Helios Technologies Inc (HLIO) 2006 Q2 法說會逐字稿

Greeting, ladies and gentlemen and welcome to the Sun Hydraulics second quarter 2006 conference call.

At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentations. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Rich Arter, Investor Relations spokesperson. Thank you. Mr. Arter, you may begin.

Thank you, Ryan. Good afternoon, and thank you for joining us today.

With me 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 21-E 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, everyone.

Business continued to be brisk in the second quarter and we again were able to achieve double-digit growth on both the top and bottom lines. July and August orders to date have remained strong and we expect to continue our string of double-digit growth in sales and earnings in the third quarter.

While sales and orders were strong in the second quarter, our earnings lagged. We continued to see material and fixed cost increases in the quarter, which kept us at the low end of our earnings forecast.

For the past couple of years, we've been able to overcome most of the cost increases we have seen with productivity gains. However, the increases caught up with us in the second quarter and they had a negative impact on earnings.

To combat any further margin erosion and to improve future earnings, we implemented a mid-year price increase in July and accelerated some of our capital investments. We expect the combination of continuing strong sales, further productivity improvements, and close to a full quarter's effect of the price increases to boost third quarter earnings to approximately $0.39.

Tricia will provide further comment on the financial results and outlook in a few minutes.

Throughout the beginning of this year, Sun has received national recognition from several sources. Business Week ranked Sun Number 61 of the Top 100 Hot Growth Companies for 2006 and Fortune Magazine ranked Sun Number 14 on its 2006 Small Business 100 list. For the second year in a row, we have been recognized by Fortune.

In July, NASDAQ announced that Sun qualified for and was included in the new Global Select Market group. As stated by NASDAQ, inclusion in the Global Select Market recognizes a company's commitment to high standards and good governance. Everyone at Sun is extremely pleased to be recognized for our performance over the past few years.

I would now like to turn the call over to Tricia to provide some more of the details on the quarter. Tricia?

Thanks, Al.

All comparisons will be to the same period last year.

As Al mentioned, we saw double-digit growth in the second quarter with net sales up 19% to $37 million. Net income was up 23% to $4.3 million, and basic and diluted earnings per share increased to $0.39, up approximately 20% over last year.

Broken out geographically, Asian sales continued to grow, up 26% to $5.7 million. Increases continued to be led by sales in Korea and to China. European sales were up 24% to $10.7 million with significant increases in France, the U.K., Germany, Sweden, and Italy.

Growth also continued in the North American manufacturing sector with sales up 13%. Shipments within the U.S. were up 12%.

In whole dollars, gross profit increased, however, we continued to see erosion in the gross profit percentage, which was down two points to 30.4%. This decrease was due to higher material costs coupled with an increase in the fixed cost base, which includes salaries and fringe benefits, building maintenance, and depreciation. As Al stated earlier, we have taken steps to improve future earnings with the mid-year price increase and accelerated capital investment.

SG&A increased a modest 3.7% to $4.7 million. The increase was driven by higher compensation expense, including additional engineering and marketing personnel.

The income tax provision was 33.6% of pretax income compared to 36.7%. The majority of the decrease is attributed to last year's reduction in the U.S. effective tax rate of approximately 3%.

This reduction has carried over into this year and we expect to maintain a consolidated effective rate of approximately 34% for the remainder of 2006.

Net cash from operations was $8 million, down slightly from last year. Higher accounts receivable and inventory balances were partially offset by the increases in net income, depreciation, and stock-based compensation.

Days sales outstanding increased from 34 to 37. We have historically been around 36 days and perceive the 37 in Q2 of this year to be within our normal range. We are extremely pleased that inventory turns continue to improve by half a turn to 11.2.

Capital expenditures through June were nearly $5 million and are now projected to be approximately $10.5 million for the year.

In June, the Board of Directors declared a quarterly cash dividend of $0.10 a share. Dividends were paid on July 15th to shareholders of record on June 30th.

The Board also announced the stock buyback of up to $2.5 million in June. The buyback was completed in July with 135,400 shares being bought at an average price of $18.47.

Our outlook for the third quarter calls for continued growth. Sales are estimated to be approximately $36 million, a 25% increase over last year. Earnings per share are estimated to be between 38 and $0.40 per share, approximately $44% higher than the third quarter last year.

Thank you. I will now turn the call back to Rich for Q&A.

Thanks, Tricia.

Before we take questions from the audience, we did have one question -- or a series of questions, that came in via e-mail. The questions are from Michael Bragg and they are, when was the last time Sun instituted a mid-year price increase? How large is it? And is there any concern it may have triggered dealer pre-buying?

Sun has previously instituted mid-year price increases, the last time back in 2002. For competitive reasons, we really don't want to divulge the amount of the current increase, but we expect the overall net effect to be about 2%.

We don't believe there's been any pre-buying of any significance and that's substantiated by distributor inventories, which at the end of June were up about 5.5% compared to the first quarter which was down 7% from year-end. So essentially, field inventories have remained flat or steady.

And with that, Ryan, I'd like to open up the call to Q&A with the dial-in people. Ryan?

[OPERATOR INSTRUCTIONS] Our first question comes from the line of Scott Macke with Robert W. Baird.

Good afternoon, everybody.

Hello, Scott.

I was wondering if we could talk just a little bit more detail on the third quarter outlook. Just in looking over the last two years, usually we'd expect to [technical difficulties] I'm sorry, can you hear me all right?

Well, you cut out for a minute there. Last thing I think we heard was expected.

Normally we'd expect in the third quarter to see more of a sequential decline in revenue and earnings and it certainly looks like you're forecasting, well, something that is not as seasonal, particularly with revenue and something that would be closer to only a $1 million sequential drop-off.

Are we seeing less seasonal demand right now? Is it a function of the price increase or do we have some catch-up to do with capacity constraints?

I'll take that question, Scott, this is Al. I can probably tell you more what it's not than what it is. To start with.

Okay.

I do not believe it has anything to do with our pricing, which was extremely modest and probably has little impact on what our customers or dealers would do. We felt that going in, too, and we've been following orders and inventory very closely and we don't believe that it's that. We do know that our business outside the U.S. continues to grow and our U.S. business continues to grow.

Orders are very, very strong for our products and I believe it has more to do with our business model of providing on-time products to customers, our Web initiative, which we've outlined in previously conference calls, in other words providing information to customers around the world when they want it in real-time. I think it has more to do with that and the general business economy continues to be very strong worldwide. So those are the factors.

In terms of the orders being strong, what sort of magnitude are we talking about year-over-year order increases in the second quarter and perhaps as we look in through July as well?

Well, we've -- I think we've detailed that in some of the information. Orders are running somewhere around 20% growth year-over-year. We've seen that in the second quarter, which turns into shipments in the third quarter and those kinds of numbers continue on in July and August, which bodes well for certainly the third quarter and perhaps even into the fourth quarter.

Okay. And then -- I'm sorry, Tricia.

The run rates that we've seen in July and August are very steady compared to what was incoming with June as well.

I see. And then especially in the context of this very strong third quarter revenue forecast and the talk of accelerating some capital spending, have we seen lead-times stretch? Do we have more of those orders stretching out into the third quarter than maybe we saw last year at this time?

Not really, because all of our scheduling is done to customer request and fundamentally, we monitor our past due relative to customer request and that's running pretty well. I think it's more to do with a strong business climate out there and it's not just North America, it's not just Europe, it's not just Asia.

All of the stars are kind of in alignment and all the economies that we deal with continue to grow, continue to do well, and we're making investments really that are not really outside of what we anticipated other than we're probably pulling them forward a little bit. But we expected the kinds of investments we're making, we expected to make those investments. It's just a matter of what was the timing and maybe we pulled them forward two or three months.

I see. And just one last question related to that, to the price increase.

What have you seen in terms of competitors in the market, in terms of price increases? Is this 2% consistent with what you see going on out in the market right now, is it a little high, is it a little low, where does it shake out?

It's probably less than what other people are doing. I don't think you can take this mid-year increase alone, I think you have to take in context what's been done over the last three to four years and I believe that we've held our prices quite steady over the three or four years and have been able to do that because our productivity gains outweighed our material cost increases.

But because of energy, particularly because of energy, we're seeing cost increases to raw materials, to electric usage that we just are not able to absorb those kinds of increases and were forced into a mid-year increase.

Okay. Well, I'll hop back in queue. I would assume somebody will follow-up or I will follow-up on some more of the cost increases. Thank you.

Thanks, Scott.

Our next question comes from the line of Will Lyons with Westminster Securities.

Hi. Congratulations on another great quarter.

Thank you.

I was wondering if you could give us some color and depth to new product introductions during the first half of the year and an outlook for the rest of the year? I know in the past you'd stated that you thought specifically that was what the acquisition of White Oak would give you, but could you kind of expand on that for us? Update us on it?

Sure.

Our new product introductions continue to be centered around electrohydraulic products and packages. We did release some White Oak products in the second quarter and more to follow.

I don't believe the White Oak products at this point in time are material to why we're seeing large growth in orders. I think they will, but I think it's electrohydraulic products in general, in valve packages and just overall demand for our common vanilla products as well.

On the capital investments side, could you give us some expansion on that, exactly what -- is it new, completely new production capacity or just upgrading your current capacity, what are you doing there?

It's some of both. For example, we've ordered, I believe, it's four CNC machining centers, that machine the manifolds. Some of those CNC machining centers will replace existing equipment that's 18 years old and I believe that's half of them.

And the other half is going to be additional capacity in our Kansas plant so it's there, for example, and that's nearly $2 million or maybe over $2 million of our capital in the second half of this year just in four CNC machining centers.

And then we have some finishing equipment, which will improve productivity by allowing us to machine -- to finish parts like honing and grinding and lapping. Finishing parts with greater precision, faster, with less scrap.

So the primary reasons there are both productivity and capacity. So it's a smattering, a little bit of everything.

But again, I'd like to just sort of step back and reiterate how we do these things. We take a look constantly at where we have productivity gains to be had, where we have capacity issues, where we have scrap, and we're constantly assessing what our constraints are and taking corrective action on those constraints. That's what drives our capital spending and we make those decisions daily.

Have you seen an increase in hourly employee -- or per employee hourly working? I mean are people working longer hours for you?

I think that was probably true in maybe April, May, early June. But we've hired a fair amount of summer help, college kids, that I believe the number is somewhere around 30, which allows us to lighten the load during the summer months. People take a lot of vacations during the summer months.

So I would say the answer to your question is no. We have not seen more hours being worked by our employees during the summer months for those reasons.

Which would logically mean that you would expect to see that in the second half of the year after the summer vacations are over?

That's correct, but to offset that, we are bringing in some pieces of automation which will help us in not requiring perhaps as many man hours into some of the products and, in fact, we just had a discussion about this this morning. And we'll probably come pretty close with the automation that's installed in the second half of this year versus the need for man hours, it's probably going to just about offset it.

Interesting. Okay, thanks. That's all I had.

Our next question comes from the line of Brian Rafn with Morgan Dempsey Capital Management.

Good afternoon, everybody.

Hello, Brian.

Can you give us a sense as to how many shifts you guys are running now in the summer both on the manifold and the cartridge side?

It's a strange answer to the question. We have a very flexible workforce and we're very flexible with our workforce so you don't have, like, 200 people standing in line to punch in at 8:00 in the morning and they work the first shift until the second shift punches in at 10:00, we don't operate that way. So you've got a real mixture of trying to define what's a shift.

And then we've also implemented during the summer months -- we've had the opportunity to implement a weekend shift, where people work Friday, Saturday, Sunday, just to keep some of the critical operations going.

But in a broad sense, with all that behind us, we are still primarily two shifts a day with -- if the first shift's at 100%, the second shift is probably at 50 or 60% supplemented with a weekend shift of, I don't know, probably 5% and then overlapping in lots of areas at lots of times throughout the course of a normal week, which is for us four days 10 hours a day and Friday and Saturdays as needed.

Can you give us a sense as to versus the first quarter, any more or less overtime? Tricia, do you want to take a crack at that?

Sure.

We are experiencing labor as a percent of sales productivity levels just about same between Q1 and Q2, actually going back to Q2 of last year as well. So as the sales increase, we are seeing a few more overtime hours, but as a percent of sales, the labor is staying very flat.

Okay.

You talked about adding some engineering headcount. Can you kind of define or give us a sense as to what your hiring market is out there for, say, skilled engineering, maybe skilled CNC tool operators, what your retention rates are and what pressure you might have on, you know, you talk about SG&A, wage and labor costs?

Sure.

There's a couple of answers I'd like to provide with that. First of all, we are seen in Sarasota as one of the better companies to work for. And when we have openings for manufacturing personnel, generally we have multiple people interested in the job.

A couple of the local manufacturers here are scaled back. One in fact is closing a facility and that's opening up a labor pool for us of some good people.

On the engineering and marketing side, there are some possibilities again with the facilities that are scaling back or closing to hire some of their people and we're in a very enviable position in our business. Being in Sarasota, Florida, with the reputation that Sun has and the brand recognition, we're a desirable place for a lot of people to work. So we really aren't suffering finding good, qualified candidates to fill positions as they open up.

Having said that, I don't want to make it sound like it's easy and it's like fruit falling out of the trees. You do have to work at it and our HR and other employees throughout the Company work at that very hard.

In fact, probably the number one mechanism for us finding new employees is an existing employee recommends a neighbor or friend, somebody they know to apply for a job at Sun, and so the referral is quite good with our 600 plus employees making referrals all the time.

Okay.

Can you give us a sense as to what your SG&A base labor rates are running? Would you say low single-digits, mid single-digits, can you give us a sense as to what kind of the underlying pressure is maybe to not just hire people in but also to retain and minimize the turnover that you have?

Our turnover rates vary from time to time ranging from 10 to 15% of our workforce and that turnover rate is everything. It's people retiring, people relocating, probationary, it's all of the turnover but it's 10 to 15% and for this part of the world, it's extremely low.

And your kind of, maybe Tricia can answer kind of your wage, salary, what might be that be for the year going forward, 2%, 3%?

We're not expecting a wage increase until the end of the year, January.

Okay, okay.

We do them just once a year.

Okay.

Can you kind of give us a sense as for what, starting in '06 -- I'm just getting a pattern, is it more normalized? I'm looking more for the numerical outlier.

We had one manufacturing out in Orem, Utah, they had to raise wages 9% because of 1% unemployment out there. What are you guys seeing? I'm just getting a sense as to what you paid in this year.

We aren't seeing that at all. It's in the single-digits. It's very -- it varies between department and demand, but we aren't seeing anything like what you're describing.

Can you give us any sense as to the magnitude on some of the costs of the raw materials, oil and gas, steel, diesel, freight, electric, kind of year-over-year what magnitudes are up?

The aluminum, we're obviously seeing quite a big increase over last year, probably 20 to 25% over Q2 last year. The purchased parts that we're buying that are steel, most of those cost increases came through last year, starting with surcharges that they placed on them that have rolled over into the actual cost for this year.

On the utilities, we have definitely seen increases as a percentage, it's probably close to 30% on a monthly basis that we're seeing on our electric bills.

Is that based upon usage or is there a power grid problem with the population growth in Florida? Is there an issue with any of your local power authority?

The answer is both. The cents per kilowatt is up and we're using more kilowatts.

Okay. Of the $10.5 million you guys talked about, property, plant and equipment, what percentage of that might be just maintenance for the year?

I would venture to say probably about 20% of that.

About 20%. Okay, I'll jump back in line. Thanks, guys.

Our next question comes from the line of Scott Macke with Robert W. Baird.

Hello again.

Obviously they didn't pick up on your questions to your satisfaction.

Well, I'm glad that you say that, because I managed to disconnect myself but I just want to follow-up then, especially if I haven't talked about it yet. If you could estimate the impact in the quarter in terms of percentage of revenue of the higher input costs?

I have a breakdown of the gross profit percentage quarter-to-quarter, the material portion of it is, of the 2% that gross profit decreased, the majority of it was material. I would say 80% of it was material.

It sounds like that there wasn't much year-over-year incremental price realization built into that number?

No.

Into the sales increase? Okay.

And then, relative, I guess, maybe if you put it in baskets, the aluminum versus steel versus fixed costs, are they all running -- have similar impacts, one disproportionately more than the other?

The aluminum is less than the steel inputs on the purchased parts. Aluminum accounts for about a third of the material portion. The steel purchased parts account for two-thirds. Any currency affect at the gross profit line was minimal for when we sell to our subs.

And then the portion related to the fixed overhead is about the same as the portion for the steel in whole dollars. There's really no effect from the labor and variable overhead portion, it's relatively stable.

Okay.

And then I was wondering if you could dive into the segments real quick? Both Korea and U.K., Korea in particular, down slightly sequentially in the second quarter both in terms of revenue and operating margins and I know that's kind of nitpicky in a segment that's up 25% year-over-year, but is there something in particular that's going on that maybe we didn't get a sequential bounce, a seasonal bounce in Korea or the U.K.?

In the U.K. in particular, we are handling some of the sales that were derived from that office in the previous year through the U.S. now instead of through their office and there's some commission issues, which is why you're seeing the sales flow through the U.S. and not on the U.K. side, which accounts for them being down, but it also accounts for their operating income being up because of the way we're handling commissions.

Let me elaborate on that just briefly if I could, Tricia. Our model in Europe for the longest time has been for us in Sarasota, where the majority of the cartridges are manufactured, to manufacture those cartridges and put them in inventory in our U.K. facility, or our German facility. And then they would ship to distribution in other countries from the U.K.

They would ship to Finland, they would ship to Sweden, they would ship to Holland, they would ship wherever. And we found earlier -- well, essentially late last year that our on-time shipments and our ability to ship directly without buffer inventory, a huge buffer inventory in the U.K., was something that we could and should do, would make us more efficient, would make our distributors more efficient, because they'd get product faster. They wouldn't be drop shipped, let's say, to an intermediate place.

And so today what we're doing, not true in all places, but in many places of Europe, the distributor in Finland or Sweden or wherever will actually enter his order directly on the manufacturing plant, not the intermediate marketing company. And we ship directly to -- fulfill that order directly to the distributor on a weekly basis, taking time and cost out of the sales channel.

I see, I see. And then, how about Korea?

Korea was down 100k from Q1. There's no particular reason that sequentially they had any decrease in sales, just timing of the shipments and orders.

Fair enough. That's all I had. Thank you.

Thanks, Scott.

Our next question comes from the line of Brian Rafn, Morgan Dempsey Capital Management.

Can you guys elaborate a bit on, you talked about your real-time where some of your customers could go in and set up packages, specifications, functions, work on your system. Can you measure that traffic as similar to bids and quotes and can you also measure your conversion between somebody navigating into your system from an engineering standpoint and actually coming in with a purchase order?

I don't believe we have that level of detail. We can measure more on a macro standpoint and obviously the more people you have looking at your merchandise, the more opportunities it is to turn it into sales.

We can say that more and more people are going to our Web site to get information. It grows every quarter. But is there a direct correlation from, let's take a look at what these guys have to an order, no, I don't believe we can do that. Very difficult to quantify, Brian.

Can you measure, Richard, the hit rate or is there any numerical connotation you can put on it? When you talk about traffic into your site, can you measure that, maybe?

Well, we kind of measure unique visits as opposed to hits and stuff like that, how many times you have a unique visitor coming to your site. And as Al said, that continues to increase quarter to quarter to quarter to quarter, every quarter, but tying it to sales, we speculate, but that's all we do is speculate on that.

Okay.

Can you measure from somebody going in and setting up specifications, functionality, and packages and that and maybe the throughput efficiency to that person then putting in a live order and actually getting it shipped out versus the old way of perhaps going through the dealer or distributor and all of the engineers contacting? Can you go back that system electronically versus maybe five, six, seven, ten years ago?

We can do that today, we couldn't do that five years ago. We have a program called Quick Quote where a customer or distributor can go in and configure a unique package and from that unique package that they've configured, then we can say, did we ever get an order for what they configured, because it does assign a date stamp and a part number to it. So we're tracking that today, but, of course, we didn't have that tool five years ago, so there's no way of comparison.

But we're quite happy with the conversion rate of our Quick Quote program and it's getting better. I'm not going to give you the number, because it's a piece of marketing information that I don't really want to let the world know.

Sure, sure. Allen, can you expound on that and get a sense as to what your cycle time between your first initial customer contact via the Web and. like you said, configuring packages and actually coming out, making an order and then you shipping directly to them versus the old days of coming through the dealer, the distributor, talking to your engineering guys with their engineering guys and all of the back and forth?

It's much, much quicker, maybe a factor of four to five times.

Oh, okay.

We get Quick Quote orders probably in a matter of days, certainly in a matter of weeks today. And you wouldn't even get -- you wouldn't even get the configuration settled in a matter of weeks in the old system. You'd still be bouncing it back and forth with a fax machine.

Okay. And what would the total time in the old days have been, from alpha to omega it would have been months?

Six, eight, ten weeks.

Six, eight, ten weeks. Okay.

And we're able to do today in one or two days what would have taken six, eight weeks.

Good answer. Thanks, guys.

Ladies and gentlemen, I'm showing no questions in the queue at this time. Do you have any closing remarks?

Nothing other than to say thank everybody for joining us on the call and we'll talk to you next quarter.

Okay. Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation.

Thank you.