Helios Technologies Inc (HLIO) 2004 Q2 法說會逐字稿

Good day, everyone, and welcome to the Sun Hydraulics second-quarter 2004 financial results conference call. Today's call is being recorded. At this time I would like to turn the call over to the investor relations spokesperson, Mr. Rich Arter, please go ahead, sir.

Good afternoon and thank you for joining us for our second-quarter conference call. With me are Allen Carlson, Sun's CEO and President and Dick Dobbyn, Sun's CFO. Once we have finished our prepared statements we will open the lines for questions and answers. Before we begin, please be aware that any statements in today's presentation that are not historical facts are considered forward-looking statements within the meaning of section 21-E of the securities exchange act of 1934. For more information on forward-looking statements please see today's press release. I would now like to introduce Allen Carlson.

Good afternoon. As I stated in the press release we are extremely pleased that we have been able to respond to the demand surge and maintain a high level of on-time shipments to our customers' requirements. When the economic cycle rebounds Sun sees demand very quickly due to our place in the supply chain. That is why it is so important for Sun to maintain our ratings even when times are tough as they have been for the past few years.

We continue to see new business opportunities, some of which are trivial to the business cycle, but others are the result of our product and marketing initiatives. Our electrohydraulic products continue to expand our solutions capability, and allow us to compete for business that we weren't able to compete for before. These products also help us "win more of the value added and integrated package business." Our website is generating inquiries and interest from all over the world and exposing existing and potential customers to the full array of Sun's products and capabilities. This medium is ideal for us as it allows us to broadcast our product information to markets all over the world.

We are very pleased with the second-quarter results, from both a top-line and bottom-line perspective. And delighted that Sun's Board of Directors increased Sun's quarterly dividend from 4 cents to 5 cents per share. Last week I met with our employees to present our new employee stock ownership plan, this is very exciting for everyone at Sun. As I stated in the press release I truly believe this program will strengthen the link between the Company's performance, its shareholders and our employees. This represents a win-win all the way around and will align the Company for even better future performance.

At this point I am going to turn the call over to Dick to review the financial results and then we will be back with you for Q and A.

Thank you, Al. Net income for the quarter was 2.6 million of 10 percent of sales compared to 800,000 or 4 percent of sales in the same quarter last year. Excluding the cost of funding the employee stock ownership plan, net income would have been 3 million or 11 percent of sales. Net sales of 26.5 million, an increase of 7.6 million or 40 percent. United States operation increased 52 percent consisting of a 55 percent increase in sales to Asia; Canada increased 33 percent and sales within the United States increased 57 percent. Net sales in the Korean operation increased 27 percent.

The demand for construction equipment in China is driving a significant portion of the increased sales in Korea as well as Japan and other Asian markets. United Kingdom operation increased 4 percent, to moderate increases in Scandinavia and sales within the UK were relatively unchanged from the same quarter last year. Sales on the German operation increased 47 percent; the increase consisted of a 36 percent increase in Germany, a 59 percent increase in Italy, and a 60 percent increase in Austria.

Gross profits for the Company increased 52 percent or 2.9 million compared to the same quarter last year. Gross profit as a percentage of net sales increased to 32 percent from 29 percent last year. The increase in gross profit as a percentage of sales was due to the favorable effects of increased sales volume, exchange rates, and productivity increases. Gross profit was reduced by the cost of the employee stock ownership plan. Excluding the ESOP costs, gross profit would have been 33 percent of sales.

Selling, engineering and administrative expenses decreased 2 percent or 100,000 to 4.2 million compared to the second quarter of last year. The second quarter of last year included a recurring write-off of software in the UK operation. Excluding the non-recurring item last year, selling, engineering and administrative expenses increased 8 percent or $300,000. The increase was primarily due to higher professional fees, outside services, and compensation-related expenses including the employee stock ownership plan.

Cash from operations for the first half of the year was 6.1 million compared to 2.9 million for the same period last year. The increase was primarily due to the increase in net income offset by the natural rise in accounts receivable due to the higher sales volume. Inventory was held at the same level as last year with a 44 percent increase in terms. Days sales in accounts receivable improved 33 days compared to 39 days last year.

Capital expenditures for the first half of this year were $2.5 million, capital expenditures for the year are projected to be approximately 5 million. As Al mentioned in June in June our quarterly dividend increased from 4 to 5 cents per share. Our outlook for the third quarter; the Company's (indiscernible) trend has historically tracked closely to the United States purchasing managers index. At the end of June this index indicated continued economic expansion. Net sales are projected to increase approximately 30 percent over the third quarter last year and be approximately $23 million. Net income per share in those sales should yield between 22 and 25 cents per share.

Thank you, Dick. David, we would now like to open up the call to questions.

(OPERATOR INSTRUCTIONS) Peter Lisnic with Robert W. Baird.

A couple of numerical questions, Dick, I missed your description of the United States sales increase. U.S. was 57, Canada 55, and what was Asia? Do I have those first two numbers right, I guess?

The U.S. operation in total was 52 percent, and that was 55 percent increase for Asia. Canada increased 33 and the U.S. domestic was 57.

The tax rate this quarter was 37 percent. I'm guessing that it increased over last quarter because of a higher proportion of income from the U.S. operations?

Correct.

Then if I look at just in the U.S. the profitability. I know that's where you book the entire ESOP costs, correct?

Correct.

It looks like profitability may have been a little bit weaker than it was in the first quarter from an incremental operating margin perspective even if you take those costs out for the ESOP. Was is there something in mix or productivity initiatives or something non-recurring that maybe kept profitability a little bit lower than at least what we were expecting in the second-quarter in that segment?

I think we are pretty close to what you would expect once you take out the 500,000 for the ESOP. I am not sure I totally -- (multiple speakers)

-- number that I look at in the first quarter was like a 48 percent incremental operating margin. And now if I add back 500,000 to operating income for the quarter I am at 40 percent, so it was marginally weaker. What I was willing really getting at was whether there were any non-recurring productivity costs in there because you did mention them again in the press release. But, fair enough, you answered my question.

Okay.

The big question is, you talked about in the press release shipping on time and being able to gain some share. Can you go into a little bit more detail in terms of where you think you might be getting some share or maybe even taking a step back, what kind of targets you've set for on-time shipments, where you are heading? Just how you are able to outperform or what you are doing better than you did maybe a year ago relative to competitors and relative to the industry?

That's a pretty broad question so I'm going to narrow it down just a little bit and if I don't really hit your sweet spot with the answer come back at me with some more specific questions.

I will try.

We started in the late '90s with taking a look at how we ran our business. And how we measured our business in terms of satisfying the customer. In the late '90s we began entering all orders to customer request and basically eliminated our internal scheduling. And then we began tracking how we were doing and what were the constraints that prohibited us from meeting the customer's requirement. Of course the first week we did that, we identified all kinds of constraints, and they were big ones. And this was right in the upturn in business in the late '90s. So constraints were easy to come by; we could find them on a regular basis. But we kept knocking them down one by one. Both internally and with our supplier base.

We started, when we flipped the switch to scheduling to request, about 16 percent on time to our customers' request in the late '90s. Today we consistently run above 90 percent on time to request. And if I looked at the last two year average it's probably 94, 95 percent. The approach is pretty much the same; we continue to look for constraints, why can't we meet it? And what do we need to do? Not only do we look at shipping on time to request, we also look at when we miss it, how badly do we miss Do we miss it by a day, a week? And keep adding capability to better service the customer.

That is really helping us grow our business in the upturn because many of our competitors are struggling keeping up with demand and we are ready with product. That is sort of a picture of how we ship it from the factory on time to request. But don't forget there is another $8 million of Sun inventory around the U.S. that's readily available to all of our customers and all of our distributors to draw on if they really need it quickly, like if they want it tomorrow morning, FedEx'd from Portland, they can get it. The combination of our distributors capability and our own internal manufacturing capability have allowed Sun to perform to the customers and we are hearing this on a repeated basis from the customers that we talk to -- it is getting us new business.

One of the things I was trying to get at was I assume you are gaining some share because you're better able to service your customers relative to your competitors, that is part of the equation. But the other part is new products and I was just trying to get a sense of -- basically I can look at what the NFPA numbers to get a sense of maybe industry growth and then compare it to what you guys have and a piece of that access, let's call it, would be from your ability to better service. But then there has got to be a piece from new products. I'm just trying to distinguish is the new product piece the biggest driver of what I'll call above industry growth? Or is it more your ability to execute or is it just a combination of both and they are equal?

Maybe just to frame this in for some of the other listeners. The NFPA which is the National Fluid Power Association in North America, U.S. predominately, they track sales through the industry segment. I don't know that I have the most up-to-date information but I believe they are showing numbers for the industry growing at about 20 percent, is that right, Pete?

It depends on whether you look at shipments or orders?

Just shipments.

Shipments I have got up around -- well, also depends on what category but are up closer to 30 percent, hydraulic shipments at least in June. For the quarter around 20s is probably the right number.

Their quarterly, let's say 20, 25 percent and if you took a look at our North American segment, it's up over 50 percent. In fact, that is an indication that we are taking market share. So the reason, what is the reason why? We probably haven't talked about this in a while but our market mix and strategy is thousands of $100 customers out there that use our products all the time. We don't have any super big customer or groups of customers that we can look at and measure how we are doing. It's all kinds of little points of light out there that are very difficult to quantify or justify but when you put them together, as an aggregate you then get to paint a picture of how you're doing relative to the market share.

We are also involved in industrial and mobile markets so the combination of the number of different customers out there is in the thousands. It is very difficult for me to say what market segment is up or down or sideways. I am convinced it's a combination of our ability to perform, meets the customer's requirements both in terms of the quality of the products that we produce as well as the services we provide, getting the product on time. As well as our marketing and engineering initiatives which are geared towards more packages, electrohydraulic packages, is what we have been working on for the last five or six years. That combination is driving our market share.

And then just to kind of continue, I guess if I can, just to ask one more question along the same lines, last quarter we talked about a prototype electrohydraulic product with CAT, and I'm just wondering if you can give us an update on that, how that is going, whether there is more? We basically suggested there may be more product penetration there I guess last quarter. Can you just talk about how that product is going and what you've heard on CAT I guess in terms of performance and whether there is more opportunity than just out of the one excavator line, mid excavator line that you had the product on?

All I am able to tell you at this time is that the testing is continuing on, there are still trials, they are continuing to tweak the software package. I believe the hydraulics in the controls provided by the hydraulics meet their specifications. We're still on board for that project.

That's all I have. Thank you.

Brian Raphine of Morgan Dempsey Capital Management.

Question for you on steel prices. Are you guys getting any pass-through or is the sales revenue growth you are seeing year-over-year primarily unit volume related?

We've passed no price increases on through this steel upturn. We made some minor adjustments in January of this year but there have been no price increases since some minor tweaking in January. We are seeing steel price increases, they are significant. And we are working very hard with our suppliers and internal productivity gains to be able to offer our customers stable prices through the run-up in steel. Maybe that's part of the reason that we're seeing a little bit of margin erosion because we are not passing those prices on at this time.

How painful does it have to get before you look at that or is it a defensive market share protection strategy for you guys?

We look at it monthly with our production people and with our key suppliers. We had thrown a challenge out to our key suppliers to find ways to be more productive to absorb the steel increase, the same challenges to our own manufacturing people. To date we have been very successful at being able to manage those costs down and not have to pass it on in the marketplace. We will continue to monitor it on a monthly basis.

Can you guys talk about, you also talked about accelerating your delivery time cycle. Can you break that out relative to manufacturing cycle times, vis-a-vis robotics or the differentiations of cellular lines and the way you kind of package your throughput on the shop floor?

As you can see from our turn rate that we have made a lot of progress in that area in the last three or four years. And how do we do that? It varies by product line. Our lower volume products where we are producing, one of this and five of that, it's a result of some internal capabilities; we've added some instant (ph) machine equipment that gives us greater turnaround. We've added a second heat treat furnace that allows us to get it to the shop quicker. We have now scheduled screens on the shop floor that is color-coded so that employees can immediately see that there is an expedited order so that they jump on it. It is very much employee driven and that is on our lower volume product. On our higher volume product line it's working with our suppliers because predominately the turned parts on our higher volume products come from outsource suppliers. And it's better communications and better understanding of their role and our needs in that equation.

Okay. I'm guessing on this area, the accelerated depreciation tax credit here that is disappearing at the end of this year. Does that have any bearing on order rates for you guys?

I don't believe so. I don't know of any of our customers that when I go around and talk to them that they are making decisions because of that, there probably are some but I don't believe it's a huge driver. Now on the turned parts supply side where we get our parts from, I do know that a number of our suppliers have taken advantage of that to add some capacity in the last two or three years. I think there's an impact, I'm not sure it's more on the supply-side than it is on the marketing side.

Relative to kind of wage and salary growth in what you guys are saying and health-care benefit inflation? And maybe just a comment on your employee retention rates.

We have been very aggressive with our healthcare providers. We have made some changes to the providers over the last couple of years. I can tell you that in 2003 over 2002 our health care costs remained flat. 2004, we have made some more changes, and when I say changes we are not taking it out of our employees benefits. We are getting more efficient at how we use the service. And working also with local doctors and hospitals to make sure we get the best coverage and good value. I think it is those kinds of initiatives that have allowed us to keep our healthcare costs much lower than what the national average is. And essentially it's flat over the last couple of years but it is a concern, we have to work very hard at going nowhere. But going nowhere is a win.

Sure, very much so and then just on employee retention, what you guys are seeing labor staffing, availability of machinists, that type of thing.

Our turnover rate continues to be very low. Our employees understand the last three or four years we had no layoffs, we kept employees on board that we were investing in them. And in the good times they invest in us. As I said earlier, the ESOP which we rolled out last week, is a very positive benefit for our employees see going forward. They now have a piece of the ownership of this Company as well. All of those things combine to keep our turnover low and our morale of our employees very high.

Keep up the good work, guys. Superb job.

(OPERATOR INSTRUCTIONS) Brett Miley (ph) with Rutabaga Capital Management.

I was wondering if the mix of business actually had any meaningful changes or impacts the industrial versus the mobile in the quarter this year or whether that's been pretty stable versus prior time periods?

Looking at our sales on a quarter-to-quarter, year-to-date last year and so on, we don't see an appreciable change in the mix of our products. Even those we know particularly go to mobile or those that particularly tend to go to industrial. The answer is we haven't seen a big change in mix.

Okay, so it sounds like one part of the economy is really improving faster than the other it sounds like?

We don't see that.

Your European numbers seem very strong, I know you have some type of relationship with Bosch, can you talk about whether that is driving it or are there other things? Can you comment on that relationship if you wouldn't mind?

The alliance that we have with Bosch is an alliance very similar to programs we have with other companies supplying them cartridges. And that program over all while Bosch is a big piece of it, the program overall has been very successful for Sun over the years. In Europe they are certainly a factor in the growth that we are seeing, but there are other factors as well. We are picking up market share and we are adding distribution in places like Italy, like in Austria and some of the Eastern countries we are working very hard with our marketing people to grow that. The growth in Europe is lots of things associated with it and new products as we talked about earlier. Our largest customers for new products are in Europe.

Would you also quantify the impact of foreign exchange please on the top line and the operating line, if you could please?

In the second quarter our sales were affected only about 1 to 1.5 percent. We have favorable translation gains in Korea and Germany and then they are somewhat offset by the fact that the UK also sells a lot in dollars. That is it for the top line.

How about on the operating line? Is there anything there --

On the operating line it's about taking the effect of the UK, year-to-date it's only about 261,000 net, and for the quarter it's like 130. That is (indiscernible) gross profit.

Okay, pretty diminimus, great. The CapEx you guys will spend the rest of the year -- are there particular areas, or are you just debottlenecking at this point, is it maintenance or are there particular projects you are working on?

The capital expenditures for the year are pretty much determined as we go throughout the year. As I said earlier, the way that we run our business is to enter all orders through customer request and then understand what the constraints are. And sometimes the constraint is that we need a piece of machinery; and with orders up 50 percent some of the machinery that we need has been placed on order in the April, May, June timeframe which will be coming in towards the end of the year. We continue to look, every week we look at our constraints, our manufacturing constraints, and find areas that we need to shore up. Sometimes it hits the CapEx line.

Very good. Thank you.

(OPERATOR INSTRUCTIONS) Peter Lisnic with Robert W. Baird.

Back again, just another follow-up question on that capacity addition question. Where are you in terms of actual capacity utilization or how much room do you have before you have to make maybe more significant capital expenditures?

As far as I can see, looking forward, the bricks and mortar are in place for significant growth. We are making, as I said, some CapEx -- but it's primarily in selected areas where we have some bottlenecks that we identified. I don't see us having to put out large sums of money for bricks and mortar.

So it is just 1 machine or 2 machines here or there kind of deal?

Yes.

In terms of the kind of what we've heard out of the general economy, maybe the old soft patch in June, and people thinking about things picking up in July. Can you talk about progress through the quarter and maybe what you have seen in July and kind of how all that factors into your outlook? And what you've heard out of your customers in terms of June kind of being the soft patch even if it was one? And just kind of go through that a little bit?

The way our cycle historically works quarter-to-quarter, is like say you have level A in the first quarter, then you have level A+ in the second quarter, and the third-quarter goes back to level A. And the fourth quarter can be like an A-. That is kind of the way our yearly cycle works. We started to see the oncoming summer cycle, if you will, being more akin to the first quarter than the second, and we are kind of in that mold right now. What we are seeing is what we normally see. I can't really comment on the soft patch thing.

I will add to what Dick just said. During the summer months, the June/July timeframe, our European customers go on vacation. Northern Europe is usually July, southern Europe is usually August. As you know a large percentage of our output ultimately gets shipped to Europe. So some of the soft spot that you are referring to is seen in our operations numbers out of Sarasota, but in reality it is Europe going on vacation.

I guess if I decipher Dick's answer what you are saying is basically there was no real June slowdown and kind of the momentum if you will, throughout the quarter has been pretty consistent with historical trends.

That is correct.

Thank you.

We are standing by with no further questions at this time.

We'd like to thank you all for joining us. This call be archived on Sun Hydraulics website at www.SunHydraulics.com for the next quarter. Thank you.

Thank you for your participation in today's conference call and you may disconnect at this time.