Helios Technologies Inc (HLIO) 2003 Q3 法說會逐字稿

Good day and welcome everyone to the Sun Hydraulics' third-quarter 2003 financial results conference call. Today's call is being recorded. At this time I would like to turn the call over to the IR spokesperson, Mr. Rich Arter.

Good afternoon and as Lisa said, my name is Rich Arter, Sun's Investor Relations spokesperson and with me are Allen Carlson, Sun's President and CEO; and Dick Dobbyn, Sun's Chief Financial Officer.

Allen will begin today's call with a brief overview after which Dick will review the third-quarter results before we take questions from the analysts. Before we begin, however please be aware that any statements in today's conference call that are not historical facts are considered forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. For more information on forward-looking statements please read the section titled forward-looking information in yesterday's press release. Now I would like to introduce Sun's CEO and President, Allen Carlson.

Sales for the third-quarter were 18 million an 11 percent increase compared to the same quarter last year. U.S. sales increased 6 percent and there were many signals indicating the U.S. manufacturing economy is finely recovering, and the increase in domestic sales is consistent with those signals.

International sales in the quarter increased 17 percent compared to last year's third-quarter; however, when adjusted for the effect of exchange rates, the increase was 5 percent, with increases in Germany of 13 percent, and Korea 10 percent, with a three percent decrease in the UK.

As we have stated throughout the year our investments focus has shifted from manufacturing side to marketing. In addition to new operations in the Midwest and France and our new electrohydraulic products, we have continued to invest in our Website. Our most recent efforts are aimed at electronically providing customers visual and technical information on the millions of possible combinations of our cartridge manifold assemblies.

This web feature will be available early next year and will greatly enhance our distributors and customer's ability to configure their product requirements. The key to future earnings lies in increasing sales. The investments of the past year have helped to stimulate demand with a high level of customer satisfaction in a very difficult economy.

As the economy continues to improve we expect shareholders will be pleased with our financial results. Dick will now review the third-quarter financials.

I would first like to comment on the changes to the income statement for the third-quarter compared to the same quarter last year.

Net income was 500,000 and the same as last year and basic and diluted earnings per share were 8 cents, also unchanged.

Gross profit increased 15 percent primarily due to the 11 percent increase in sales. Gross profit as a percentage of net sales was unchanged at 25 percent. In addition to higher sales volume, gross profit was favorably affected by the strength of local currencies against the U.S. dollar. This created lower material costs in the German and Korean operations. Gross profit in the United Kingdom was adversely affected by increased material cost and lower productivity as the outsourced mold product from the U.S. operation.

The long-term investment for growth we're making in the marketing area are evidenced by the 19 percent increase in selling, engineering and administrative expenses. We also experienced an increase in professional fees. Some of these costs are incremental and we anticipate lower spending levels in these areas starting with the first quarter of next year. That said, we do expect to continue investing in marketing and related areas.

Turning to cash flow and the balance sheet. During the quarter the Company declared and paid a special dividend of 2 dollars per share that totaled 13.3 million. The Company refinanced existing debt and increased the total debt 10.9 million to 20 million.

Refinancing expenses of 250,000 incurred during the quarter were capitalized and will be amortized over the new loan period of five years.

The Company also declared its regularly quarterly dividend of four cents per share to shareholders of record on September 30, which was paid on October 15.

The outlook for the fourth-quarter. Sales for the fourth-quarter are projected to be 17 million with net income of 8 cents per share. Last year sales for the fourth-quarter were 15.5 million and net income per share was six cents. Thank you.

Before we take questions from the analysts, we would like to first respond to some of the questions we received via e-mail after the press release yesterday. The first five questions are from Brent Miley (ph) with Rutabaga Capital.

Question number one, would you please review the status of the electrohydraulic valve line? How is acceptance versus planned? What is the niche you are targeting and what is its potential? I think Allen Carlson will answer that question.

Brent, there are two potential problems with new products. The first is that nobody wants them and the other is that everybody wants them. The new range of electrohydraulic valves is enabling Sun to sell packages. This allows us to compete in markets we had previously been excluded from. This is particularly important to many of our distributors particularly outside the U.S. who have not had access to this range of product.

As with our other cartridge products the target market is with customers that appreciate the performance and reliability of the Sun range of products. I would also add that these range of products are designed to incorporate into the Sun cavity. We do not establish sales targets but broadly promote capabilities and use other complementary Sun products to sell electrohydraulic valves into system packages. To date we are very pleased with our progress.

Thank you Allen. Question number two, would you please quantify the investment cited in the press release that drove costs? Will they continue into 2004 or are they largely complete? Dick?

I would like to address that question by first answering the question as to what drove our 19 percent increase in selling and engineering and administrative expenses in the third quarter compared to the same quarter last year. That was about a 600,000 increase. It was made up of 350,000 of marketing type expenses, about 150 of which will be reoccurring, and 200,000 of which is incremental.

Also in the quarter we had increased professional fees of 100,000 and currency translations affected that increase by 120,000. Looking forward next year we will see a lot less of these type of investments in the first quarter as we start to wrap up our website development project.

Brent’s third question is about accounts receivable. Accounts receivable appear to be quite a bit more than sales year-over-year. Is there any particular reason why? And I think Dick will answer that one again.

The answer is no, there isn't any particular reason. The day sales outstanding for the Corporation in total at the end of the third-quarter were 40, and that compares with 36 days for the third-quarter in 2002. The U.S. and the UK are up in terms of the DSO, however, in reviewing all of the agings of accounts receivable we do not have any significant overdue accounts and our bad debt expense is normal.

Brent's fourth question is, are capital budgets done for 2004? If so, what is the estimate for CAPEX and where will it be spent? I think Allen would like to answer that question.

Sun has never had a formal annual budget process. We have a rather unique budget and forecasting process that we use. In fact, our approach has been written about in Harvard business school case studies and more recently there is a book titled Beyond Budgeting that describes much of our style and beliefs. Rather than annual budgets we use ongoing reviews by competent peers to determine needed investment that support our business strategies. This year we will have spent approximately 4 million in CAPEX. Next year should be similar.

Brent's last question. Question number five, would you please talk about the dollar's weakness and how that is helping or hurting you. I think both Allen and Dick would like to respond to that question.

I have just returned from Europe where I visited with many Sun customers. All either use Sun today or did at one time. They recognize our product integrity and breadth of products. It is clear from my visit that a normal dollar in exchange for the euro will create new opportunities for us. I would like to reiterate we don't believe that the dollar is weak but rather is more normal. If any of you have doubts about that, plot the dollar exchange to European currencies over the past fifteen years. Dick would you like to comment on the financials?

Yes, specifically in the quarter, we had approximately 200,000 favorable effect, primarily in German and Korea as a result of the currency changes from the third-quarter this year to the third-quarter last year.

The next set of question is from Brad Auslinger (ph) with Deprince, Race and Zollo. And Brad sent in four questions. The first one is a two-part question. SG&A engineering expenses increased roughly 20 percent of 583,000 year-over-year. And I believe Dick already spoke to that. The second part, do you expect the same type of investments in the fourth-quarter?

The answer is yes we do expect about the same level in the fourth-quarter.

The next question, when do you anticipate that these investments will contribute to the P&L statement? Allen?

We will see the impact in 2004.

Thank you. Question number three; in order to try and get a sense of earnings leverage to improving volumes, it would also be helpful to get an idea for current capacity utilization and ballpark contribution margin given incremental revenue. Allen, would you like to start on that one?

Sun doesn't measure on a micro basis our capacity utilization. However, we know what with the primary assets we have in place, we could double our sales revenue in the next three to five years.

Dick, would you like to comment on the contribution margin?

I think a good number to use is 40 to 50 percent on incremental revenue and that depends on what products the revenue is made up of and where the revenue is coming from.

Brad's last question, what is the outlook on international sales going forward? I think Allen will respond to that.

Over the past year, Sun has done well growing our international sales in particularly difficult markets. Today over 50 percent of our sales are outside the US. This trend will continue and could accelerate if the dollar remains normal.

Thanks Al. Now we would like to turn the call back over to Lisa and we will invite questions from the analysts that have dialed in.

(OPERATOR INSTRUCTIONS) Pete Lithneck (ph) with Robert W. Baird.

I was wondering if you could give us some color on where or at least some color on economic commentary that you kind of hinted at in the press release and in your opening remarks. Maybe seeing some sort of turn in the U.S. economy. What are you seeing out there, what are you looking for? Just some more background on what is going on out there?

I think what we are talking about is the institute of supply management index in particular this week which is up for the fourth month in a row and is hitting in the high -- 57 percent --.

Is that translating into more order inquiries from your distributors? Are they more willing to stock inventories now? What are you hearing from your customers? That leads you to believe that we might be seeing a little bit of a turn here.

We are getting more activity in terms of quotes, phone calls on product questions. The business climate just appears to be much more inducive to new business going forward. There is a spirit of optimism that perhaps will feed on itself.

So I gather that a higher percentage or however you want to measure of these inquiries are turning into orders now?

Sure. We don't again measure it on a micro basis. You get a very broad snapshot of what is going on in the marketplace. Additionally Rich Arter just came back from AEN (ph) meeting and the whole mood of that meeting was very upbeat. We had also attended the IQ (ph) meeting. These are in conferences that our customers participate in and the mood there as well was upbeat. Overall there is just a lot of indicators. None individually that I hang my hat on but when you look at them together, the business climate is certainly getting more conducive to growth.

I think I ask this question every quarter but I'm going to ask it again. Is there a particular sector, I know it is hard for you guys to pin a particular -- where your product is going in particular -- but is there a particular sector, perhaps construction, heavy-duty truck or anything that you can identify that has really picked up or is relatively stronger when compared to some other markets or are we just generally make the classification that we are seeing a broad upturn in all of your end markets?

I know I answer this question every quarter. The answer is we sell to a very, very broad market through both industrial and mobile distribution. It is good news and bad news, but the bad news is oftentimes we don't get the visibility that we would like to have. But the good news is that we touch almost every market, every industrial market around the world.

Okay. Fair enough. Thanks for your answers.

(OPERATOR INSTRUCTIONS) Michael Braig with A.G. Edwards.

Maybe I can tackle that next question a different way.

However way – (multiple speakers)

Indications that there is mobile equipment demand coming primarily from the two ends of the spectrum, first of all the lighter small contractor equipment that typically goes into rental fleets. I'm wondering if you may have seen something there from J. L. G. (ph)? And at the other end there are some indications that the heavy mining equipment is also becoming stronger and I think there was a time when you were doing some development work in Germany for some very large compression collars as opposed to screw in valves suitable for very large application. Have you seen anything in your larger series valves?

Not really, Mike. I do believe that the rental market is a market that is going to pick up soon if it already hasn't. And when it does pick up I think it will pick up rapidly. Primarily because the aging of the fleets that are out there, the last two or three years the fleets have not been replaced or kept current. There is a lot of equipment that needs replacing and the rental guys will turn it on as soon as they believe that there is a business climate pick up. It could very well feed on itself and it could be very rapid when it does happen.

I would also comment that I did visit one of our customers about a month ago that manufactures utility vehicles for the Electric Power and Light and they commented that their business picked up almost immediately after the power problems in the U.S. There is a lot of things that are driving business conditions. I don't think I could put my hat on any one of them but just all of them together means that there is more business.

I think if I can add something, Al, not to specific product areas because we haven't analyzed it, but our October orders show again an increase in North American business. So what we are seeing in the third quarter is contending the fact that the increase is even larger percentage wise than we experienced in the third quarter.

Can you comment that all as to whether that increase is skewed toward the smaller or the larger frame sizes?

I can't, I can't.

All right, thank you.

Pete Lithneck with Robert W. Baird.

I am back again and I won't ask any question about end markets. I want to know, you just alluded to what you’re seeing in October in terms of orders and you said North America was up. Can you give us a sense as to A, how much it was up? And then B, what are you seeing internationally in October?

Let me say this. Although the domestic in North American orders were up month to month in October 2002 to this October, they were up about as I recall over 10 percent. However, the total orders are not pretty much on the line of the run rate that we saw in the third quarter, weekly order run rate.

And can you give us a sense as to where or what the third quarter weekly run rate was?

I already went way out on a limb, Pete, and told you the sales. 17 million and you are saying how can that be? It should be more. It isn't because typically at the end of December, people stop ordering and we stop shipping.

Okay.

It is almost like a 12-week quarter versus a 13-week quarter.

Okay. I just wanted to ask a quick follow-up on kind of this spending more on marketing that you’re doing right now. What you are saying is that you're basically going to be done with this incremental spending by the end of this year and be all set for next year. I am wondering if your comments in the press release basically say that you're still kind foggy on what '04 might look like. If '04 turns out to be a good year, are their things out there that you would like to do that you’re kind of limiting yourself from doing because of where the economy is and what visibility is like? I'm just wondering if there is something like maybe next are you may decide to do that could be incremental and what something like that might be given a stronger than what we think might happen the next year outlook actually occurs?

As I said our CAPEX spending is done on a rolling basis and an ongoing basis. A lot of our spending is the same way. We look at opportunities that are presented to us and make a decision as to what investments we need to fund those activities. Almost a week doesn't go by that we don't take a look at opportunities or improvements or cost reductions or how to make a new product or how not to make a new product or a better product. This is an ongoing thing, it happens all of the time.

Additionally Sun has improved its productivity and its manufacturing. Nearly all of our orders today come in with a 21-day window in front of us. That means we really don't know what is going to happen on December 5. Or January 5 or February 5. We are very dynamic, we can move, we are very agile, we can move very quickly. That is allowing us to grow our business, we are becoming recognized as having great operational efficiencies in being able to service our customers. That is the good news. The bad news we don't a lot of visibility. That is going to continue and we will make decisions on investment or expenses or marketing plans based as they come forward, not based on a budget or a forecast.

Okay. That is all I had. Thanks.

Michael Braig with A.G. Edwards.

Maybe I could try some Clintonian parsing on Dick's analysis of the SG&A increase. As I look at the adjectives you have used to describe the pieces of that $600,000 increase, 200,000 is incremental. Is it safe to assume that continues in the fourth quarter but perhaps not thereafter whereas the 150,000 recurring is the continuing costs of maintaining some of those Web services?

That is right, Mike. Right up until the end, the recurring piece of the 150 is marketing personnel related, that we have used throughout the world to beef up our efforts. But you are right in what you assumed.

Okay, thank you.

Pete Lithneck with Robert W. Baird.

I promise this is my last question. In terms of the UK, you mentioned profitability I guess or sales being impacted by outsourcing product from the U.S. Can you just explain how that flows through the operating income line? You posted a loss in that segment, despite sales being up 6 percent, so I am just wondering how is that accounted for? How is that working?

It is not working very well obviously. But sales are really not up, sales are really down, three percent if you take the currency effect.

In the UK?

In the UK, yes. But what has happened there is that our costs base both manufacturing including direct labor and all of our SG&A costs have not gone away; however, they are manufacturing less than they did before and buying the product from the U.S. So what we have somewhat of a hangover from the unsuccessful software implementation in the second-quarter. We are working on moving the product back to them to manufacture and they are also working on more productivity increases.

Okay. So there is a temporary drag here but it sounds like there might be an opportunity to I don't know what the appropriate word is, but maybe trim some -- maybe not capacity but maybe trim a little bit of the direct labor or do some things that would get costs more in line and maybe -- should we look for that particular part of the business to return to profitability kind of after you've got the software thing behind you? Or do you see it being unprofitable for the next 1, 2 or 3 quarters? Any idea?

We think they are going to improve, the question is how rapidly are they going to improve. We do also have some people resources there that we don't want to just throw out the door. We are taking a hard look at that in fact, I am leaving to go over there Sunday night and spend a couple of weeks and we will know better. But they are improving as we speak.

Okay, have a good trip to England.

Thank you. Cheers.

At this time, we have no more questions in our queue. Mr. Dobbyn, I would like to turn the call back over to you for concluding remarks.

Thank you very much and I would like to turn it back to Rich.

I would like to thank you too, and I would like to turn it over to Al.

Thank you all for your participation.

This concludes today's conference call. We thank you for your participation. You may disconnect at this time.