Helios Technologies Inc (HLIO) 2006 Q4 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Sun Hydraulics fourth quarter and year end 2006 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [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 CFO. We are hosting an Investor Open House during this call, and have a number of people, probably about 30 or 35 people in the room here. So, after we have concluded our formal remarks, we are going to take questions from the audience, both here and from the dial-in participants, and we will move back and forth.

Before we begin, 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 that please see yesterday's press release.

I would now like to turn the call over to Allen Carlson.

Thanks, Rich. Good afternoon. Sun had an exceptional year in 2006. Demand remains strong and steady, and we ended the year even better than we anticipated. The robust order rates for the fourth quarter have continued into the first quarter of 2007. We expect to continue to grow at a rate that outpaces our industry.

Our outlook calls for continued double-digit top and bottom line growth in the first quarter, which is exceptional given the strength of last year's first quarter. As we said in the press release, the keys to our success have not changed. Shipping reliability, new products, integrated packages, our geographic presence, and our website are the main drivers of our success. Shipment reliability means our customers get the products they need, when they need them, and where they need them.

Our ongoing focus on operational efficiency and productivity improvements helps us maintain our ability to respond to our customers demands. Operational efficiency is also a key factor in allowing to us to continuously improve our bottom line. In the product area, we continue to design and introduce new complimentary products. In this sense, complimentary means that the new products have a multiplying effect on our product line, helping us to sell more existing products as well.

Our efforts in the electro-hydraulic arena continue to open new opportunities all over the world. In April, we will be introducing more new electro-hydraulic products at a trade show in Germany. The Hannover Fair is perhaps the largest hydraulics trade show in the world, and held every other year. This is an ideal venue to release more of our new electro-hydraulic products into the marketplace.

Our focus on integrated packages goes hand in hand with the evolution of our electro-hydraulic products. With these cartridges we are able to provide complete hydraulic control systems for a wide variety of mobile and industrial machinery. Because of the unique design characteristics of our cartridges, we provide a complete package that is smaller and more efficient than those provided by our competitors. And I might add also oftentimes more cost effective.

As our customers move their production around the world to better serve their markets, Sun and its distributors are able to respond to those needs. Our wholly-owned companies are strategically located and augmented by more than 65 of the best independent distributor organizations in the hydraulics industry.

Finally, but not least, is our website. When we launched the website six years ago, no one at Sun understood the impact it would have. It has proven to be an incredibly efficient tool for delivering product information to customers, distributors, and even employees everywhere.

We are continuing to invest in and expand the capabilities of the website, including new functionality to better service our customers. All of the things I just mentioned have helped Sun achieve above industry growth over the past five years. We expect the future and this focus will help us continue to grow. In essence, it boils down to having the right products at the right place, and meeting or exceeding customers' expectations.

On a final note, I would like to comment on Sun's history as a public company. We completed our IPO in January 1997, ten years ago. Since that time, an investment in SNHY has increased more than 300%. Everyone at Sun is extremely proud of our performance, and we look forward to continue to provide superior performance for our customers, our employees, distributors, and our shareholders, for the next ten years and beyond.

I would now like to turn the call over to Tricia Fulton, who will provide some details on the quarter. Tricia.

Thanks, Al. All comparisons will be to the same period last year. I would first like to comment briefly on the fourth quarter results. Net sales were up 25% to nearly 35 million. Net income rose 31% to 3.8 million. And basic and diluted earnings per share increased to $0.35 versus $0.26.

Our guidance for the fourth quarter was in the range of $0.31 to $0.33 on 33 million in sales. We exceeded the EPS estimates based on higher than anticipated sales, which were partially offset by additional tax expense of approximately 300,000. Half of this increase resulted from the repatriation of $5 million from the U.K. and Germany in the fourth quarter. The remainder is attributable to a higher effective tax rate in Korea, and increased state tax in the U.S.

Now to summarize the results for the year. As Al mentioned, our double-digit growth continued into the fourth quarter, and rounded out the year with sales up 22% to 142 million, and net income up 27% to 16 million. Basic and diluted earnings per share ended the year at $1.49 and $1.48 respectively, an increase of 26% over last year.

North American sales increased 14% to 74 million. Outside of North America demand continued to be strong in Asia and Europe. Asian sales increased 42% for the year to 23 million. European sales increased 26% to 41 million. We are continuing to see significant opportunities in Europe and Asia.

Gross profit increased 19% to 44 million. Gross profit as a percentage of sales was 31%, compared to 31.5% last year. We battled margin erosion caused by higher material and fringe costs throughout the first three quarters of the year, but we were able to gain ground in the fourth quarter with the full effect of a mid-year price increase.

[SENA] increased 6.5% to 19 million. The increase was driven by higher compensation expense including additional engineering and marketing personnel, and property and casualty insurance. These were offset by decreased advertising and professional fees.

Our effective tax rate was 35%, compared to 33%. The higher rate was primarily due to the relative levels of income and different tax rates in effect among the countries in which we sell our product, and an increase in the U.S. effective rate of almost 2%.

Net cash from operations was nearly 20 million, up from 17 million last year. Higher net income of 3.5 million was partially offset by working capital changes. Days sales outstanding remain constant at 36. And inventory turns decreased by 0.5 a turn to 9.5.

This is due to timing differences of inventory levels in anticipation of January 2007 orders. Capital expenditures for the year were 9.5 million, compared to 8.8 million last year. 2006 purchases consisted primarily of CNC and Automation equipment to increase capacity in all business segments. Debt was reduced in the fourth quarter as we were able to utilize the $5 million brought back from Europe, to pay down all remaining U.S. debt.

A quarterly cash dividend of $0.10 per share was declared in the fourth quarter. Dividends were paid on January 15th to shareholders of record on December 31st. Last week we declared a $0.10 for the first quarter of 2007, payable on April 15th to shareholders of record on March 31st.

We have again successfully completed documentation and testing, related to compliance with Sarbanes-Oxley Section 404. The Sarbanes-Oxley Act requires management to assess the effectiveness of internal controls over financial reporting. Based on our evaluation we have concluded that the internal controls were effective in 2006. The cost for complying with SOX 404 in 2006 was 400,000.

Our return on capital employed, which we include in our Annual Report, increased to 26% for 2006, up from 24% at the end of 2005. Return on capital employed is a good measure, because it represents the return Sun is realizing from use of its debt and equity. Or in other words, the efficiency with which our shareholders' capital is being utilized to generate revenue. We are extremely proud of our performance against this measure. As Al stated earlier, our outlook for the first quarter of 2007 is for continued growth. Sales are estimated to be 39 million, a 14% increase over Q1 2006.

Earnings per share are estimated to be between $0.42 and $0.45, compared to $0.38 last year. Capital expenditures are projected to be approximately 10 million. SOX 404 compliance is estimated to be about 300,000.

Thank you. We will now open the call up for Q&A. Rich.

Thanks, Tricia. I'll tell you what, Ryan, why don't we do the first question from the dial-in, then we will do one here live.

Okay. Ladies and gentlemen, [OPERATOR INSTRUCTIONS] First question comes from the line of Brian Rafn, Morgan Dempsey Capital Management.

Good afternoon everybody.

Hello, Brian.

Can you, Allen, you talked about getting some functionality to the website. You have talked certainly about specifications, engineering bids and quotes. Can you kind of talk in '07 as to what that will include?

The website started in 2000 timeframe, as a means to deliver product information, specifications if you would, pricing, things that customers would need to place an order. Or not necessarily to place an order, to place it with our distributor. That initiative was completed a couple, two or three years ago, and what we have begun to do is to provide the ability for customers to configure products, a selection of products. And that effort will continue to grow. We have some of that today, mostly our catalog product, but we will be getting more and more ability to configure custom products and custom systems.

Okay. Can you talk, I'll just ask one more question, then get back in line. Can you talk about the margin erosion? Can you give us any sense as to magnitude year-over-year, say your plastic, resin, steel, iron ductal, castings, and that, what your sense was, say '06 versus '05 in materials? And you also mentioned I think you had some pressure in fringe costs, SG&A wages, benefits, and that. Can you give us a sense maybe '06 versus '05?

I will answer it broadly, and Tricia may have some details that would support it. Essentially what we saw in 2006, starting off early 2006 continuing through mid-year and into the later half of the year, was aluminum prices, escalated steel prices, a lot of the raw material that go into our products. And that was what required us to initiate a mid-year price increase, was to recover some of this cost increase that we had to pass it along.

In terms of fringe benefits and wages and salaries, there was some increase but that was pretty much offset by productivity. That is what we'd like to do, is to use the productivity gains to offset the wage and salary increases, and challenge our suppliers on the material side, but when all else fails to recover it through a price increase, if we have to. That is exactly what happened in 2006. Towards the end of the year we began to see that moderate. I wouldn't say that the numbers started going south. I just think it moderated, and it's been holding at the levels we saw mid-year.

So you're saying it's plateaued in the second fourth quarter versus mid-year?

That is correct.

Can you give us a sense overall as you work the price inflation through from mid-year what the sense across all products, what your price hike was, low single digits? Can you give us a number?

We had about a 4% overall year-to-date increase that resulted from both the mid-year price increase, and the selective price increase that took place at the beginning of the year, but those were pretty much as Al said, offset with the material increases that we saw in the first and second quarter specifically.

Okay. From a historical context, with the big runup in certainly commodity feedstock raw materials, if we see that same rollover, is there some hesitancy from your end users to come back and to recapture some of that with more competitive prices? I.e., 4% is not a huge number. I am just getting a sense as to how elastic your end users are?

I think that number will probably stay because that is the kind of number that's being passed on in the industry. Obviously if we saw a sharp decline in materials, we would take a look at it, and readjust, but at this time, we have no plans to make any readjustments.

Thanks. I will get back in line.

Is there anybody here in the room that would like to pose a question? Yes, sir.

Would you comment on the areas that you serve, market areas that you serve where you receive premium pricing, and the market areas where you receive commodity kind of pricing, and give us a sense of the relative growth in each area.

The question if you couldn't hear it out there is, areas, are there market areas where we receive premium pricing versus market areas where we receive commodity pricing, and if there are what is the difference?

We strive to differentiate our products, and avoid the commodity market. There are times in certain product lines, there are certain applications, where that perhaps may not hold true, but for the most part, our product is priced as a premium product in the marketplace, because it's unique, it's different, it's better. The analogy I have used in the past is the BMW analogy, our position is more like BMW would be in the automotive market, and we avoid the commodity market.

Does that answer your question?

I guess you would have no commodity pricing anywhere.

I wouldn't say we don't have it anywhere, but for the most part it's very if he -- I can't say this product is always one or always the other. It depends on a lot of circumstances, but for the most part it is very small, and it would be in selected areas, not across the board. Even in the product line, I can't say this product is always one or always the other. It depends on a lot of circumstances, and we look at those individually as they come up, but generally speaking we avoid being in the commodities market.

Ryan, another question from the dial-in audience?

We have a question from the line of Andrea Sharkey with Sidoti & Company.

Good afternoon everyone. Quick question, I have heard from Eaton, Parker Hannifin, Sauer-Danfoss about softer North American sales that they reported in their December quarter, and projecting kind of a mid-single digit growth in the U.S. in '07, mainly brought on by recurred demand for construction equipment. It doesn't look like this affected you in this fourth quarter, and even looking at what you are projecting for the first quarter, it doesn't really look like it's hitting you. Is this something that you are expecting to catch up, or are you just kind of growing through this and if you are, maybe what are your thoughts on why this is happening?

The markets that we participate in are very broad, very diversified both in terms of the end use of the product, as well as the geographic. So that i a probably explains why we're not seeing it and some other people are. For example, as you know, the housing market has slowed down significantly. I think the people that you referenced are probably seeing some of the housing market slowdown. We are seeing part of that too, but it's a small part of our total mix.

Okay. Can you, I know you don't usually break it out, but do you have a sense how big the housing part is to your sales? Maybe 5, 10%, in that range, or higher? Lower?

I have no numbers to support it, Andrea. We really don't look at it that way. If you saw alright, give me a guess, the number I'd use is probably 3 to 5%.

Okay. That's pretty low. Just looking at the sales growth, how much of that was attributable to maybe positive foreign currency exchange?

We had about half a million over the year that was attributable to it, and quite a bit of that fell into the fourth quarter.

Okay. That seems like a pretty small percentage. Any reason for that? A lot of the other companies have seen that percentage is a lot higher. Any thought on why it's so low for you guys?

Part of it is our foreign entities are buying from us in U.S. dollars, so Korea and Germany specifically are seeing more fluctuations than they see in the U.K. The U.K. buys from us in U.S. dollars, and sells a substantial of their sales in U.S. dollars as well, so they don't see the fluctuation as much as you would expect them to see if they were selling in Pounds.

Okay. That makes sense. Is it, I don't know if it's something that you track, but could you give us a sense of the new products that you guys have been introducing during the past two or three years, how much, what percentage of your sales of those products are now contributing?

I don't have a number for that. Tricia?

We consider new products to be any products that has been developed in the last five years, and we are seeing, approximately 15 to 20% of our total sales are new product sales, based on that definition.

Okay. Great. Thanks a lot.

Thank you, Andrea. Let's bounce back to the room here. Is there anybody in the room that wants to ask a question? Yes, ma'am, back in the back.

Can you talk about some of your new products.

The question is about what types of new products we will be introducing next month in Germany.

I really don't want to get into a lot of the details because unveiled them yet, but let me just say that they are going to be electrically actuated, they are going to be very unique, and I think I will just leave it at that.

What markets would they address?

All of the markets that we participate in. Our products as we develop new products go across the board, they go into industrial applications, they go into mobile applications, very, very broad based. That's one of the strong, the strengths of Sun is the market that we participate in. We really don't look at any one particular segment. It is across the board. Anything that moves, that requires force, would be a candidate for our product.

Another question from the room.

We have heard a great deal in the political arena of how much effect both the property insurance increases, because of the hurricanes here in Florida, and the property tax increases for those industrial firms, Florida, Homestead, how much effect they would have on various companies, and how much business they would drive away from Sun. Can you tell me, Tricia perhaps, has more knowledge than anybody, how valid are those?

The question is about property tax rates and property tax and insurance in the state of Florida and what impact that might be having on Sun.

I will address the property tax issue first. We are not seeing huge increases in our property tax. We report differently than individuals do for property tax sales on residential homes, so when we are reporting on a yearly basis of all of our fixed asset rolls to the counties, we don't tend to get the big increases that you see, the 30 or 40% increases that some of the housing markets have seen, so we are fortunate in that.

In addressing the property insurance issue, we are seeing huge increases just like everybody else is on the hurricane wind coverage. The market is not there to even have availability to get it for some companies. We are fortunate that we do have some coverage in that area. Other companies are choosing to not even do it. We are looking at increases of a couple hundred thousand this year, and we are hoping the market will soften a little bit next year that we will both be able to both obtain more insurance, and for a little bit more reasonable price per million that we are obtaining it at.

Am I hearing, Allen this would not necessarily be dire a subset of the [inaudible]?

No, it's not going to chase us away, but there are some companies who would look at that tax burden and that insurance burden and decide that they are better somewhere else. Of course, our employees also have that burden. So it's not just the Company's burden. We have responsibilities to see that our employees are also in a position to be able to afford their insurance and their taxes.

So it is a factor for all of us, but it is not the only factor. Our buildings as well if you take a look at them are pretty easy to insure. They are well designed, well built. The construction, this building is not going to blow away with the first wind that comes along. We have also taken measures to tighten down on some of the areas that we could improve on, to lower our insurance rates, at the suggestion of our insurance company. So there is a lot of factors that have come into play.

Could I jump back to the dial-in for a minute, then we will come back to the room. Ryan, somebody from the dial-in audience please?

We have a question from the line of Scott Macke with Robert W. Baird.

Good afternoon everyone. I apologize, Tricia, I was wondering if you could repeat the answer to your question on the percentage of revenue generated by new sales. We were too busy laughing at Allen deftly passing that off to you. [laughter]

Sure.

Let me answer that. [laughter] Scott, just so that you know, I do know the answer. It goes something like this. First of all, you have to decide, describe what the new product mix is made up of. Our definition is a new product is anything that has been released in the last five years, that requires a new assembly number. So it's kind of all inclusive. With that definition, the answer is approximately 15 to 20% of our business was products that were developed in the last five years. Did I do okay, Tricia?

Yes.

Thank you. That is very helpful. I also kind of want to dive back into just looking at your revenue growth over the second half of last year. It certainly appears you were up unique in that year-over-year growth accelerated through the year. I think that most of the companies that we cover showed a deceleration. It sounds like you probably got a little help from the mid-year price increase.

I was also curious as 2006 progressed, if maybe you got a benefit from a compression in lead times. I remember going back to mid-year, we were talking about some capital spending at some test stands stood out. If maybe you didn't get some help, or what sort of contribution you got from some of that CapEx spending in the back half of last year?

I'll take a go at it, and if Tricia has any details I will pass it on to her. You are right, during the course of 2006, we accelerated throughout the course of the year. To a large part, that acceleration in orders, was because of our ability to ship those orders. When I look around in our industry, a lot of the people in the industry were having trouble supplying the demand that they had. And we continued to take new orders and to ship on time. That did put some pressure on our manufacturing, and it is fortunate that we had planned on some additional capacity.

Actually, we began ordering equipment in mid-late 2005 to be installed in mid-2006, particularly some CNC machining centers, which have almost an 11-month lead time. We also took advantage of outsourcing. Our suppliers played a significant role in helping us to achieve our on-time performance, and that is what allowed us to capture some market share in 2006. When others couldn't deliver they looked to Sun.

Okay. In that vain, then as we look out into 2007, and you mentioned the CapEx, sounds like it will be up just a little bit in '07 relative to '06, to $10 million. Wondering if you could comment, in terms of where that CapEx spending is going, and especially relative to any capacity constraints you foresee maybe on the horizon in 2007?

We are continuing to add CNC equipment. The CapEx that is in the numbers of approximately $10 million, I would say there's a third of it, we don't even have a plan as to exactly where it's going to be spent. Our approach to dealing with manufacturing is elimination of constraints, and to use that money to identify and eliminate constraints as they happen. So about two-thirds of the $10 million is tagged, but about a third of it is for discretionary spending, as we identify it during the course of the year.

A lot of it depends on the incoming order rate, what kinds of products are we getting, and where do we need the capacity, what can our suppliers do. So we are constantly evaluating that, I would say on a daily or weekly basis, and making adjustments on the fly as we need to.

Thank you. I will hop back in line, but let me congratulate you on another great quarter!

Thank you.

Jim.

I think the question was partly addressed already in that last sequence, but I was just going to ask what are your priorities for use of cash?

We are going to spend about $10 million on CapEx. We have got a dividend last year we paid out $4 million in dividends. That would look to be the same again. And product development, other new initiatives that we are taking a look. And there are some things on the horizon that will use up some cash.

As you can tell by looking at our facilities here, somewhere down the road we are going to have to add additional capacity, so we are taking a look at that. That is not on the horizon right now, but as we look forward and continue to grow, we will be adding additional capacity, in terms of bricks and mortar. I can't tell you when, but we are looking at it now.

Is there any other questions in the room here? Yes, ma'am.

Can you talk a little bit about your [inaudible] efforts, things like contracts [inaudible] inventory? I'm curious as to whether or not [inaudible].

The question is about our relationships with our distributors, and how they might be similar to, or contrasted to other people in the industry who have maybe minimum requirement kind of contracts, either for inventory or sales that exist in the industry.

I will take that one. We are on the opposite end of the spectrum. There nor contracts, no quotas. Our distributors represent us in the marketplace. Their obligation to us is to do the best they can selling our products, to train their people, but not to swallow so much inventory, that we want to push at them. Some people do that.

Ultimately what happens is that inventory collects, stagnates, and you end up in a downturn, with a parking lot full of pink Cadillacs that nobody wants to buy. And so our idea is to compress the cycle time. We have talked about that a number of times, where we are constantly trying to shorten the lead time of our products to take that inventory out of the channel. I don't view that inventory as a positive.

It's a negative. It's not good for the customer who has to pay for it. It's not good for us, because we have got this slack in the chain. We begin to lose real demand, and it certainly isn't good for our distributors, who are sitting on a pile of cash that they can't sell.

Can you comment on hub distributors, inventory turns, and their-- [inaudible].

Sure. That's a good suggestion, Rich. Typically, distributors look at that time margin they make on the products they sell, whether they are our products, or somebody else's products, the margin they make on the products they sell times the number of turns. That gives them a number that they kind of rank. And the number they are looking for is approximately 100. So, in other words, and it doesn't matter how you get to 100. So 4 turns at 25% margin equals 100. Okay. 3 turns requires 33% margin. Or 10 turns only requires 10% margin.

But it is the combination of turns and margin that establishes a distributor's profitability. So it ties into the inventory question. If they are sitting on a lot of inventory, okay, they have to raise their margins to pay for it. And the customer pays for that.

How are you -- how is [inaudible]? I'm sorry, what was the question? Distributors, basically getting more distributors all over the world.

How are we growing the distribution network?

Yes.

Our distributors worldwide are authorized for a certain territory. For example, in Florida, our authorized distributor is Gulf Controls. There are no competing distributors in that territory. So for us to grow our distributor base is new geographic markets.

So in the last year, we have added new distributors but they haven't been in North America. They have been in places like Eastern block countries, previously Eastern block countries. I think there has been three or four distributors added that year. One that I visited recently was our distributor in Turkey.

We are doing very well selling our product in Turkey through a new distributor, who has a branch in Istanbul, and headquartered in Ankara, to promote and sell and engineer systems that use our product. So we have a very close relationship with the selected distributors that we have, and we view them as an extension of our sales force.

To follow up on that, given the broadness of the markets which you address, do you find that your distributors are in some cases limited, in how well they can cover that broad --?

The question is whether we, if we find our distributors limiting in their ability to cover their area of the market?

What happens in that case, of course, there are cases where the distributor has a geographic territory, but from a market presence, he is not involved in a particular piece of the market. The distributor that is authorized in a territory will generally tag team with a reseller, and work with the reseller to promote our products in the market that he is not participating in.

So you get the best of both worlds. You get the local inventory, the local coverage, the local support of our authorized distributor, but you get the expertise in the market by the reseller.

Ryan, could we jump back in for a moment to the dial-in audience, please.

We have a question from the line of Brian Rafn with Morgan Dempsey Capital Management.

Yes, I just wanted to ask, what are you guys running, as far as manufacturing shifts down in Florida, number of shifts, and what kind of overtime have you had, given the demand?

The shifts are, I guess, essentially four days a week, ten hours a day, in a primary shift, and a second shift which starts and runs the second ten hours. There is some overlap in between. But that is the official of what we do. But what we really do is flex hours. And so there are people who are coming in working hours that work for them and work for us, and don't match the traditional shift approach.

Overtime-wise, we are working, I would say our average Sun employee is 45 to 48 hours a week during the upturn, and maybe some areas that are working more, but on average, I believe the number is 48 to 48. But again, very flexible.

During the course, one thing that just came to mind, during the course of '06, we actually added a weekend shift, which I believe is still operational. We have some employees that said, we would really like to work the weekends because kids are home, or not home, or family requirements, so forth, and so I believe we have, I don't know, probably a dozen people working a weekend shift, really added to our capacity, because sometimes we are constrained by a piece of equipment, not by the people running the equipment. So getting the extra hours on a particular piece of equipment is extremely helpful.

Okay. You talked about constraints in brick and mortar, and we have been grilling you for years on that. Would you describe, without delineating the time for expansion, whether you have more pressure to expand capacity on the cartridge side, or the manifold side?

You are right, you have been grilling me on that for years.

I am finding unique ways of asking the same question.

I don't know.

That sounds like Dick.

I tell you what, when we do know, you'll be the first one to know.

Okay. You guys had a treasury facility repurchase, about 2.5 million, I think it was through January 15th of '07. Did you fill that and do you have an average price maybe?

Yes. We actually filled in that the third quarter of the year. Average price was $18.50 a share.

$18.50. You talked about adding some of the CNC machine capacity. Is that milling machines, turning machines, test stations? What specific--?

We are in the process, have been for the last couple of years, of replacing some turning equipment, particularly it is Hardinge, we have got some machines that are 15, 18 years old that are three-axis machines, and we are replacing those, I guess a couple of machines a year, with five-axis equipment, which allows us to drop parts off the machine complete, and at the same time replace a 15 or 18-year-old machine.

So we gain productivity in two ways, we don't have any downtime that we are experiencing with the 18-year-old machine, and then we don't have to take parts from that machine, the three-axis machine, move it to another machine to complete the part, the part comes off complete.

Okay.

That's one area. The other area where we're having significant investment is five-axis machining centers that make our manifold blocks, again replacing equipment that has been depreciated for probably ten years.

Okay. Allen, can you quantify your shipping reliability, or shipping on time? Would there be a compression of that, or a higher percentage, say from December '05 to December '06?

There is some seasonality during the course of the year that enters into the number. From month to month, it doesn't change much.

In other words, the month of February this year compared to the month of February last year is very much the same, but we do have some seasonality to our business. Right now is high season for our products, and you would see some of our on-time shipments slipping a little bit during the high season, but it doesn't change much year to year.

Okay. So you would describe that your on-time delivery is about the same overall in '06 versus '05? I guess I am looking for kind of an incremental delta change.

Approximately the same. It probably slipped a little bit, but not noticeable.

Okay. Superb job, guys. Thank you.

Thank you, Brian. Let's go back to the room here. John, you had a question.

Yes. You had very strong organic growth over the last five or six years, a very clean balance sheet. Has there been any thought to accelerating sales growth, via an acquisition, and what is the acquisition strategy?

The question is, given the growth that we have had and the money we have generated, and most of our growth, all of our growth has been organic, is there an opportunity on the acquisition front, and what is the strategy?

That is a strange question coming from a banker. [laughter] Usually bankers like clean balance sheets. So you are selling? Is that what you are doing?

Encouraging -- [inaudible].

To answer your question, we are constantly looking for opportunities in the marketplace. We came across one a couple years ago. We invested in a small company called White Oak.

White Oak has been instrumental in some of our new product development, and the question earlier about some products at Hannover, you will see some of the White Oak products embedded into our products on display at Hannover, so White Oak in a way was an acquisition, an investment acquisition that is helping to us grow organically with our products. There are some opportunities out there.

We look at them all the time. But we don't feel compelled to make an acquisition, and go through all the integration problems associated with an acquisition, unless it is just absolutely the right thing for us to do at the time. But rest assured, we are looking, and we will try to use up that line of credit. [laughter]

Let's go back to the phone queue, Ryan.

We have a question from the line of Andrea Sharkey with Sidoti & Company.

Hi. Just a couple of follow-up questions. The sales coming out of your Korea and Germany regions were very, very strong. Obviously those end markets are really doing very well. But I was wondering if you had any sense as to maybe how much is related to just strong end markets, and how much is related to you guys just expanding your market presence and gaining share in those regions.

That's a tough question to answer, but I'll give you my best off-the-cuff guess. I believe it is like 50/50. Let me break it down a little bit finer for you. If we take a look at Korea, for the last five or six years, our Korean team has really, really been busy trying to identify new customers and new markets.

In fact, when I visit Korea, I don't ask any other question than, how is the new customers and new markets? And for them, it's a stretch, because they historically have had three or four big customers in a few markets, and they have had to shift gears and find mid-size customers and grow that way.

So they have grown with new customers and new markets, but at the same time they have been finding new opportunities, there are three or four gorilla customers have grown rapidly, to a large degree because they are shipping more of their machines into China. So Korea is benefiting from the China growth as well.

In Germany, we are picking up new OEMs in Germany itself, but we are also penetrating some new markets that we traditionally haven't done all that well in, or that we haven't been known in. Eastern block, but also in some of the heartland European countries we are also growing. It is really a mixed bag, but I think 50/50 is kind of the answer.

Okay.

Andrea, just to add a bit, one of the only magazines, there are not a lot of magazines that cover our industry, but one of them in the States is Hydraulics & Pneumatics Magazine, and they occasionally do a brand recognition study. And for forever, Sun has been by a long stretch the most recognized brand of cartridge valves in the world. So we are in these markets, but we have a very strong brand presence all over the world.

Do you have a follow-up, Andrea? She dropped. Okay. How about the room? Ryan? Anybody else in the queue?

We have a question from the line of Scott Macke with Robert W. Baird & Company.

Hello again. Wanted to ask you guys pretty routinely do a survey of the distributors in terms of inventory levels. Was wondering if you could comment on how the distributor inventory levels look at this point?

Our distributor inventory levels have been holding flat for about the last six or seven years, which is kind of remarkable, because they have been holding flat as a number as the business has grown, which means their return, their inventory returns have been improving a lot.

I think our on-time delivery reliability has made our distributors very comfortable with just holding their inventory. And historically when business grows, their inventory level grows. The good news is their inventory level does not to have grow, to support probably twice the amount of business from when we started doing the inventory surveys about five years ago.

Okay. Thank you. And I won't ask the typical question in terms of share repurchases relative to acquisitions, in terms of what you do with cash, but now obviously net cash positive with no debt on the balance sheet, just kind of looking back through the '90s into 2000, it appeared that you were running the Company with debt to total capitalization somewhere in the 20 to 25% range. Was just curious, as you look over through the cycle, is that sort of a target range that you would like to get back to, or where are you comfortable, or what debt level are you comfortable running the Company?

I don't think we really have a target, per se. Debt is a factor of a lot of things. Where do we see the future, what are the opportunities? What kind of investments do we want to make? It is a combination of strategic as well as tactical issues. There is no target that we are trying to get to, so I can't give you a number to plug into your model.

Back in '03, when did you a special dividend, can you walk us through how you arrived at the amount of that special dividend?

Well, the decision was made at the Board level, and there were discussions that went on for, perhaps six months to a year at the Board level, as to the reasons why, the reasons why not, what are the opportunities, timing enters into it for sure. But again, there are a lot of factors that enter into it, and the decision that we made three or four years ago and the factors we went into it, I'm quite sure that those factors and timings would be significantly different today.

Fair enough. And then wanted to follow up on a question that Andrea asked earlier, in terms of U.S. growth relative to international growth.

Over the back half of last year, the two seemed pretty equivalent, in terms of magnitude of growth on a revenue basis. As you look at the order book development, or the order intake, January and February, are the two, in terms of year-over-year growth, are they equivalent still, or are you seeing a divergence between international growth say being stronger than U.S. order growth?

For the incoming orders in the first part of '07, which we have for January and February, we are seeing, they are staying is about the same as what they were in the fourth quarter as far as the division between North America and the Europe and Asian grouping, which were similar to what we gave on the year-to-date data in the scripted part of the call.

Thank you. That's helpful.

14% North America growth.

All right. Thank you. Appreciate all your time.

Thanks a lot. We will take one more question from the audience before we conclude the call. Is there anybody left out there, Ryan?

We have a question from the line of Brian Rafn.

You got the last one, Brian.

Okay, I will bat cleanup. On the questions you guys have talked when you put the new control systems in, can you get a sense as to what, you guys have talked about packaging. Can you get a sense as to what the cartridge manifold demand is in packages, or what you have sold them integrated with control systems, versus just one individual where the cartridges versus manifolds? Give me a sense in sales or volume, unit volume, whatever you want to describe.

I believe our assembly business, which we classify as cartridges with the manifolds is about 22 to 25% of our business, is in that packaged business, and it's when we package it. So it's probably even higher, because there are times where our distributor will buy the cartridge and the block separately, and package it himself, because there may be other products, so it's at least a fourth of our business, and probably higher. The business usually starts out with a cartridge selection, or a cartridge selection, and a typical package would include somewhere between 5 to 10 cartridges in a block.

The circuit is configured with the cartridge selection, and then the next question is, okay, the customer is saying, I am satisfied with the cartridge selections, it will do the job I want, but now I have to package it, and so Sun, would you package this for us in a way that is the smallest, or perhaps has the ports over here, or configured in a certain way, and that is when the manifold package comes in. It starts with the cartridge, but at the end of the day it is the package and how it's put together that differentiates it significantly in the marketplace.

Our job is to be able the do that packaging with five-axis machine equipment, five-axis design, in a way that is superior than what anybody else can do. A customer oftentimes will look at alternative ways of packaging it. It still would use our cartridges but perhaps not the way we would package it. So as we have grown over the last three or four years, we have gotten better at being on-time with quoting, with using five-axis design, and shrinking the package, and if you can do that, oftentimes it takes costs out of the overall system. It has been a large part of our growth in the last three years.

Does the website and the configurations you are talking about going forward, does that also help that process?

Absolutely, because the cartridge selection starts out with usually web specifications and web information, and then the packaging is done after the components are selected.

Okay. Superior job, guys. Thanks again.

Thank you.

Thank you, Brian, and thanks, everybody, for joining us. I want to add, before we close, two things. I would just like to tell everybody that the first quarter earnings are going to be released on Tuesday, May 8th, and Sun will hold its Annual Meeting of shareholders here in Sarasota on Tuesday, June 19th. Thank you all for joining us on the call.

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