Helios Technologies Inc (HLIO) 2006 Q1 法說會逐字稿

Greetings, ladies and gentlemen. Welcome to the Sun Hydraulics first quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] It is now my pleasure to introduce your host, Mr. Rich Arter, Investor Relations spokesperson. Thank you Mr. Arter, you may begin.

Thank you, Tina. Good afternoon, and thank you for joining us. With me today are Allen Carlson, Sun's President and CEO and Tricia Fulton, Sun's Chief Financial Officer. After our prepared remarks we will take questions from the dial-in audience. Please be aware that any statements made in today's presentation 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 see yesterday's press release. It is now my pleasure to introduce Allen Carlson.

Good afternoon. Sales and orders were very strong in the first quarter, and we continue to see strength in April, and into May. Compared with first quarter 2005, sales were up 18% and orders were up 23%. Earnings met both the analysts and our own expectations with net income at $4.2 million, an increase of 20%. Internally, our major focus continues to be on our delivery performance and satisfying our customers needs. Our employees, and our suppliers are dedicated to achieving this goal. Externally, together with our distributors, we remain committed to our global strategy of expanding our international footprint. Sales to international customers were up 25% over last year, with sizable growth in the European and Asian markets. Domestic sales also continue to be strong with a 10% increase year-over-year. With order rates remaining steady at a high level and our short book to ship cycle we expect second quarter results will continue to show strength.

In April we released the first products that resulted from our WhiteOak joint venture, which we entered into last year. The products include a valve mounted digital amplifier and a handheld programming unit,which will significantly ease the programming of our proportional valves. These complementary electronic products are just the beginning of a new innovative technology that will result from our association with WhiteOak and we expect to continue to bring more products to market as the year progresses. WhiteOak products are interesting and exciting additions for Sun's product line. These complimentary auxiliary devices will help increase sales of electro hydraulic progresses as well as integrated packages. I would like to add that our 2005 annual report and proxy were mailed outlast Friday. The annual report is also available electronically at the Investor Relations section of our web site. Thank you. Tricia will now discuss our financial performance for the first quarter.

Thanks. Please note all comparisons will be to the comparable period last year. First quarter net sales were up 18% to over 34 million. Net income was up 20% to 4.2 million, compared to 3.5. Basic and diluted earnings per share increased to $0.38 versus $0.33 and $0.32. Asian sales continued to grow and were up 49% to 5.5 million. Increases were led by sales in Korea and to China. European sales increased 21% to nearly 10.5 million with significant increases in the U.K., Germany, and Scandinavia. Growth also continued in the North American manufacturing sector, with sales up 8%. Shipments within the U.S. were up 10%.

Gross profit was up 13% to 11 million compared to just under 10 million. Gross profit, as a percentage of net sales, decreased to 32% compared to 33.5. Gross profit decreases were due to higher material costs including raw materials, energy related increases, and exchange rate fluctuations. Gross profit was also influenced by increased fixed costs including salaries and fringe, utilities and depreciation. Decreases were partially offset by the increased sales volume and selective price increase in January of this year. Selling, engineering and administrative expenses were up 11% to 4.7 million. The increase was driven by additions to marketing and engineering personnel in changes in accrued liabilities. The provision for income taxes was 33% of pre-tax income, compared to 37%. The decrease was due to a change in the relative levels of income and different tax rates in effect among the countries in which we sell our products. However, a majority of decrease is attributed to the reduction in the U.S. effective tax rate of approximately 3% that took place during 2005. This reduction has carried over into this year and is expected to maintain a consolidated effective rate of approximately 33% for the remainder of 2006.

Net cash from operations was 3.5 million, up 1.7 million. The increase was due to higher net income and timing of tax payments. Day sales outstanding improved from 39 to 36, and inventory turns improved from 10 to 11. Capital expenditures for Q1 were 2 million and are projected to be approximately 9 million for the year. A quarterly cash dividend of $0.10 a share was declared in March. Dividends were paid on April 15 to shareholders of record on March 31.

Looking forward, second quarter sales are estimated to be in the range of 36 million, a 16% increase over last year. Second quarter earnings per share are estimated to be between $0.39 and $0.41, compared to $0.32 last year, a 22 to 28% increase. Thank you. Rich.

Thanks, Tricia. Tina, I think we would just like to open the lines now for questions and answers.

[OPERATOR INSTRUCTIONS] Our first question comes from, Mr. Scott Macke with Robert W. Baird. You may proceed with your question, sir.

Good afternoon, everyone.

Hi, Scott.

Just to start off, wondering if you could provide a little more color in terms of the gross margin year-over-year. I know you mentioned increased materials costs, increased fixed costs. If you could rank those in order of significance.

Yes, the material costs were about equal to what we saw in the increase in the fixed costs portion. The raw material costs are coming from increases in aluminum costs, as well as, some of the price increases we saw over last year in the purchase part that took place as progress over the year. We did have some exchange rate fluctuations that affected the gross margin, primarily in Germany as well.

The former two were more significant than the exchange rate impact?

Yes.

Do you have an estimate for all of these combined, how many points of margin they cost you for the quarter?

Well, it is pretty much the entire 1.5% that we decreased as a percent of sales.

And then I guess I am curious, in terms of price realization for the quarter, if this is we're talking about this, we're talking about it net of price increases, or what did price contribute roughly to the quarter?

Overall, it was about 2%, and the increase wasn't across the board. It was just on selective products, so trying to compare quarter to quarter is a little difficult. Overall it was only about 2%.

Okay. And then what sort of relationship are we looking at that's embedded in your second quarter forecast? Are we looking at another year-over-year gross margin decline?

We're expecting it to stay about the same going forward into second quarter.

And, given whatever expectations you have for incremental costs for the balance of the year and price realization, are we looking at flat gross margins year-over-year? Just in terms of what you may have, or what you are currently anticipating in terms of price realization and materials cost inflation, would you anticipate gross margin being flat, then, year-over-year? Balance of the year?

No, probably not. I don't think we'll see the extreme of the trend we saw last year, but if depending on what sales do, if sales go below where they are or what we're anticipating for second quarter, the margins could erode a little with the decrease in volume.

We don't expect that, though. We expect our volume will continue to grow in the second quarter. If the volume maintains where it is at, I think what Tricia is saying is the margin will remain flat. We don't expect to see a lot more price increases. A lot of increases we've got are energy related. Tricia mentioned it is aluminum, but the reason aluminum prices are going up is you use a lot of energy to make aluminum, and a lot of the price increases that we've seen are cost increases are related to energy prices, and I think we're probably already at the peak. We also have additional automation equipment coming online that will help to boost our gross profit and improve productivity. Throughout this whole thing we have had some productivity gains, and we will continue to realize those productivity gains.

I see. And I guess I think in terms of what appears to be a pretty strong market up until as we speak currently through May, is this I gather this is strategic on your part, not to try to go back and get more price, at this point in time to offset some of the higher costs?

We constantly are looking at our pricing, and in particularly with selected products where we're seeing aluminum costs go up, but strategically we want to grow the top line, but we want to grow it profitably, so there is a fine mix and balance of do we get more pricing, and sacrifice volume or take advantage of the volume? It varies by product line and by market. I can't give you a rule of thumb. All I can tell you is we're constantly taking a look at the mix of sales revenue versus profitability.

Okay. And looking at the United States segment in particular in the year-over-year operating margin decline, is this explained by the gross margin phenomenon we saw, or do we have operating expenses in the U.S. segment that also contributed to that year-over-year operating margin decline?

It is mostly in the gross margin.

It is mostly in the gross margin.

Okay. So no unique, special, nonrecurring, one-time costs segment in the quarter.

No.

Thank you. I will hop back in line.

Thank you. Our next question is coming from, Mr. Bill Lyons with Westminster Security. You may proceed with your question, sir.

Hi, guys. Congratulations on another good quarter. Could we talk about international a bit. Sounds like that's really where your growth is, North America is interesting, but sounds like international is most interesting. What was your break down regionally, of your revenues in the quarter, North America, Asia, Europe, Asia Pacific.

North America we were up about 8%, about 17.5 million. Europe 10.5, up 21% like we said, 10.5 million, and then the Asian markets were up about 5.5 million, if you include Australia, it is another half.

For your total revenues, how did each of those regions account? Where are they standing now?

I am not sure I understand.

North America is what percent of total revenues? Or Asia Pacific what percent of total revenues?

North America is half.

Half.

Europe is -- Asia is about 16, and Europe is 30.

A lot of room for growth in Asia.

Absolutely.

Not discounting the fact that the whole economy is growing. China, you mentioned, that's obviously an interesting market for you. Are you supplying that primarily out of Korea?

Primarily supplying it out of either, Sarasota for the cartridge products, and for packages and blocks they would be coming out of our Shanghai joint venture. We have a 50/50 jointed venture located in Shanghai.

I wish I had visited last time I was there. Interesting. That's all I had. I wanted a break down of those things. Thanks very much.

Next time you're in China, come and visit us. We will be happy to show you around.

I will make a pointed of doing that. Thanks.

Thank you. Our next question comes from, Mr. Brian Rafn with Morgan Dempsey Capital Management. You may proceed with your question, sir.

Good afternoon, everyone. Question for you guys, and I asked Dick this in the past. I don't expect you to illuminate me with the numbers, but can you give us a sense on the raw materials, the aluminum, the Delta change, everybody is tying it into the commodity. Are you still seeing upward pressures on aluminum prices that you're seeing pass through, or has it leveled off in the first quarter can you give us a magnitude or Delta change?

We're definitely seeing it continue in the first quarter and our purchasing people are expecting that to be coming through shortly. The prices are definitely up there. I don't know that I have a Delta -- I don't know what period you want a Delta.

They're still rising is what you're saying.

Yes.

Are you doing any forward purchase? Anything different than you might have done the last few years and forward sourcing, aluminum, or for your cartridges?

We lock in prices for the quarter in advance, so what we're purchasing right now is at the price was a quarter. How long do you want to lock in, is kind of a gamble you can play if you would want to. We feel comfortable with looking at it quarter to quarter and locking in.

Okay. Allen, I think you talked about automation. Are you talking machine tools, are you talking robotics and if it is on the tool side, is it unit volume capacity additions, or is it cycle time, speeds, or rigidity? What specifically, when you talk about automation, are you referring to.

It is all of the above. We have added C&C machining equipment. We've just added one that increases our capacity from a size standpoint. We're finding that customers are more and more often today integrating cartridges into blocks. We call those integrated packages. We're finding that they want to integrate even more cartridges into bigger blocks, the ability to make a block that maybe is twice the size of what we have historically made, in either aluminum or in iron, is opening up market share for us on equipment that perhaps we couldn't have done we would have had to do it some other way,.

So size is an incremental market for you guys.

Incremental market for us, exactly. Another one is robotics and automation. I wish I had -- your question just gave me a measurement I would like to be able to throw out and next quarter I will. We're adding robots at the rate of how many per year, and I think the number is pretty amazing. A part of our CapEx is automation for additional capacity. Our goal is to be able to grow without adding a lot of people and do it through automation, particularly in jobs that people don't want to do.

Okay.

I would say maybe a third of our CapEx spending is in the area of automation and robotics.

And that you're saying then, that automation is incremental to your work force, it is not an attrition issue of trying to ut can the work force by 10% or you're trying to add on.

Trying to add on and we're trying to, at the same time, to improve productivity and throughput, and I can be quite happy to show you examples the next time you're in town.

Sure. Sure. Absolutely.

Very concrete parts I could show you.

Okay. Let me ask you, where you guys are in Sarasota, and a number, certainly, open to the manufacturing people. You guys have had a very stable head count, you have had a very strong culture. Is the immigration issue with salary and wages, is that an issue where you guys are down in Florida, as far as, illegal aliens.

Well it is, probably, in Florida, but it is not at Sun. We had the Monday March, I think it was May 1, or something like that. I don't believe we had any of our employees that were out on march. We are pretty confident that through our hiring practices that everybody is a legal immigrant that we have. We don't have a lot of immigrants to begin with in terms of the percentage of the total work force. But, the ones that we have we have been very, very careful to make sure both, they and us, are legal.

Okay. Okay. Let me ask you your web site that you guys rolled out, are the customers still involved with looking at engineering designs, specifications, looking at cartridge mountings on manifolds? Can you sell through the web site, or is it still a conduit of information and specifications.

It is a conduit of information and specifications. If we were to open up a selling channel through there, I think there would be a lot of barriers that we would have to get through to open it up as a sales channel. It is primarily information. It is a little more than just information. They are able to configure products as well.

Exactly. Sure. Let me ask you from that standpoint is there a way you can measure the traffic to the web site through that versus your standard configuration where you talk with engineering specs and that? Can you measure volume hits on the site?

We do measure the hits. It is a big number. We also have a section in there where users of our products can register, so that when we make a change or have a new product we send them an auto e-mail if you're a registered user. The last count I had on registered users was somewhere around 1500 registered users from around the world, and these are people that are crawling on our web site all the time getting specifications of product, and I would say the predominance of them are outside the U.S. The number of hits--it's visits.

The more meaningful measure is unique visits.

Do you have a number on that, Rich?

I don't have a number.

We trace it.

Is there a way of, do you get a sense that the value-added in that information conduit and design leads to a higher percentage of actual sale than versus the old standard engineering, where, I am sure, their engineers are interacting with your engineers, is there any difference in actually coming to the consumption of the sale?

There is no question about it. There is a direct correlation, and maybe the best way to describe that or present it is to describe how that works. In the olden days engineers would be designing new equipment. They would most frequently design it as work, and they might do design at home at night. They couldn't because all the catalogs was there. The information was there. It is interesting to see a number of engineers that are maybe designing new equipment at midnight and they have access to a full information by going to, www.sunhydraulics.com. They will configure, make the circuit, they can price it out. They can walk into their office the next day and talk to the materials people or the purchasing people and say this is what I want to do. We get an order the next day for circuit that was designed the evening before.

Okay.

It is all time. It is speed, getting it done quickly and being able to get it done in multiple languages and multiple time zones.

Okay. Okay.

Let me add to that, Brian. For us to produce a catalog when we had to produce print catalogs was difficult, expensive and time-consuming, so you would end up having five years worth of products that you had to try and include in a new catalog, where as today we have the ability to put those up immediately when they're ready to go to market, and people therefore see all of these new products.

Right, right. Okay. It is very good point. Let me ask you guys on the manifold production in Manatee, is the manifold business dissimilar from the cartridge business, or is it from the standpoint of -- is there a different not maybe business cycle, but different volumes, different pricing separate from the cartridges, or is your movement toward integrated packages, really making cartridges and manifolds really sub-components of the end package?

The cartridges that we manufacture, the analogy that you could make would be in the electronics world, a microprocessor. Essentially the cartridges process fluid. They control pressure and they control flow, just like an Intel chip processes digits and 0's and 1's. Our cartridges are not useful unless they're on a printed circuit board like the microprocessor. It has to be a printed circuit board. The manifolds that we make are basically printed circuit boards which are used to house our cartridges, house the processor. They go together one on one. You can't do one without the other. Generally speaking when people select a Sun product they start with the selection of the cartridge and then say, "I need a printed circuit board for it as well." We sell a printed circuit board to go with the processor that they selected.

Okay. Okay. Let me ask you relative to the, what has been -- you talked about the WhiteOak electronics, the electro hydraulic packages. What kind of year-over-year and the demand for that, I think you mentioned that the last two calls, is that been a rapid demand for that or is it -- you guys have continued to talk about focusing on integrated packages. Is that more marketing nuance or really value there with the package?

I don't have the number at my finger tips, maybe Tricia does, or Rich. The fastest growing segment of our business for the last two or three years is our package business, and it is growing at the rate of 60, 70% a year. I don't know the exact numbers.

That's helpful. That's helpful.

It's a little lower, 40 last year, 70 the year before. It is the fastest growing segment of our business. The growth is because we are -- we have all the information out there on the web site. That's one reason. Another reason is we are quick at putting packages together for customers.

Right.

And we have a real breadth of products we're adding to with the electrohydraulics, we added another layer of capability, and with the electronics now that's being added is another layer of capability. It is kind of like this onion that keeps growing layer on layer on layer. The more layers you have, the more markets that's interested in your product.

Do you guys measure when you talk about cycle time or delivery times, can you give me a sense as to what year-over-year, and I know there are different sources of orders international versus domestic. Can you give us a sense as to what your delivery times might be? Are they standing, out?

Sure. First of all, we don't publish a lead time. Every order that we take is scheduled by the customer. If you want it tomorrow, that's what he puts in our system, and we measure our performance against the customer's request. I think it is safe to say that 95% of our orders are scheduled at less than four weeks. I would say there is probably 25 or 30% scheduled less than three weeks. I know that there is 10% that is scheduled at less than a week, so it is that kind of compression and these are customer requests.

Right, right.

Our on-time to request, we look at it a lot of different ways. The most meaningful way is, it is on time, or missed by less than seven days.

Okay.

The latest statistic I have seen on that is we're running at about 85%.

85%. That figure specifically, how has that figure changed year-over-year? Would you have been 75, 80 a year ago, or is it because of the business build-up that you're running a little more delayed from the standpoint of business volume? Can you give us a sense, has it been pretty much --

I would like to take you back to '98 and answer it that way. When we first started scheduling orders to customer request, which was in October of '98, our on-time to customer request was 16%. It got better during '99, and we put in a new manufacturing system in late '99, and it went back to 16%. It got as good as 40% and went back to 16%, and we've been continuing to build on that improving during the 2001, 2002, 2003 time frame. I believe at one time we were running about 98% on time, or less than a seven-day miss. Today we're at 85% from about 98%, so the increased volume in demand has taken somewhat of a toll on that number. If you look the at it from an historical perspective it is significantly better than it was eight years ago.

That's a good problem. One last one for tradition, your CapEx you said you're budgeting for 9 million this year and Allen said a third that far is for the C&C stuff. What component might be maintenance CapEx?

I would say probably about 500,000, maybe up to 750. It is a small part of the stuff that we're doing. A lot of it is automation that Al was talking about in C&C type machinery.

Okay. And has there been any head count change from year end? Have you added any staff, engineers of that for the first quarter?

We've added head count in almost all areas, marketing, engineering, direct hourly.

Anything on salary, wages, what you guys are seeing, retention rates, turnover in Florida?

Our turnover rate has remained pretty constant over the last two or three years and significantly better than the Florida average. Last year's turnover was 15%.

Okay. Okay. Anything on the salary wage inflation pressures you are seeing to keep people, or is it about normal across the U.S. manufacturing?

I would say that the pressures on wages and salaries are probably slightly higher. Our employees, the energy costs of just getting to work, but having said that, I think our focus with productivity gains is to more than offset our direct manufacturing costs through productivity gains.

Superb job, guys. That's all for me.

Thank you. Our next question is coming from, Mr. Scott Macke with Robert W. Baird Baird. You hey proceed with your question, sir.

Hello again. I want to follow back up on the on-time to customer request, and around 85%, which is certainly an outstanding number. With the CapEx that you have planned this year, and the automation equipment, if I recall correctly, we also talk about some milling equipment, some test stands in the past, which I assume are in the '06 budget, as well. Would you expect over the course that far year that 85% number to increase or does this hold that steady?

First of all, I want to correct the 85% number. Tricia just did the calculation, and what it is actually right at this very moment, and it's at 68% currently, which is still a very good number. I believe we started the year somewhere around 85%, and the additional volume that we saw in the first quarter, that number slipped from 85 to 68. However, I expect that it will it is beginning to rise, and it will be back at the mid 80's by this time next quarter. In terms of capacity and our capital expenses, what we do is we look at our constraints, and we try to visual lies these looking forward a quarter, a year. Some of the equipment that we need is eight months, ten months lead time. And so we're constantly monitoring constraints. Frankly, the biggest constraint that we see right now is direct hourly head count in that it takes awhile to bring people up. We did not anticipate the strength that we saw early in the first quarter. We expected the first quarter to be strong towards the end, but we came out of the starting blocks in January, February, very, very strong, unexpectedly strong, so it is taking us a little while to bring some people on that were hired in the January, February time frame, which are beginning to make an impact on our delivery right now. Does that answer your question, Scott?

Yes, that's helpful. I guess given the run rates you're at now, the first quarter and second quarter, I know that we -- it must be at least every other conference call that we ask you about bricks and mortar. If you looked out a year at the run rates you're at, first quarter, second quarter, this year, to put another 10% on top of that, are you able to do that with the equipment and the current CapEx budget, or are we start to go talk about, or look at bricks and mortar as we think about '07?

We're in good shape for the short to midterm. I think I mentioned it last quarter that we are beginning to look out beyond a year and say what are we going to do, and when are we going to pull a trigger on it, and where do we put it, and what products do we put in there. Those discussions are taking place, but short to midterm we don't have any bricks and mortar constraints anywhere in the world.

Fair enough. Thank you. I also want to follow back on the discussion of the increased sales volume in Asia and China specifically, and as we think about how you currently serve the China markets with the joint venture, is that something that could change, either within the framework of that joint venture, or just given,what I would presume to be the incredible sales potential there, is there a shift going forward or the potential for shift going forward in terms of how you serve that market?

We constantly are looking at the way we take our products to market. We've had many discussions both in China and in other places about how to better take advantage of the local market, other discussions going on and have they been going on? They have been going on since we formed a joint venture in '98 as to how best to take advantage of the Chinese opportunities, and today we're located in Shanghai, which is a great place to be, but being located in Shanghai is kind of like being located in San Francisco. There are other markets China we need to go after, and how we go after them is certainly a topic of discussion that's been going on for some time.

Fair enough. And like to ask or two more if I may. Again in other discussion I know we have had within the last two or three conference calls, but when you look at the prospect of cash beginning to accumulate on the balance sheet, if you could revisit the priorities for that excess cash going forward. I don't know if you can rank in terms of inclination to do acquisitions, relative to increasing dividends, relative to maybe another one-time dividend, or the potential for share repurchase.

There is plenty of opportunities to spend cash obviously. No shortages there. We tend to look at an acquisitions for opportunistic way with a strategic focus, but opportunistically. We knew a year ago we wanted to get more into electronic products that complemented ours, so we bought an equity interest in WhiteOak to add to our portfolio of product. There are other discussions going on that could lead to some acquisition, but that's just one avenue. Another one is organic growth. Sun has, for the most part, grown organically, and we tend to sort of grow with the bricks and mortar we've got until, at some point, we need to bust the walls out and add more bricks and mortar. You see a pattern that profitability is much, much stronger when we're filling up and getting close to filling up a facility, than when we invest in another facility, so I think some of the money that we have will be used for additional capacity down the road. Like I said, it is not in the near term or perhaps even the midterm, but longer term we will add more capacity, and we're having discussions of where. I can't really give you a definitive answer other than to say we're considering all possibilities with a focus on growing both, the top line and the bottom line.

Fair enough. And in talking about acquisition and is especially with the back drop of already introducing products that incorporate some of the technology from WhiteOaks, as you look at potential acquisitions or the idea of acquisitions, is that what we should expect to see, things that would augment product capability? Would we also think about product line extensions? Is there a potential for acquisitions to add to geographic reach? What sort of things might we expect with acquisitions?

Generally with the acquisition and with our own internal product development, what we look for is holes in the matrix of products, and then the question is, do we fill that hole with internal product development, or with an acquisition? Generally speaking the discussion is all around, well, where is there an opportunity because there is no good product or no good service that's currently filling that hole. So, another thing we look at is differentiation. We want products that are highly differentiated from our competitors. It kind of goes along with the holes, if there is a hole, that's an opportunity for you to jump in with a differentiated product. If you haven't gone to our web site to take a look at the WhiteOak, it is on the home page of our web site. It is a very interesting, as I said, but very differentiated product. You can program this thing using light, as opposed to piddling with potentionometers on the product. Take a look at our web site. It is a great product. It is highly differentiated.

We'll do that. I have a couple housekeeping questions, but I will hop back in line. Thank you.

[Operator Instructions] Our next question is from, Mr. Shaun Nicholson with Kennedy Capital. You may proceed with your question, sir

Thanks, guys. Wanted to touch on the end markets a little bit. Mover other questions have been answered. What particular end markets, is there some more than other that is have seen the strength more so in the first in April and May that you think have beginning of the cycle?

That's the answer to that question is good news and bad news. The good news is the end markets are growing. The bad news is we have a very difficult time of telling you exactly where. Our portfolio of products and markets that we serve is very, very diverse. It is sold through dealers with thousands of transactions. We do know that there are some general markets that we serve that we have maybe a bit better handle on it like, for example, aerial work devices. Sun is very strong in that market and we know that market is growing. Beyond that, we have a very, very diverse customer base, which is very good, but to be able to know that 2% of your market is in this area and it grew to 3%, we don't really track it, or have that information.

I didn't know how hard it would be with the distributors to track that.

But, it is very diverse, which is a real key to our business.

Okay. And on the acquisition front, I know the bigger players out there are Parker Hannifin, have you heard any of the consolidation? Do want to get into this -- I think they bought somebody a little while ago that competed with you guys in the strict cartridge. They bought a company called Sterling Hydraulics not too long ago, but over the years they've purchased other cartridge companies dating back to the early 90's. Parker has a portfolio of cartridge products that they take to market, which is not unusual because we have a -- we're not hurting for competitors. We have big competitors and small competitors and Parker happens to be one, but some of the other big guys also have cartridge offerings. Our offering tends to be unique and differentiated from what they have. On the in general the global market, I read in the presentation that the hydraulic valve market is 3 million, but you participate in 25% of that, or 800 million. Is that about the same, do you see that growing around 20% every year I think you stated? Is that still fair to say?

Our growth is 20%? You mean the market growth.

The market growth.

I don't know what the number is, Shawn, what we like to say is that the overall valve market will grow at a rate of X, whatever X is over time. The cartridge valve segment will probably grow at a rate twice that, because it is growing at the expense of the overall valve market, because it is taking market share from conventional valves, and our hope and wish would be that we could grow at a faster rate than the cartridge valve market.

Okay. Great. That's all I had. Thanks, guys.

Thank you. Our next question comes from, Mr. Brian Rafn with Morgan Dempsey Capital Management.

Question on your Sarbanes-Oxley 404 costs, either time or dollars, give me a sense as to what you might anticipate for '06.

We're last year we spent about 500,000. Right now we're looking at, depending on what happens with rules and what level of auditor involvement we have with the work that we do interimly, we're looking at least 400,000. If we don't have to have the auditor at testation, it could be less than that.

Question. You talked, you made a reference relative to the lead times on machining centers and that. Are you seeing any either the sub-components that you have source outside or raw materials? Are there any time delays? We've talked, I think, about price. Is there a time factor?

Not really, because our suppliers are on board with us relative to supplying to requests. It trickles down. If we get an order from a customer that needs it in Australia in three days, obviously we have to have suppliers that can also respond, and we've been working with our suppliers since the late 90's, so that they're on board with either they have the ability to turn it on quickly, additional volume, or they carry some buffer inventory if they can. Our suppliers, for the most part, have kept pace with us, probably struggled a little bit like we have.

My question was more on the pressure on just the unit volume of demand, not that they don't want to do or that you have that supply chain logistics in tact or set up, but it is just the enormous pressure of that demand coming through the pipe, but you're saying they pretty much kept that up.

Kept it up, exactly. In some cases where we've had difficulty, we have done some resourcing with suppliers who did have additional capacity, so overall supplier capacity has not been an issue.

Okay. You guys, in the past Dick had mentioned, you guys were doing some, correct me if I'm wrong, some outsourcing of some of your manifold machining. Is that now more internal or you still doing that?

Yes, we continue to outsource our -- the higher volume, lower complexity blocks. That has accelerated. I can't tell you what percentage of our total manifold business is, but it's probably somewhere in the range of 15 to 20% is outsourced.

Is that something that you would like to capture internally or is that just --

No. We will continue to outsource where is makes sense. In almost every case we were able to outsource, which meant we didn't have to spend the capital to make it, and the outsourced cost was equivalent or less than our internal manufacturing costs.

You still had the quality --

Actually the quality had been superb. We do the final stamping, packaging, so before it goes to a customer, it is viewed by a pair of Sun eyes.

Okay. Okay. Superb. Thanks, guys.

Thank you. Our next question comes from, Mr. Scott Macke with Robert W. Baird. You may proceed with your question, sir.

Last time, I promise. Housekeeping items. What was currency in the quarter?

We have two components to it. The first component is what flowed through on the transaction line, and that was less than 50,000. We have some small effect that we get through the sales as well in the conversion, and that was about 400,000.

400,000 in head wind, correct?

Say that again.

400,000 head wind?

Yes.

Okay. Notice that the debt picked up a little bit on the first quarter balance sheet. Is that just seasonal and working capital needs?

Yes. You will see we had a lot of cash on there, too. But, a lot of the cash is sitting out in the foreign subs, and a lot of the cash out lays from the corporate standpoint have been from U.S. cash, so we borrowed against the U.S. line of credit for things lining dividends and repurchase plans from Q4 and Q1 this year, as well as, CapEx dividends in repurchase.

Fair enough. Is the stock compensation expense for the quarter ,I gather, is allocated up to the segments? For reporting purposes?

No.

Okay. And, I also wanted to ask about the margins in the U.K. reported segment appear to be outstanding. We went from 7.6% in the first quarter of last year to 15.9% this year. I was wondering, that's something like 90% incremental operating margin. I was wondering what factors might be at play there?

I'll take the first crack, while Tricia is looking at the fine details. From a macro standpoint, our U.K. business did not recover as quickly as some of our other business segments did. A year ago at this time they weren't operating it at full capacity, and during the past year we've seen their business pick up and they're now operating at full capacity plus. I think it is a capacity issue. As we did in the states, when we saw the downturn, we didn't let our employees go. We maintained the head count and as a result the productivity was down until the volume came back.

Okay. And then, the final question, I would suspect, and correct me if I'm wrong, that at some point here we would start showing some or already recording interest income on cash balances, does that show up in the other income line item as well.

Say that again.

Where I would expect to see interest income on cash balances.

For interest income, yes, interest rates we're getting on some of our investments in Korea and Germany are typically lower than what we're experiencing in the U.S. for what you could get in a money market fund, but we're in the process of looking at some longer term investments for the cash that's sitting over there, right now we have very short-term things and until we can figure out where we want to put them.

Okay. Fair enough. That's all I have. Thank you very much.

Thank you. Mr. Arter, there are no further questions.

Okay. Thank you very much, Tina. Before we go I would like to remind everybody that the annual meeting of the shareholders for Sun will be on Tuesday, June 13, at 2:00 p.m. at our facility at Talavas Road. An with that, thank you all for joining us.

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.