 due to system product line within our Electronics Group. We expect to complete the development of these products in 2004, and reduced sales quantities for magnetics products. Backlog for our Electronics Group decreased $3.1 million to $115.4 million sold limited quantities in 2003. at December 31, 2002, on $183.8 million in net orders in 2002 compared to $183.5 million in 2001. Amortization of Intangible Assets. Amortization of intangible assets increased in 2003 primarily due to certain Net revenue in the Industrial Group increased $39.6 million in 2002 due to the full year effect of the May 2001 contract identifiable intangible assets acquired during 2003. with Dana and the addition of a contract with Visteon. The contract with Dana for fully machined, medium and heavy-duty Interest Expense, Net. Interest expense decreased in 2003 due to the repayment of debt and a lower weighted truck axle shafts and other drive train components, generated outsourced services revenue totaling $38.1 million in 2002, as average interest rate. We used proceeds from our 2002 stock offering to repay $52.5 million of our outstanding debt, reducing compared to $16.5 million in 2001. Under the contract with Visteon we began supplying light axle shafts for pickup trucks and our weighted average debt outstanding to $31.1 million during 2003 from $49.8 million during 2002. The weighted average sport utility vehicles during the first quarter of 2002. Backlog for our Industrial Group decreased $5.0 million to $38.8 million interest rate decreased to 5.4% in 2003 from 5.8% in 2002 due to the July 2003 expiration of interest rate swap rate at December 31, 2002, on $82.0 million in net orders in 2002 compared to $58.6 million in 2001. Net orders in 2002 increased agreements with higher than market interest rates. primarily due to the contracts with Dana and Visteon. Income Taxes. Our effective income tax rate increased to 37.5% in 2003 from 30.1% for 2002. The lower effective tax rate in 2002 was primarily due to a reduction in the valuation allowance on deferred tax assets. Sypris Solutions 32 33 Sypris Solutions Gross Profit. Gross profit was higher for our Electronics Group driven by higher gross margin as compared to 2001. QUARTERLY RESULTS Gross margin increased due to cost reductions, improved manufacturing efficiencies and a more favorable revenue mix in The following table presents our unaudited condensed consolidated statements of income data for each of the eight 2002 as compared to 2001. Most of the gross margin improvement was offset in gross profit by lower revenue. quarters in the period ended December 31, 2003. We have prepared this data on the same basis as our audited consolidated Gross profit for our Industrial Group increased due to revenue growth from contracts with Dana and Visteon. While gross financial statements and, in our opinion, include all normal recurring adjustments necessary for a fair presentation of this margin improved in 2002 compared to 2001, we believe start-up costs and manufacturing inefficiencies related to our initial information. You should read these unaudited quarterly results in conjunction with our consolidated financial statements and production under the Visteon contract limited the gross profit contribution from this business. related notes included elsewhere in this annual report. The consolidated results of operations for any quarter are not Selling, General and Administrative. Selling, general and administrative expense increased in 2002 due to the necessarily indicative of the results to be expected for any subsequent period. additional management and administrative infrastructure to support the growth in our Industrial Group, partially offset by reduced selling expenses in our Electronics Group. During the fourth quarter of 2002, selling, general and administrative expense was 8.8% of net revenue, primarily due to a reduction in our incentive bonus expense based on performance measures defined in our incentive plans. Research and Development. The increase in research and development costs is driven by development of a new data system product line within our Electronics Group. Amortization of Intangible Assets. In 2002, we amortized intangible assets other than goodwill and indefinite-lived intangible assets. We recognized substantially less amortization expense in 2002 because amortization of goodwill and indefinite-lived intangible assets ceased when we adopted SFAS No. 142 effective January 1, 2002. Interest Expense, Net. Interest expense decreased in 2002 due to the repayment of debt and a lower weighted average interest rate. We used proceeds from our stock offering during March and April 2002 to repay $52.5 million of our outstanding debt, reducing our weighted average debt outstanding to $49.8 million during 2002 from $74.5 million during 2001. The weighted average interest rate decreased to 5.8% in 2002 from 7.4% in 2001. There was no capitalized interest for 2002 as compared to $1.8 million for 2001. Income Taxes. Our effective income tax rate decreased to 30.1% in 2002 from 31.4% for 2001. The lower effective tax rate was due to a reduction in the valuation allowance on deferred tax assets totaling $0.7 million in 2002 compared to $0.3 million in 2001. (In thousands, except per share data) First Second Third Fourth First Second Third Fourth 2003 2002 Net revenue: Electronics Group Industrial Group Total Cost of sales: Electronics Group Industrial Group Total Gross profit: Electronics Group Industrial Group Total Selling, general and administrative Research and development Amortization of intangible assets $ 35,689 $ 45,544 $ 46,468 $ 53,032 $ 44,076 $ 49,297 $ 46,341 $ 46,848 19,830 66,678 25,077 70,621 22,430 68,898 23,226 58,915 24,212 73,509 25,139 78,171 24,416 70,757 18,457 62,533 28,390 20,574 48,964 7,299 2,652 9,951 6,149 1,022 21 35,821 21,759 57,580 9,723 3,318 13,041 7,036 1,066 21 38,304 21,025 59,329 41,952 22,768 64,720 35,388 16,016 51,404 8,164 1,405 9,569 6,925 1,030 67 11,080 2,371 13,451 6,601 1,048 85 8,688 2,441 11,129 6,514 831 51 40,280 20,347 60,627 9,017 3,865 12,882 7,188 932 3 36,111 20,672 56,783 36,987 18,155 55,142 10,230 3,744 13,974 7,522 773 21 9,861 1,675 11,536 5,890 818 22 Operating income 2,759 4,918 1,547 5,717 3,733 4,759 5,658 4,806 Interest expense, net Other expense (income), net 486 67 547 85 384 65 276 13 1,082 (29) 660 (31) 470 (9) 530 (90) Income before income taxes 2,206 4,286 1,098 5,428 2,680 4,130 5,197 4,366 Income taxes Net income 827 1,607 412 2,037 855 1,325 1,663 1,091 $ 1,379 $ 2,679 $ 686 $ 3,391 $ 1,825 $ 2,805 $ 3,534 $ 3,275 Earnings per common share: Basic Diluted Shares used in computing earnings per common share: $ $ 0.10 $ 0.10 $ 0.19 $ 0.19 $ 0.05 $ 0.05 $ 0.24 $ 0.23 $ 0.18 $ 0.17 $ 0.20 $ 0.19 $ 0.25 $ 0.24 $ 0.23 0.23 Basic Diluted 14,184 14,407 14,213 14,430 14,241 14,799 14,267 14,868 10,169 10,742 13,971 14,696 14,121 14,621 14,151 14,478 LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION Net cash provided by operating activities increased $13.7 million to $27.3 million in 2003. We made contributions to pension plans totaling $7.5 million in 2002, which included a voluntary contribution totaling $5.7 million, compared to contributions totaling less than $1.0 million in each of 2003 and 2001. Increases in our working capital resulted in a decrease in net cash flow totaling $1.0 million, $6.8 million and $8.1 million in 2003, 2002 and 2001, respectively. Net cash used in investing activities increased $25.6 million to $45.8 million in 2003 driven by net assets acquired totaling $21.8 million in connection with the Dana Morganton transaction and capital expenditures for our Electronics Group and Industrial Group totaling $10.6 million and $11.8 million, respectively. Capital expenditures for our Electronics Group were principally comprised of manufacturing, assembly and test equipment. Our Industrial Group’s capital expenditures included forging, machining, and centralized tooling equipment in support of our truck components & assemblies operations. Capital expenditures for the Industrial Group in 2002 and 2001 totaled $12.0 million and $19.5 million, respectively, which included new forging and machining equipment to increase and expand the range of production capabilities. In 2001, the Industrial Sypris Solutions 34 35 Sypris Solutions Group acquired certain assets of Dana’s Marion, Ohio facility for $11.5 million, and received $5.4 million in proceeds from Effective January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, sale and leaseback transactions for certain machinery and equipment. Capital expenditures for the Electronics Group in 2002 goodwill and indefinite lived intangible assets are no longer amortized but will be reviewed at least annually for impairment. and 2001 totaled $7.5 million and $7.9 million, respectively. We also received $1.4 million in 2001 for the sale of certain assets Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. by our Electronics Group. In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation Net cash provided by financing activities increased $12.4 million to $18.2 million in 2003 due to borrowings in connection of ARB No. 51." This Interpretation explains how to identify variable interest entities and how an enterprise assesses its with assets acquired for the Dana Morganton transaction, partially offset by $1.7 million in dividends paid. In 2002, we interests in a variable interest entity to decide whether to consolidate that entity. This Interpretation requires existing received net proceeds totaling $55.7 million from our public stock offering that was used primarily to reduce debt. In 2001, unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively we borrowed $22.5 million, primarily to fund capital expenditures and the acquisition of certain assets from Dana. disperse risks among the parties involved. We adopted the Interpretation in the fourth quarter 2003 and such adoption did not We had total availability for borrowings and letters of credit under the revolving credit facility of $68.8 million at affect our financial statements. December 31, 2003, which, when combined with our unrestricted cash balance of $12.0 million, provides for total cash and borrowing capacity of $80.8 million. Maximum borrowings on the revolving credit facility are $125.0 million, subject to a $15.0 FORWARD-LOOKING STATEMENTS million limit for letters of credit. The credit agreement includes an option to increase the amount of available credit to $150.0 million from $125.0 million, subject to the lead bank’s approval. Borrowings under the revolving credit facility may be used to finance working capital requirements, acquisitions and for general corporate purposes, including capital expenditures. Most acquisitions require the approval of our bank group. Our principal commitments at December 31, 2003 consisted of repayments of borrowings under the credit agreement and obligations under operating leases for certain of our real property and equipment. We also had purchase commitments totaling approximately $3.9 million at December 31, 2003, primarily for manufacturing equipment. The following table provides information about the payment dates of our contractual obligations at December 31, 2003, excluding current liabilities except for the current portion of long-term debt: (In thousands) 2004 2005 2006 2007 2008 Thereafter Revolving credit facility Operating leases Total $ $ 3,200 6,428 9,628 $ $ — $ — $ — $ 6,489 5,963 5,590 53,000 4,489 6,489 $ 5,963 $ 5,590 $ 57,489 $ $ — 2,947 2,947 2009 & We believe that, without taking into account the proceeds from this offering, sufficient resources will be available to satisfy our cash requirements for at least the next twelve months. Cash requirements for periods beyond the next twelve months depend on our profitability, our ability to manage working capital requirements and our rate of growth. If we make significant acquisitions or if working capital and capital expenditure requirements exceed expected levels during the next twelve months or in subsequent periods, we may require additional external sources of capital. There can be no assurance that any additional required financing will be available through bank borrowings, debt or equity financings or otherwise, or that if such financing is available, it will be available on terms acceptable to us. If adequate funds are not available on acceptable terms, our business, results of operations and financial condition could be adversely affected. RECENT ACCOUNTING PRONOUNCEMENTS Effective January 1, 2001, we adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" as amended by SFAS No. 137 and 138. SFAS No. 133, and its subsequent amendments, requires us to recognize all derivatives on the consolidated balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value must be recognized currently in earnings. In 2001, we entered into interest rate swap agreements, which were deemed to be effective hedges in accordance with SFAS No. 133. These swap agreements expired in July 2003. In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations." SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. SFAS No. 141 also specifies criteria for the recognition of identifiable intangible assets separately from goodwill. We applied the provisions of SFAS No. 141 to all business combinations subsequent to the effective date. This annual report contains forward-looking statements including statements concerning the future of our industries, product development, business strategy, the possibility of future acquisitions, continued acceptance and growth of our products and dependence upon significant customers. These statements can be identified by the use of forward-looking terminology such as "may," "will," "expect," "anticipate," "estimate," "continue" or other similar words. These statements discuss future expectations, contain projections of results of operations or of financial condition or include other forward- looking information. You should not place undue reliance on these forward-looking statements. Important factors could cause performance to differ materially from projected results contained in, or based upon, these statements, including: the discovery of, or failure to discover, material issues during due diligence; the failure to agree on the final terms of definitive agreements, long-term supply agreements, collective bargaining agreements, or related agreements or any party’s breach of, or refusal to close the transactions reflected in, those agreements; the ability to successfully manage growth or contraction in the economy, or the commercial vehicle or electronics markets; access to capital on favorable terms as needed for operations or growth; the ability to achieve expected annual savings and synergies from past and future business combinations; competitive factors and price pressures; availability of third party component parts at reasonable prices; inventory risks due to shifts in market demand and/or price erosion of purchased components; changes in product mix; program changes, delays, or cancellations by the government or other customers; concentrated reliance on major customers or suppliers; cost and yield issues associated with the Company’s manufacturing facilities; revisions in estimated costs related to major contracts; labor relations; risks inherent in operating abroad, including foreign currency exchange rates; performance of our pension fund portfolios; changes in applicable law or in the Company’s regulatory authorizations, security clearances, or other legal rights to conduct its business, deal with its work force or export goods and services; adverse regulatory actions, or other governmental sanctions; risks of litigation, including litigation with respect to environmental or asbestos-related matters, customer or supplier claims, or stockholders; the effects (including possible increases in the cost of doing business) resulting from future war and terrorists activities or political uncertainties; natural disasters, casualties, utility disruptions, or the failure to anticipate unknown risks and uncertainties present in the Company’s businesses; dependence on current management; as well as other factors included in the Company’s periodic reports filed with the Securities and Exchange Commission. In this annual report, we rely on and refer to information and statistics regarding the markets in which we compete. We obtained this information and these statistics from various third party sources and publications that are not produced for the purposes of securities offerings or economic analysis. We have not independently verified the data and cannot assure you of the accuracy of the data we have included. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. All additional borrowings under our credit agreement bear interest at a variable rate based on the prime rate, the London Interbank Offered Rate ("LIBOR"), or certain alternative short-term rates, plus a margin (1.0% at December 31, 2003) based upon our leverage ratio. An increase in interest rates of 100 basis points would result in additional interest expense approximating $0.6 million on an annualized basis, based upon our debt outstanding at December 31, 2003. Fluctuations in foreign currency exchange rates have historically had little impact on us because the vast majority of our transactions are denominated in U.S. dollars. Inflation has not been a significant factor in our operations in any of the periods presented, and it is not expected to affect operations in the foreseeable future. Sypris Solutions 36 37 Sypris Solutions Report of Management Report of Independent Auditors The management of Sypris Solutions, Inc. is responsible for the preparation and integrity of the accompanying consolidated financial statements, which were prepared in accordance with accounting principles generally accepted in the United States. The financial statements include amounts based on management’s best estimates and judgments. Financial Board of Directors and Stockholders Sypris Solutions, Inc. information included elsewhere in this annual report is consistent with these financial statements. We have audited the accompanying consolidated balance sheets of Sypris Solutions, Inc. as of December 31, 2003 and We maintain a system of internal control designed to provide reasonable assurance that transactions are executed in 2002, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in accordance with proper authorization and are appropriately recorded in order to permit preparation of financial statements in the period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our conformity with generally accepted accounting principles, and that assets are adequately safeguarded and accountability for responsibility is to express an opinion on these financial statements based on our audits. assets is maintained. Although no cost-effective internal control system will prevent all errors and irregularities, we believe We conducted our audits in accordance with auditing standards generally accepted in the United States. Those our controls provide reasonable assurance that the financial statements are reliable and that our assets are reasonably standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements safeguarded. Internal controls and procedures are periodically reviewed and revised, when appropriate, due to changing are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and circumstances and requirements. disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant To ensure the effective administration of internal control, we carefully select and train our employees, maintain and estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits disseminate written policies and procedures, provide appropriate communication channels and foster an environment provide a reasonable basis for our opinion. conducive to the effective functioning of controls. We have adopted a Code of Business Conduct that requires all employees, In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial including officers and senior level executives, to adhere to the highest standards of personal and professional integrity. position of Sypris Solutions, Inc. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash The Audit and Finance Committee of the Board of Directors is composed entirely of outside directors, including one of flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally whom the Board of Directors has deemed to be a financial expert. The Audit and Finance Committee members meet the accepted in the United States. Nasdaq Stock Market standards for independence and operate under a written charter adopted by the Board of Directors. The Audit and Finance Committee meets periodically with representatives of management and with our independent auditors to review our financial reporting process and our controls to safeguard assets. Our independent auditors have full and free access to the Audit and Finance Committee members at all times, without the presence of management, to discuss the results of their audits, the adequacy of our internal accounting control and the quality of our financial reporting. Louisville, Kentucky January 30, 2004 /s/ Jeffrey T. Gill President & CEO /s/ David D. Johnson Vice President, CFO & Treasurer Sypris Solutions 38 39 Sypris Solutions Consolidated Income Statements Consolidated Balance Sheets (In thousands, except per share data) 2003 2002 2001 (In thousands, except share data) Years ended December 31, Net revenue: Outsourced services Products Total net revenue Cost of sales: Outsourced services Products Total cost of sales Gross profit Selling, general and administrative Research and development Amortization of intangible assets Operating income Interest expense, net Other expense (income), net Income before income taxes Income tax expense Net income Earnings per common share: Basic Diluted $ 230,632 45,973 $ 229,629 43,848 $ 209,874 44,766 276,605 273,477 254,640 203,080 27,513 195,576 28,380 181,818 29,275 230,593 223,956 211,093 46,012 26,711 4,166 194 14,941 1,693 230 13,018 4,883 49,521 27,114 3,354 97 18,956 2,742 (159) 16,373 4,934 $ $ $ 8,135 $ 11,439 0.57 0.56 $ $ 0.87 0.84 $ $ $ 43,547 26,134 3,054 1,329 13,030 4,111 (358) 9,277 2,910 6,367 0.65 0.63 Shares used in computing earnings per common share: Basic Diluted 14,237 14,653 13,117 13,664 9,828 10,028 ASSETS Current assets: Cash and cash equivalents Accounts receivable, net Inventory, net Other current assets Total current assets Property, plant and equipment, net Goodwill Other assets Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable Accrued liabilities Current portion of long-term debt Total current liabilities Long-term debt Other liabilities Total liabilities Commitments and contingencies Stockholders’ equity: The accompanying notes are an integral part of the consolidated financial statements. no shares issued Preferred stock, par value $0.01 per share, 981,600 shares authorized; no shares issued Series A preferred stock, par value $0.01 per share, 18,400 shares authorized; Common stock, non-voting, par value $0.01 per share, 10,000,000 shares authorized; no shares issued Common stock, par value $0.01 per share, 30,000,000 shares authorized; 14,283,323 and 14,158,077 shares issued and outstanding in 2003 and 2002, respectively Additional paid-in capital Retained earnings Accumulated other comprehensive income (loss) Total stockholders’ equity Total liabilities and stockholders’ equity The accompanying notes are an integral part of the consolidated financial statements. December 31, 2003 2002 $ 12,019 45,484 61,932 11,370 $ 12,403 37,951 64,443 9,187 130,805 123,984 106,683 14,277 11,730 75,305 14,277 10,039 $ 263,495 $ 223,605 $ $ 29,598 17,491 3,200 50,289 53,000 15,425 118,714 — — — 23,356 16,035 7,000 46,391 30,000 10,179 86,570 — — — 143 83,541 63,443 (2,346) 142 82,575 57,017 (2,699) 144,781 137,035 $ 263,495 $ 223,605 Sypris Solutions 40 41 Sypris Solutions Consolidated Statements of Cash Flows Consolidated Statements of Stockholders’ Equity (In thousands) Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Deferred income taxes Provision for excess and obsolete inventory Provision for doubtful accounts Other noncash charges Contributions to pension plans Changes in operating assets and liabilities, net of acquisitions: Accounts receivable Inventory Other current assets Accounts payable Accrued and other liabilities Years ended December 31, 2003 2002 2001 $ 8,135 $ 11,439 $ 6,367 12,831 6,009 832 191 846 (586) (7,724) 6,219 (2,427) 3,154 (205) 11,386 3,684 727 231 339 (7,451) 1,576 (4,559) (863) (1,010) (1,898) 9,856 479 432 122 59 (754) (8,474) (3,519) (416) 3,648 671 8,471 Net cash provided by operating activities 27,275 13,601 Cash flows from investing activities: Capital expenditures Proceeds from sale of assets Purchase of net assets of acquired entities Changes in nonoperating assets and liabilities (22,521) 175 (23,300) (171) (19,747) 211 — (662) (27,623) 6,816 (11,486) (650) Net cash used in investing activities (45,817) (20,198) (32,943) Cash flows from financing activities: Net increase (decrease) in debt under revolving credit agreements Cash dividends paid Proceeds from issuance of common stock Net cash provided by financing activities Net decrease in cash and cash equivalents 19,200 (1,709) 667 18,158 (384) (50,500) (424) 56,692 5,768 (829) Cash and cash equivalents at beginning of year 12,403 13,232 22,500 — 530 23,030 (1,442) 14,674 Cash and cash equivalents at end of year $ 12,019 $ 12,403 $ 13,232 The accompanying notes are an integral part of the consolidated financial statements. Accumulated Other (In thousands, except share data) Common Stock Shares Amount Additional Paid-In Capital Comprehensive Total Retained Earnings Income (Loss) Stockholders’ Equity Balance at January 1, 2001 Net income Adjustment in minimum pension liability, 9,709,669 — $ net of tax of $828 Change in fair value of interest rate swap agreements, net of tax of $309 Comprehensive income (loss) Issuance of shares under Employee Stock Purchase Plan Exercise of stock options Stock option tax benefit — — — 52,206 136,800 — Balance at December 31, 2001 9,898,675 Net income Adjustment in minimum pension liability, net of tax of $582 Change in fair value of interest rate swap agreements, net of tax of $99 Comprehensive income (loss) — — — — Cash dividends, $0.06 per common share Issuance of common shares Issuance of shares under Employee — 4,100,000 Stock Purchase Plan Exercise of stock options Stock option tax benefit Retire unvested restricted shares 37,695 123,983 — (2,276) 97 — — — — 1 1 — 99 — — — — — 41 1 1 — — $ 24,401 — $ 40,060 6,367 $ (353) $ 64,205 6,367 — — — — 256 566 267 — (1,124) (1,124) — 6,367 (419) (1,543) (419) 4,824 — — — — — — 257 567 267 25,490 46,427 (1,896) 70,120 — — — — — 55,615 335 758 377 — 11,439 — 11,439 — (873) (873) — 11,439 (849) — — — — — 70 (803) — — — — — — 70 10,636 (849) 55,656 336 759 377 — Balance at December 31, 2002 14,158,077 142 82,575 57,017 (2,699) 137,035 Net income Adjustment in minimum pension liability, net of tax of $2 Change in fair value of interest rate swap agreements, net of tax of $210 Comprehensive income Cash dividends, $0.12 per common share Issuance of shares under Employee Stock Purchase Plan Exercise of stock options Stock option tax benefit — — — — — 38,160 87,086 — — — — — — — 1 — — — — — — 353 456 157 8,135 — — 8,135 (1,709) — — — — 4 349 353 — — — — 8,135 4 349 8,488 (1,709) 353 457 157 Balance at December 31, 2003 14,283,323 $ 143 $ 83,541 $ 63,443 $ (2,346) $ 144,781 The accompanying notes are an integral part of the consolidated financial statements. Sypris Solutions 42 43 Sypris Solutions Notes to Consolidated Financial Statements NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Revenue Recognition Consolidation Policy The accompanying consolidated financial statements include the accounts of Sypris Solutions, Inc. and its wholly- owned subsidiaries (collectively, "Sypris" or the "Company"). All significant intercompany accounts and transactions have been eliminated. Nature of Business Sypris is a diversified provider of outsourced services and specialty products. The Company performs a wide range of manufacturing, engineering, design, testing, and other technical services, typically under multi-year, sole-source contracts with corporations and government agencies in the markets for aerospace & defense electronics, truck components & assemblies, and for users of test & measurement equipment. Use of Estimates The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Inventory Contract inventory is stated at actual production costs, reduced by the cost of units for which revenue has been recognized. Gross contract inventory is considered work in process. Progress payments under long-term contracts are specified in the contracts as a percentage of cost and are liquidated as contract items are completed and shipped. Other inventory is stated at the lower of cost or market. The first-in, first-out method was used for determining the cost of inventory excluding contract inventory and certain other inventory, which was determined using the last-in, first-out method ("LIFO") (see Note 4). The Company’s reserve for excess and obsolete inventory is primarily based upon forecasted demand for its product sales, and any change to the reserve arising from forecast revisions is reflected in cost of sales in the period the revision is made. Property, Plant and Equipment Property, plant and equipment is stated on the basis of cost. Depreciation of property, plant and equipment is generally computed using the straight-line method over their estimated economic lives. For land improvements, buildings and building improvements, the estimated economic life is generally 40 years. Estimated economic lives range from three to fifteen years for machinery, equipment, furniture and fixtures. Leasehold improvements are amortized over the respective lease term using the straight-line method. Expenditures for maintenance, repairs and renewals of minor items are expensed as incurred. Major renewals and improvements are capitalized. Interest cost is capitalized for qualifying assets during the period in which the asset is being installed and prepared for its intended use. Capitalized interest cost is amortized on the same basis as the related depreciation. Goodwill Beginning in 2002 with the adoption of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," goodwill is no longer amortized, but instead tested at least annually for impairment. Prior to 2002, goodwill was amortized using the straight-line method over its estimated period of benefit of 15 years (see "Adoption of Recently Issued Accounting Standards" below). Goodwill is reported net of accumulated amortization of approximately $4,146,000 at December 31, 2003 and 2002. Long-lived Assets A portion of the Company’s business is conducted under long-term, fixed-price contracts with aerospace & defense companies and agencies of the U.S. Government. Contract revenue is recognized using the percentage of completion method, generally using units-of-delivery as the basis to measure progress toward completing the contract. The costs attributed to contract revenue are based upon the estimated average costs of all units to be shipped. The cumulative average costs of units shipped to date are adjusted through current operations as estimates of future costs to complete change (see "Contract Accounting" below). Revenue under certain other long-term fixed price contracts is recorded using achievement of performance milestones or cost-to-cost as the basis to measure progress toward completing the contract. Amounts representing contract change orders or claims are included in revenue when such costs are reliably estimated and realization is probable. Revenue recognized under the percentage of completion method of accounting totaled approximately $111,341,000, $120,424,000 and $134,478,000 for the years ended December 31, 2003, 2002 and 2001, respectively. In 2003, approximately 88% of such amount was accounted for based on units of delivery and approximately 12% was accounted for based on milestones or cost-to-cost. In 2002 and 2001, substantially all such amounts were accounted for under the units- of-delivery method. All other revenue is recognized as product is shipped and title passes, or when services are rendered. Contract Accounting For long-term contracts, the Company capitalizes in inventory direct material, direct labor and factory overhead as incurred. Selling costs are expensed as incurred. Costs to complete long-term contracts are estimated on a monthly basis. Estimated margins at completion are applied to cumulative contract revenue to arrive at costs charged to operations. Accounting for long-term contracts under the percentage of completion method involves substantial estimation processes, including determining the estimated cost to complete a contract. As contracts may require performance over several accounting periods, formal detailed cost-to-complete estimates are performed and updated monthly via performance reports. Management’s estimates of costs-to-complete change due to internal and external factors, such as labor rate and efficiency variances, revised estimates of warranty costs, estimated future material prices and customer specification and testing requirement changes. Changes in estimated costs are reflected in gross profit in the period in which they are known. If increases in projected costs-to-complete are sufficient to create a loss contract, the entire estimated loss is charged to operations in the period the loss first becomes known. Product Warranty Costs The provision for estimated warranty costs is recorded at the time of sale and periodically adjusted to reflect actual experience. The accrued liability for warranty costs is included in the caption "Accrued liabilities" in the accompanying consolidated balance sheets. Concentrations of Credit Risk Financial instruments which potentially expose the Company to concentrations of credit risk consist of accounts receivable. The Company’s customer base consists of various departments or agencies of the U.S. Government, aerospace & defense companies under contract with the U.S. Government and a number of customers in diverse industries across geographic areas, primarily in North America. The Company performs periodic credit evaluations of its customers’ financial condition and does not require collateral on its commercial accounts receivable. Credit losses are provided for in the consolidated financial statements and consistently have been within management’s expectations. Approximately 43% of accounts receivable outstanding at December 31, 2003 are due from the Company’s four largest customers. The Company recognized revenue from contracts with the U.S. Government and its agencies of approximately $49,143,000, $44,185,000 and $40,046,000 during the years ended December 31, 2003, 2002 and 2001, respectively. The Company’s largest customers for the year ended December 31, 2003 were Dana Corporation and Raytheon Company, which represented approximately 15% and 14%, respectively, of the Company’s total net revenue. The Company’s largest customers for the year ended December 31, 2002 were Raytheon Company and Dana Corporation, which represented The Company evaluates long-lived assets for impairment and assesses their recoverability based upon anticipated approximately 19% and 14%, respectively, of the Company’s total net revenue. The Company’s largest customers for the year future cash flows. If facts and circumstances lead the Company’s management to believe that the cost of one of its assets ended December 31, 2001 were Raytheon Company and Honeywell International, Inc., which represented approximately may be impaired, the Company will write down that carrying amount to fair value to the extent necessary. 21% and 11%, respectively, of the Company’s total net revenue. No other single customer accounted for more than 10% of the Company’s total net revenue for the years ended December 31, 2003, 2002 or 2001. Sypris Solutions 44 45 Sypris Solutions Stock Based Compensation In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 46, "Consolidation Stock options are granted under various stock compensation programs to employees and independent directors (see of Variable Interest Entities, an Interpretation of ARB No. 51." This Interpretation explains how to identify variable interest Note 11). The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion No. 25, entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. "Accounting for Stock Issued to Employees" ("APB 25"). For purposes of pro forma disclosures, the estimated fair value of This Interpretation requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries the options is amortized to expense over the options’ vesting period. The Company’s pro forma information is as follows: if the entities do not effectively disperse risks among parties involved. The Company adopted the Interpretation in the fourth (In thousands, except per share data) 2003 2002 2001 NOTE 2. ACQUISITIONS Years ended December 31, quarter 2003 and such adoption did not effect the financial statements. Net income Pro forma stock-based compensation expense, net of tax Pro forma net income Pro forma earnings per common share: Basic Diluted Derivative Financial Instruments $ $ $ $ 8,135 $ 11,439 1,624 6,511 0.46 0.44 1,591 9,848 0.75 0.72 $ $ $ $ $ $ $ 6,367 1,390 4,977 0.51 0.50 In 2001, the Company entered into interest rate swap agreements, which were deemed to be effective hedges in accordance with SFAS No. 133, "Accounting of Derivative Instruments and Hedging Activities" (see Note 7). All derivatives on the consolidated balance sheets are reported at fair value and changes in the fair value, net of income tax, were recognized in other comprehensive income (loss) on the consolidated statements of stockholders’ equity. Adoption of Recently Issued Accounting Standards In June 2001, the FASB issued SFAS No. 141, "Business Combinations." SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. SFAS No. 141 also specifies criteria for the recognition of identifiable intangible assets separately from goodwill. The Company applied the provisions of SFAS No. 141 to all business combinations subsequent to the effective date (see Note 2). Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, goodwill and indefinite lived intangible assets are no longer amortized but will be reviewed at least annually for impairment. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. The nonamortization of goodwill has increased the Company’s net income and earnings per share beginning in 2002. Following are pro forma results assuming goodwill had not been amortized prior to January 1, 2002: On May 31, 2001, the Company acquired from Dana Corporation certain assets and liabilities of the Marion Forge plant. The business produces fully machined, medium and heavy-duty truck axle shafts and other drive train components for integration into subassemblies and is included with Sypris Technologies in the Industrial Group. The transaction was accounted for as a purchase, in which the purchase price of $11,486,000 was allocated based on the fair values of the assets and liabilities acquired. The purchase price was allocated primarily to property, plant and equipment. The results of operations of the acquired business have been included in the consolidated financial statements since the acquisition date. The acquisition was financed by the Company’s Credit Agreement (see Note 7). On December 31, 2003, the Company acquired from Dana Corporation certain assets and liabilities of a plant that will expand Sypris Technologies’ manufacturing capabilities in certain light, medium and heavy-duty truck steer axles and other drive train components. The transaction was accounted for as a purchase, in which the purchase price of $22,297,000 was allocated based on the fair values of the assets and liabilities acquired. The results of operations of the acquired business will be included in the consolidated financial statements beginning January 1, 2004. The acquisition was financed by the Company’s Credit Agreement (see Note 7). The Company paid Dana $21,780,000 on the closing date and $517,000 in January 2004. Following are the estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition, which are subject to refinement: (In thousands) Current assets Property, plant and equipment Other assets Total assets acquired Current liabilities assumed Net assets acquired $ 4,540 17,746 1,727 24,013 (1,716) $ 22,297 Years ended December 31, Company will amortize on a straight-line basis over the life of the contract. Other assets represents the estimated fair value of an eight-year supply agreement with Dana Corporation that the (In thousands, except per share data) 2003 2002 2001 Reported net income Adjustment for amortization of goodwill, net of tax Adjusted net income Basic earnings per common share as reported Adjustment for amortization of goodwill, net of tax Adjusted basic earnings per common share Diluted earnings per common share as reported Adjustment for amortization of goodwill, net of tax Adjusted diluted earnings per common share $ $ $ $ $ $ 8,135 — 8,135 0.57 — 0.57 0.56 — 0.56 $ $ $ $ $ $ 11,439 — 11,439 0.87 — 0.87 0.84 — 0.84 $ $ $ $ $ $ 6,367 782 7,149 0.65 0.08 0.73 0.63 0.08 0.71 There has been no change to the carrying value of the Company’s goodwill since January 1, 2002. Goodwill, net of accumulated amortization, at December 31, 2003 for the Electronics Group and the Industrial Group was approximately $13,837,000 and $440,000, respectively. The Company’s other intangible assets subject to amortization and the related amortization expense are not material to the Company’s consolidated financial position or results of operations, respectively. NOTE 3. ACCOUNTS RECEIVABLE Accounts receivable consists of the following: (In thousands) Commercial U.S. Government Allowance for doubtful accounts December 31, 2003 2002 $ 39,978 6,100 $ 46,078 34,108 4,366 38,474 (594) (523) $ 45,484 $ 37,951 Accounts receivable from the U.S. Government includes amounts due under long-term contracts, all of which are billed at December 31, 2003 and 2002, of $4,508,000 and $2,930,000, respectively. Sypris Solutions 46 47 Sypris Solutions NOTE 4. INVENTORY Inventory consists of the following: (In thousands) Raw materials Work in process Finished goods Costs relating to long-term contracts and programs, net of amounts attributed to revenue recognized to date Progress payments related to long-term contracts and programs LIFO reserve Reserve for excess and obsolete inventory December 31, 2003 2002 $ 22,394 15,854 3,052 $ 18,493 14,769 4,588 36,569 (9,851) (940) (5,146) 34,778 (2,737) (1,007) (4,441) $ 61,932 $ 64,443 option to increase the amount of available credit to $150,000,000, subject to the lead bank’s approval. Current maturities of long-term debt at December 31, 2003 and 2002 represent amounts due under a short-term borrowing arrangement included in the Credit Agreement. Standby letters of credit up to a maximum of $15,000,000 may be issued under the Credit Agreement, and no significant amounts were outstanding at December 31, 2003 and 2002. Under the terms of the Credit Agreement, interest rates are determined at the time of borrowing and are based on the London Interbank Offered Rate plus a margin of 1.0% to 2.0%; or the greater of the prime rate or the federal funds rate plus 0.5%, plus a margin up to 0.75%. The Company also pays a fee of 0.20% to 0.25% on the unused portion of the aggregate commitment. The margins applied to the respective interest rates and the commitment fee are adjusted quarterly and are based on the Company’s ratio of funded debt to earnings before interest, taxes, depreciation and amortization. The weighted average interest rate for outstanding borrowings at December 31, 2003 was 2.7%. The weighted average interest rates for borrowings during the years ended December 31, 2003, 2002 and 2001 were 5.4%, 5.8% and 7.4%, respectively. The Credit Agreement contains customary affirmative and negative covenants, including financial covenants requiring the maintenance of specified fixed charge coverage and leverage ratios and minimum levels of net worth. As of December The preceding amounts include inventory valued under the LIFO method that totaled approximately $11,476,000 and 31, 2003, the Company was in compliance with all covenants. $12,663,000 at December 31, 2003 and 2002, respectively. NOTE 5. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consists of the following: (In thousands) Land and land improvements Buildings and building improvements Machinery, equipment, furniture and fixtures Construction in progress Accumulated depreciation December 31, 2003 2002 $ 2,173 23,420 148,733 15,539 189,865 $ 1,736 19,132 119,740 6,201 146,809 (83,182) (71,504) $ 106,683 $ 75,305 Depreciation expense totaled approximately $12,637,000, $11,280,000 and $8,468,000 for the years ended December 31, 2003, 2002 and 2001, respectively. Approximately $3,488,000 and $494,000 was included in accounts payable for capital expenditures at December 31, 2003 and 2002, respectively. NOTE 6. ACCRUED LIABILITIES Accrued liabilities consists of the following: (In thousands) Employee benefit plan accruals Salaries, wages and incentives Other December 31, 2003 2002 $ 5,219 1,708 10,564 $ 4,585 3,735 7,715 $ 17,491 $ 16,035 Included in other accrued liabilities are employee payroll deductions, advance payments, accrued operating expenses, accrued warranty expenses, accrued interest and other items, none of which exceed 5% of total current liabilities. NOTE 7. LONG-TERM DEBT The Company has a credit agreement with a syndicate of banks (the "Credit Agreement") that was entered into in October 1999 and amended most recently in October 2003. The Credit Agreement provides for a revolving credit facility with an aggregate commitment of $125,000,000 through October 2008. We had total availability for borrowings and letters of credit under the revolving credit facility of $68,800,000 at December 31, 2003, which, when combined with our unrestricted cash balance of $12,019,000, provides for total cash and borrowing capacity of $80,819,000. The credit agreement includes an On July 26, 2001, the Company entered into interest rate swap agreements with three banks that effectively converted a portion of its floating rate debt to a fixed rate basis for a period of two years, thus reducing the impact of interest rate changes on interest expense. The swap agreements, which expired on July 25, 2003, had a combined notional amount of $30,000,000 whereby the Company paid a fixed rate of interest of 4.52% and received a variable 30-day LIBOR rate. The differential paid or received was accrued as interest rates changed and was recognized as an adjustment to interest expense in the consolidated income statements. The aggregate fair market value of all interest rate swap agreements was approximately $559,000 at December 31, 2002, which was included in accrued liabilities on the consolidated balance sheet. Interest incurred, net of amounts capitalized, during the years ended December 31, 2003, 2002 and 2001 totaled approximately $1,729,000, $2,923,000 and $4,021,000, respectively. The Company had no capitalized interest in 2003 or 2002. Capitalized interest for the year ended December 31, 2001 was $1,763,000. Interest paid during the years ended December 31, 2003, 2002 and 2001 totaled approximately $1,328,000, $2,763,000 and $5,623,000, respectively. NOTE 8. FAIR VALUE OF FINANCIAL INSTRUMENTS Cash, accounts receivable, accounts payable and accrued liabilities are reflected in the consolidated financial statements at their carrying amount which approximates fair value because of the short-term maturity of those instruments. The carrying amount of debt outstanding at December 31, 2003 and 2002 under the Credit Agreement approximates fair value because borrowings are for terms less than six months and have rates that reflect currently available terms and conditions for similar debt. NOTE 9. EMPLOYEE BENEFIT PLANS The Company sponsors noncontributory defined benefit pension plans (the "Pension Plans") covering certain employees of Sypris Technologies. The Pension Plans covering salaried and management employees provide pension benefits that are based on the employees’ highest five-year average compensation within ten years before retirement. The Pension Plans covering hourly employees and union members generally provide benefits at stated amounts for each year of service. The Company’s funding policy is to make the minimum annual contributions required by the applicable regulations; however, the Company made a voluntary contribution to the Pension Plans totaling $5,660,000 in 2002. The Pension Plans’ assets are primarily invested in equity securities and fixed income securities. The following table details the components of pension expense: (In thousands) Service cost Interest cost on projected benefit obligation Net amortizations and deferrals Expected return on plan assets Years ended December 31, 2003 2002 2001 $ 137 2,265 611 (2,430) $ 172 2,306 339 (2,329) $ 358 1,939 247 (1,961) $ 583 $ 488 $ 583 Sypris Solutions 48 49 Sypris Solutions The following are summaries of the changes in the benefit obligations and plan assets and of the funded status of the The Company sponsors a defined contribution plan (the "Defined Contribution Plan") for substantially all employees of Pension Plans: (In thousands) Change in benefit obligation: Benefit obligation at beginning of year Service cost Interest cost Actuarial loss Benefits paid Benefit obligation at end of year Change in plan assets: Fair value of plan assets at beginning of year Actual return on plan assets Company contributions Benefits paid Fair value of plan assets at end of year Funded status of the plans: Benefit obligation at end of year Fair value of plan assets at end of year Funded status of plan (underfunded) Unrecognized actuarial loss Unrecognized prior service cost Net asset recognized Balance sheet assets (liabilities): Prepaid benefit cost Intangible asset Accrued benefit liability Accumulated other comprehensive loss Net amount recognized Pension plans with accumulated benefit obligation in excess of plan assets: Projected benefit obligation Accumulated benefit obligation Fair value of plan assets Projected benefit obligation and net periodic pension cost assumptions: Discount rate Rate of compensation increase Expected long-term rate of return on plan assets Weighted average asset allocation: Equity securities Debt securities Total December 31, 2003 2002 $ 35,237 137 2,265 1,450 (1,765) $ 31,983 172 2,306 2,394 (1,618) $ 37,324 $ 35,237 $ 29,480 3,958 586 (1,765) $ 24,789 (1,142) 7,451 (1,618) $ 32,259 $ 29,480 $ 37,324 32,259 (5,065) 7,714 365 $ $ 3,014 4,685 — (5,425) 3,754 $ $ $ 35,237 29,480 (5,757) 8,074 694 3,011 4,876 36 (5,661) 3,760 $ 3,014 $ 3,011 $ 22,304 22,100 16,677 $ 20,622 20,284 14,627 6.25% 4.00% 8.25% 63% 37% 100% 6.75% 4.00% 8.50% 38% 62% 100% The Company uses November 30 as the measurement date for the Pension Plans. Total estimated contributions expected to be paid to the plans during 2004 range from $1,500,000 to $2,000,000. The expected long-term rates of return on plan assets for determining net periodic pension cost for 2003 and 2002 were chosen by the Company from a best estimate range determined by applying anticipated long-term returns and long-term volatility for various assets categories to the target asset allocation of the plan. The target asset allocation of plan assets is equity securities ranging 55-65% and fixed income securities ranging 35-45% of total investments. the Company. The Defined Contribution Plan is intended to meet the requirements of Section 401(k) of the Internal Revenue Code. The Defined Contribution Plan allows the Company to match participant contributions and provides discretionary contributions. Contributions to the Defined Contribution Plan in 2003, 2002 and 2001 totaled approximately $2,737,000, $2,267,000 and $1,933,000, respectively. The Company has self-insured medical plans (the "Medical Plans") covering substantially all employees. The number of employees participating in the Medical Plans was approximately 1,325, 1,300 and 1,350 at December 31, 2003, 2002 and 2001, respectively. The Medical Plans limit the Company’s annual obligations to fund claims to specified amounts per participant and in the aggregate. The Company is adequately insured for amounts in excess of these limits. Employees are responsible for payment of a portion of the premiums. During 2003, 2002 and 2001, the Company charged approximately $7,223,000, $6,677,000 and $5,890,000, respectively, to operations related to reinsurance premiums, medical claims incurred and estimated, and administrative costs for the Medical Plans. Claims paid during 2003, 2002 and 2001 did not exceed the aggregate limits. NOTE 10. COMMITMENTS AND CONTINGENCIES The Company leases certain of its real property and certain equipment, vehicles and computer hardware under operating leases with terms ranging from month-to-month to ten years and which contain various renewal and rent escalation clauses. Future minimum annual lease commitments under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 2003 are as follows: (In thousands) 2004 2005 2006 2007 2008 2009 and thereafter $ 6,428 6,489 5,963 5,590 4,489 2,947 $ 31,906 Rent expense for the years ended December 31, 2003, 2002 and 2001 totaled approximately $7,485,000, $7,387,000 and $5,550,000, respectively. The Company entered into agreements for the sale and leaseback of certain specific manufacturing and testing equipment during 2001. The terms of the operating leases range from five to nine years and the Company has the option to purchase the equipment at the expiration of the respective lease term at a fixed price based upon the equipment’s estimated residual value. Lease payments on these operating leases are guaranteed by the Company. Proceeds from the sale and leaseback transactions during 2001 were approximately $5,420,000 and the transactions resulted in a deferred loss of approximately $787,000. Deferred losses on sales and leaseback transactions are amortized on a straight-line basis over the term of the respective leases. Cumulative deferred losses, including deferred losses incurred prior to 2001, net of amortization, was approximately $835,000 and $1,039,000 as of December 31, 2003 and 2002, respectively. Future minimum annual lease commitments related to these leases are included in the above schedule. As of December 31, 2003, the Company had outstanding purchase commitments of approximately $3,904,000, primarily for the acquisition of manufacturing equipment. The Company is involved in certain litigation and contract issues arising in the normal course of business. While the outcome of these matters cannot, at this time, be predicted in light of the uncertainties inherent therein, management does not expect that these matters will have a material adverse effect on the consolidated financial position or results of operations of the Company. Sypris Solutions 50 51 Sypris Solutions NOTE 11. STOCK OPTION AND PURCHASE PLANS The Company applies APB 25 and related interpretations in accounting for its employee stock options because, as The Company has certain stock compensation plans under which options to purchase common stock may be granted discussed below, the alternative fair value accounting provided for under SFAS No. 123, "Accounting for Stock-Based to officers, key employees and non-employee directors. Options may be granted at not less than the market price on the date Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. of grant. Options are exercisable in whole or in part up to two years after the date of grant and ending ten years after the date Under APB 25, when the exercise price of the Company’s employee stock options is at least equal to the market price of the of grant. The following table summarizes option activity for the three years ended December 31, 2003: underlying stock on the date of grant, no compensation expense is recognized. Exercise Price Range Weighted Average Exercise Price Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123. The fair value for options granted by the Company during 2003, 2002 and 2001 were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: Balance at January 1, 2001 Granted Exercised Forfeited Balance at December 31, 2001 Granted Exercised Forfeited Balance at December 31, 2002 Granted Exercised Forfeited Balance at December 31, 2003 Shares 1,553,737 632,819 (164,616) (174,980) 1,846,960 362,391 (127,561) (144,425) 1,937,365 690,811 (104,730) (178,061) $ 1.72 3.88 1.72 6.25 - $ 31.00 13.27 - 8.75 - 11.76 - $ 1.72 9.95 1.72 6.25 1.72 6.88 1.72 3.36 - - - - - - - - 31.00 19.00 10.50 16.03 31.00 16.10 10.50 16.03 7.79 6.15 3.06 8.21 7.61 14.32 6.23 9.39 8.83 8.78 5.04 9.17 8.96 2,345,385 $ 3.88 - $ 31.00 $ The following table summarizes certain weighted average data for options outstanding and currently exercisable at December 31, 2003: Exercise Price Range $3.88 - $5.00 $5.12 - $7.00 $7.37 - $10.00 $10.06 - $15.00 $15.59 - $20.00 $23.00 - $31.00 Total Outstanding Weighted Average Shares 125,120 438,970 1,212,208 466,794 96,805 5,488 Exercise Price $ 4.63 6.14 8.43 12.19 17.24 27.38 2,345,385 $ 8.96 Remaining Contractual Life 5.6 5.2 5.7 6.0 7.1 1.3 5.7 Weighted Average Exercise Price $ 4.59 6.19 8.64 10.87 18.13 27.38 Shares 102,870 103,590 520,593 79,069 55,805 5,488 867,415 $ 8.80 The Company’s stock compensation program also provides for the grant of performance-based stock options to key employees ("Performance Options"). The terms and conditions of the Performance Options grants provide for the determination of the exercise price and the beginning of the vesting period to occur when the fair market value of the Company’s common stock achieves certain targeted price levels. Performance Options to purchase 116,000 shares and 56,000 shares of common stock were granted during 2003 and 2001, respectively. The Company did not grant Performance Options in 2002. Performance Options to purchase 28,000 shares, 49,000 shares and 32,000 shares of common stock were forfeited in 2003, 2002 and 2001, respectively. One targeted price level of the Performance Options was achieved in 2002, resulting in determination of the exercise price and beginning of the vesting period for options to purchase 52,000 shares of common stock. Performance Options for which the targeted price level has not been achieved total 403,000 shares, 315,000 shares and 416,000 shares at December 31, 2003, 2002 and 2001, respectively, and are excluded from disclosures of options outstanding. The aggregate number of shares of common stock reserved for issuance under the Company’s stock compensation programs as of December 31, 2003 and 2002 was 4,750,000. The aggregate number of shares available for future grant as of December 31, 2003 and 2002 was 1,375,011 and 2,013,261, respectively. Expected life (years) Expected volatility Risk-free interest rates Expected dividend yield Years ended December 31, 2003 7 75.0% 3.69% 0.95% 2002 7 74.8% 3.83% 1.09% 2001 8 75.2% 4.93% — The weighted average Black-Scholes value of options granted under the stock option plans during 2003, 2002 and 2001 was $5.76, $9.39 and $4.71 per share, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a The Company has a stock purchase plan that provides substantially all employees who have satisfied the eligibility requirements the opportunity to purchase shares of the Company’s common stock on a compensation deduction basis. The purchase price is the lower of 85% of the fair market value of the common stock on the first or last business day of the purchase period. Payroll deductions may not exceed $6,000 for any six-month cycle. The stock purchase plan expires January 31, 2006. At December 31, 2003 and 2002, there were 121,049 shares and 159,209 shares, respectively, available for purchase under the plan. During 2003, 2002 and 2001, a total of 38,160 shares, 37,695 shares and 52,206 shares, respectively, were issued under the plan. NOTE 12. STOCKHOLDERS’ EQUITY On March 26, 2002, the Company completed a public stock offering of 3,600,000 shares of its common stock and, on April 19, 2002, an additional 500,000 shares were issued through the exercise of an over-allotment option. The shares were sold at $14.50 per share and generated proceeds, after underwriting discounts and expenses, of approximately $55,656,000. Proceeds from the offering were primarily used to repay debt. On May 7, 2002, the Company's stockholders approved an amendment to increase the Company’s authorized common stock from 20,000,000 shares to 30,000,000 shares. The Company has a stockholder rights plan, under which each stockholder owns one right for each outstanding share of common stock owned. Each right entitles the holder to purchase one one-thousandth of a share of a new series of preferred stock at an exercise price of $63.00. The rights trade along with, and not separately from, the shares of common stock unless they become exercisable. If any person or group acquires or makes a tender offer for 15% or more of the common stock of the Company (except in transactions approved by the Company’s Board of Directors in advance) the rights become exercisable, and they will separate, become tradable, and entitle stockholders, other than such person or group, to acquire, at the exercise price, preferred stock with a market value equal to twice the exercise price. If the Company is acquired in a merger or other business combination with such person or group, or if 50% of its earning power or assets are sold to such person or group, each right will entitle its holder, other than such person or group, to acquire, at the exercise price, shares of the acquiring company’s common stock with a market value of twice the exercise price. The rights will expire on October 23, 2011, unless redeemed or exchanged earlier by the Company, and will be represented by existing common stock certificates until they become exercisable. Exercisable reliable single measure of the fair value of its employee stock options. Sypris Solutions 52 53 Sypris Solutions As of December 31, 2003, 18,400 shares of the Company’s preferred stock were designated as Series A Preferred The following is a reconciliation of income tax expense to that computed by applying the federal statutory rate of 34% Stock in connection with the adoption of the stockholder rights plan. There are no shares of Series A Preferred Stock currently to income before income taxes: outstanding. The holders of Series A Preferred Stock will have voting rights, be entitled to receive dividends based on a defined formula and have certain rights in the event of the Company’s dissolution. The shares of Series A Preferred Stock (In thousands) shall not be redeemable. However, the Company may purchase shares of Series A Preferred Stock in the open market or pursuant to an offer to a holder or holders. Cumulative losses recorded in other comprehensive income (loss) for adjustments in the minimum pension liability, net of tax, totaled $2,346,000, $2,350,000 and $1,477,000 at December 31, 2003, 2002 and 2001, respectively. Cumulative losses recorded in other comprehensive income (loss) for the aggregate fair market value of all swap agreements, net of tax, totaled $349,000 and $419,000 at December 31, 2002 and 2001, respectively. NOTE 13. INCOME TAXES The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes." Accordingly, deferred income taxes have been provided for temporary differences between the recognition of revenue and expenses for financial and income tax reporting purposes and between the tax basis of assets and liabilities and their reported amounts in the financial statements. The components of income tax expense (benefit) are as follows: (In thousands) Current: Federal State Deferred: Federal State Years ended December 31, 2003 2002 2001 $ (847) (279) $ (1,126) 4,938 1,071 6,009 1,184 66 1,250 3,427 257 3,684 $ 2,161 270 2,431 706 (227) 479 Federal tax at the statutory rate State income taxes, net of federal tax benefit Change in valuation allowance for deferred tax asset Research and development tax credit Other Deferred income tax assets and liabilities are as follows: (In thousands) Deferred tax assets: Compensation and benefit accruals Inventory valuation State net operating loss carryforwards Contract provisions Accounts receivable allowance Interest rate swap agreements Other Deferred tax liabilities: Depreciation Contract provisions Defined benefit pension plan Other $ 4,883 $ 4,934 $ 2,910 Net deferred tax liability Years ended December 31, 2003 2002 2001 $ 4,426 522 — (146) 81 $ 5,567 646 (677) (330) (272) $ 3,154 238 (300) (338) 156 $ 4,883 $ 4,934 $ 2,910 December 31, 2003 2002 $ 747 1,201 560 — 226 — — 2,734 (8,652) (240) (231) (200) (9,323) $ 1,190 1,042 689 572 199 210 103 4,005 (4,115) — (258) — (4,373) $ (6,589) $ (368) The Company files a consolidated federal income tax return which includes all subsidiaries. Income taxes paid during 2003, 2002 and 2001 totaled approximately $2,250,000, $3,656,000 and $1,962,000, respectively. The Company received The valuation allowance for deferred tax assets decreased by $677,000 and $300,000 in 2002 and 2001, respectively. Management believes it is more likely than not that the Company’s future earnings will be sufficient to ensure the realization approximately $1,760,000, $208,000 and $2,108,000 in federal income tax refunds during 2003, 2002 and 2001, respectively. of deferred tax assets for federal and state purposes. At December 31, 2003, the Company had approximately $9,862,000 of state net operating loss carryforwards available to offset future state taxable income. Such carryforwards reflect income tax losses incurred which will expire on December 31 of the following years: (In thousands) 2009 2010 2011 2017 $ 2,839 560 5,999 464 $ 9,862 NOTE 14. EARNINGS PER COMMON SHARE Basic earnings per common share is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the year. Diluted earnings per common share is calculated by using the weighted average number of common shares outstanding adjusted to include the potentially dilutive effect of outstanding stock options. The following table presents information necessary to calculate earnings per common share: (In thousands, except per share data) 2003 2002 2001 Years ended December 31, Shares outstanding: Weighted average shares outstanding Effect of dilutive employee stock options Adjusted weighted average shares outstanding and assumed conversions Net income applicable to common stock Earnings per common share: Basic Diluted 14,237 416 13,117 547 14,653 13,664 8,135 $ 11,439 0.57 0.56 $ $ 0.87 0.84 $ $ $ 9,828 200 10,028 6,367 0.65 0.63 $ $ $ Sypris Solutions 54 55 Sypris Solutions NOTE 15. SEGMENT INFORMATION NOTE 16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The Company’s operations are conducted in two reportable business segments: the Electronics Group and the The following is an analysis of certain items in the consolidated income statements by quarter for the years ended Industrial Group. The segments are each managed separately because of the distinctions between the products, services, December 31, 2003 and 2002: (In thousands, except per share data) First Second Third Fourth First Second Third Fourth 2003 2002 Net revenue Gross profit Operating income Net income Earnings per common share: Basic Diluted Cash dividends declared per common share $ 58,915 $ 70,621 $ 68,898 $ 78,171 $ 62,533 $ 73,509 $ 70,757 $ 66,678 11,536 4,806 3,275 13,041 4,918 2,679 13,974 5,658 3,534 13,451 5,717 3,391 12,882 4,759 2,805 11,129 3,733 1,825 9,951 2,759 1,379 9,569 1,547 686 $ $ $ 0.10 $ 0.10 $ 0.19 $ 0.19 $ 0.05 $ 0.05 $ 0.24 $ 0.23 $ 0.18 $ 0.17 $ 0.20 $ 0.19 $ 0.25 $ 0.24 $ 0.23 0.23 0.03 $ 0.03 $ 0.03 $ 0.03 $ — $ — $ 0.03 $ 0.03 markets, customers, technologies, and workforce skills of the segments. The Electronics Group provides a wide range of manufacturing and technical services for a diversified customer base as an outsourced service provider. The Electronics Group also manufactures complex data storage systems, magnetic instruments, current sensors, and other electronic products. The Industrial Group provides manufacturing services for a variety of customers that outsource forged and finished steel components and subassemblies. The Industrial Group also manufactures high-pressure closures and other fabricated products. Revenue derived from outsourced services for the Electronics Group accounted for 52%, 55% and 67% of total net revenue in 2003, 2002 and 2001, respectively. Revenue derived from outsourced services for the Industrial Group accounted for 31%, 29% and 15% of total net revenue in 2003, 2002 and 2001, respectively. There was no intersegment net revenue recognized for all years presented. The following table presents financial information for the reportable segments of the Company: (In thousands) Net revenue from unaffiliated customers: Electronics Group Industrial Group Gross profit: Electronics Group Industrial Group Operating income: Electronics Group Industrial Group General, corporate and other Total assets: Electronics Group Industrial Group General, corporate and other Depreciation and amortization: Electronics Group Industrial Group General, corporate and other Capital expenditures: Electronics Group Industrial Group General, corporate and other Years ended December 31, 2003 2002 2001 $ 180,733 95,872 $ 186,562 86,915 $ 207,282 47,358 $ 276,605 $ 273,477 $ 254,640 $ 36,266 9,746 $ 37,796 11,725 $ 37,385 6,162 $ 46,012 $ 49,521 $ 43,547 $ 12,062 6,895 (4,016) $ 14,447 8,210 (3,701) $ 12,903 3,563 (3,436) $ 14,941 $ 18,956 $ 13,030 $ 121,560 121,429 20,506 $ 114,305 90,781 18,519 $ 121,228 73,820 16,396 $ 263,495 $ 223,605 $ 211,444 $ 7,134 5,425 272 $ 6,885 4,224 277 $ 12,831 $ 11,386 $ 10,621 11,790 110 $ 7,518 12,009 220 $ $ $ 7,951 1,694 211 9,856 7,917 19,547 159 $ 22,521 $ 19,747 $ 27,623 The Company’s export sales from the U.S. totaled $22,250,000, $25,437,000 and $23,890,000 in 2003, 2002 and 2001, respectively. Sypris Solutions 56 57 Sypris Solutions Common Stock Information Corporate Directory Our common stock is traded on the Nasdaq National Market under the symbol "SYPR." The following table sets forth, Board of Directors Corporate Officers Subsidiary Officers for the periods indicated, the high and low closing sale prices per share of our common stock as reported by the Nasdaq National Market. Year ended December 31, 2002: First Quarter Second Quarter Third Quarter Fourth Quarter Year ended December 31, 2003: First Quarter Second Quarter Third Quarter Fourth Quarter High Low $ $ 16.35 21.35 16.03 12.28 11.25 10.75 16.61 17.55 $ $ 12.50 15.30 10.00 9.94 6.88 7.50 10.25 12.78 As of March 3, 2004, there were 1,121 holders of record of our common stock. On September 22, 2002, our Board of Directors declared an initial quarterly cash dividend of $0.03 per common share outstanding. Cash dividends of $0.03 per common share have been paid quarterly since the initial dividend was declared in 2002. Dividends may be paid on common stock only when, as and if declared by our Board of Directors in its sole discretion. ROBERT E. GILL (1†) Chairman of the Board ROBERT E. GILL (5) Chairman of the Board JEFFREY T. GILL (1) President & CEO JEFFREY T. GILL (5) President & CEO DAVID D. JOHNSON (5) Vice President, CFO & Treasurer RICHARD L. DAVIS (5) Senior Vice President ANTHONY C. ALLEN (5) Vice President of Finance & Information Systems & Assistant Secretary JOHN R. McGEENEY (5) General Counsel & Secretary HENRY F. FRIGON (1,2†, 4) Private Investor & Consultant R. SCOTT GILL (1) Managing Broker Coldwell Banker Residential Brokerage WILLIAM L. HEALEY (4†) President & CEO Cal Quality Electronics, Inc. ROGER W. JOHNSON (3†, 4) Private Investor, Educator & Consultant SIDNEY R. PETERSEN (2, 3) Retired Chairman & CEO Getty Oil, Inc. ROBERT SROKA (2, 3) Managing Director Corporate Solutions Group (1) Member of Executive Committee (2) Member of Compensation Committee (3) Member of Audit and Finance Committee (4) Member of Nominating and Governance Committee (5) Executive Officer † Committee Chairman CYNTHIA Y. BELAK Vice President of Finance Sypris Data Systems, Inc. LAWRENCE J. BERNICKY Vice President of Finance Sypris Test & Measurement, Inc. KATHY SMITH BOYD (5) Vice President; President & CEO Sypris Test & Measurement, Inc. JAMES G. COCKE (5) Vice President; President & CEO Sypris Electronics, LLC JOHN M. KRAMER (5) Vice President; President & CEO Sypris Technologies, Inc. ROBERT G. MARRAH Vice President of Business Development Sypris Electronics, LLC DAVID L. MONACO Vice President of Finance Sypris Electronics, LLC G. DARRELL ROBERTSON (5) Vice President; President & CEO Sypris Data Systems, Inc. EDMUND R. STUCZYNSKI Vice President of Operations Sypris Electronics, LLC NORMAN E. ZELESKY Vice President of Finance Sypris Technologies, Inc. Sypris Solutions 58 59 Sypris Solutions Company Locations Investor Information Sypris Test & Measurement 3148 Presidential Drive Fairborn, OH 45234 Phone: (937) 427-3444 SOUTH CAROLINA Sypris Test & Measurement c/o Square D 8821 Garners Ferry Road Hopkins, SC 29061 Phone: (803) 695-7874 Sypris Test & Measurement c/o Bose Facility 2000 Carolina Pines Drive Blythewood, SC 29016 Phone: (803) 714-8397 TENNESSEE Sypris Test & Measurement 305 Seaboard Lane Suite 318 Franklin, TN 37067 Phone: (615) 771-2421 TEXAS Sypris Test & Measurement 258 East Arapaho Suite 150 Richardson, TX 75081 Phone: (972) 231-4443 Sypris Data Systems 8500 Dyer Street Suite 65 El Paso, TX 79904 Phone: (915) 757-2547 ALABAMA Sypris Data Systems 3322 S. Memorial Parkway Suite 505 Huntsville, AL 35801 Phone: (256) 881-2231 ARIZONA Sypris Test & Measurement 2320 West Peoria Avenue Building D-133 Phoenix, AZ 85029 Phone: (602) 395-5900 CALIFORNIA Sypris Test & Measurement 2102 Ringwood Avenue San Jose, CA 95131 Phone: (408) 954-8050 Sypris Test & Measurement 16340 Roscoe Boulevard Suite 100 Van Nuys, CA 91406 Phone: (818) 830-9111 Sypris Data Systems Subsidiary Headquarters 160 E. Via Verde San Dimas, CA 91773 Phone: (909) 962-9400 COLORADO Sypris Data Systems 7307 S. Revere Parkway Centennial, CO 80112 Phone: (303) 773-4700 Sypris Test & Measurement 8020 Southpark Circle Suite 300 Littleton, CO 80120 Phone: (303) 773-4616 FLORIDA Sypris Test & Measurement Subsidiary Headquarters 6120 Hanging Moss Road Orlando, FL 32807 Phone: (407) 678-6900 Sypris Electronics Subsidiary Headquarters 10901 North McKinley Drive Tampa, FL 33612 Phone: (813) 972-6000 Sypris Electronics 9020 Junction Drive Suite 3 Annapolis Junction, MD 20701 Phone: (877) 797-7478 MASSACHUSETTS Sypris Test & Measurement 53 Second Avenue Burlington, MA 01803 Phone: (781) 272-9050 Sypris Test & Measurement 257 Simarano Drive Marlborough, MA 01752 Phone: (508) 786-9633 MICHIGAN Sypris Test & Measurement 24301 Catherine Industrial Road Suite 116 Novi, MI 48375 Phone: (248) 305-5200 NEW JERSEY Sypris Test & Measurement 650 Liberty Avenue Union, NJ 07083 Phone: (908) 688-9779 Sypris Test & Measurement 1133 Route 23 South Wayne, NJ 07470 Phone: (973) 628-1363 NEW YORK Sypris Test & Measurement c/o Delphi Harrison 200 Upper Mountain Road Building 6 Lockport, NY 14094 Phone: (716) 438-4584 NORTH CAROLINA Sypris Technologies 105 Wamsutta Mill Road Morganton, NC 28655 Phone: (828) 433-4600 OHIO Sypris Technologies 1550 Marion Agosta Road Marion, OH 43302 Phone: (740) 383-2111 Sypris Test & Measurement 925 Keynote Circle Brooklyn Heights, OH 44131 Phone: (216) 741-7040 Sypris Data Systems 2460 N. Courtney Parkway Suite 107 Merritt Island, FL 32953 Phone: (321) 449-9243 Sypris Data Systems 8 Eighth Street Shalimar, FL 32579 Phone: (850) 651-5158 GEORGIA Sypris Test & Measurement 1000 Cobb Place Boulevard Building 200, Suite 240 Kennesaw, GA 30144 Phone: (770) 795-8092 ILLINOIS Sypris Test & Measurement 2055 Army Trail Road Suite 108 Addison, IL 60101 Phone: (630) 620-5800 KENTUCKY Sypris Solutions Corporate Headquarters 101 Bullitt Lane Suite 450 Louisville, KY 40222 Phone: (502) 329-2000 Sypris Technologies Subsidiary Headquarters 2820 West Broadway Louisville, KY 40211 Phone: (502) 774-6011 Sypris Technologies Tube Turns Division 2612 Howard Street Louisville, KY 40211 Phone: (502) 774-6011 MARYLAND Sypris Test & Measurement 9020 Junction Drive Suite 3 Annapolis Junction, MD 20701 Phone: (301) 483-9753 Sypris Data Systems 9020 Junction Drive Suite 3 Annapolis Junction, MD 20701 Phone: (301) 470-0110 Sypris Solutions 60 CORPORATE ADDRESS SYPRIS ON NASDAQ Sypris Solutions, Inc. 101 Bullitt Lane Suite 450 Louisville, KY 40222 Phone: (502) 329-2000 Fax: (502) 329-2050 ANNUAL MEETING The Annual Meeting of Stockholders will be held on Tuesday, April 27, 2004, at 10:00 a.m. at 101 Bullitt Lane, Lower Level Seminar Room, Louisville, Kentucky. The common stock of Sypris trades on the Nasdaq National Market under the symbol SYPR. TRANSFER AGENT LaSalle Bank N.A. 135 South LaSalle Street Suite 1811 Chicago, IL 60603 Phone: (800) 246-5761 Fax: (312) 904-2236 FOR MORE INFORMATION To learn more about Sypris Solutions, Inc., INDEPENDENT AUDITORS Ernst & Young LLP 400 West Market Street visit our site on the World Wide Web at Suite 2100 www.sypris.com. Louisville, KY 40202 Phone: (502) 585-1400 Fax: (502) 584-4221 INVESTOR MATERIALS The Sypris Web page – www.sypris.com – is your entry point for a vast array of information about CORPORATE COUNSEL Sypris, including its products, financial information, real-time stock quotes, links to each of its subsidiary operations, corporate governance information and other useful information. For investor information, including additional annual reports, 10-Ks, 10-Qs or any other financial literature, please contact Carroll A. Dunavent, Director of Legal and Corporate Services, 101 Bullitt Lane, Suite 450, Louisville, KY 40222. Wyatt, Tarrant & Combs, LLP 500 West Jefferson Street Suite 2800 Louisville, KY 40202 Phone: (502) 589-5235 Fax: (502) 589-0309 FORWARD-LOOKING STATEMENTS This report includes non-historical or “forward-looking” statements concerning future events or conditions. Important risk factors, which could cause actual results to differ materially from these statements, are set forth on page 37 of this annual report. FACES IN THIS REPORT (from left to right) People Anthony Jones - Software Engineer, Brenda Pages - Senior Software Engineer Technology Mark Edington - Maintenance Manager, Tim Gray - Integration Supervisor, Matt Rothhaar - Engineer, Eva Worstell - Process Manager, Gary Crabtree - Metallurgist, Mark Griffiths - Engineer Capabilities Robert McCracken - CNC Machinist Processes Paul Savoie - Manager Material Control, Carlos Ramirez - Warehouse Employee, Brenda Jackson - Warehouse Group Leader, Ann Beegle - Warehouse Employee, Jackie Clark - Warehouse Employee, Karie Willis - Warehouse Employee, Ronda Kappes - Warehouse Employee. Products Gary Poole - Principal Engineer Services Joe Campione - Atlanta Branch Manager, Karen Parker - Administrative Assistant 

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