Helios Technologies Inc (HLIO) 2007 Q3 法說會逐字稿

Greetings, ladies and gentlemen and welcome to the Sun Hydraulics, third quarter 2007 earnings conference call. At this time, all participants are in a listen only mode. A brief question and answer session will follow this 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 for Sun Hydraulics. Mr. Arter, you may begin.

Thank you. Good afternoon, and thanks for joining us for Sun Hydraulics third quarter earnings conference call. We are initiating this call from the offices of Flodyne/Hydradyne Sun's distributor in the Chicago area. With me are Sun's CEO and President, Allen Carlson; and Tricia Fulton, Sun's CFO. 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 this mornings press release. I would now like to introduce, Allen Carlson.

Good afternoon. Robust demand led to increased revenue and profit for the third quarter of 2007, while the U.S. economy appears to be moderating as indicated by recent PMI reports, we are pleased with our performance. With double digit growth every quarter for the past four years, we believe Sun's sustained growth continues to outpace the industry.

One of the important reasons for our success over the past few years is our geographic presence. This has helped us achieve a good balance between domestic and international sales. Sun's international demand has contributed significantly to our performance this year with 82% of our year-to-date sales growth generated in Europe and Asia. Year-to-date international sales make up 58% of the total sales of Sun. Our local presence in Europe and Asia has facilitated penetration of those markets and allowed us to capture market share.

Another driver of our success is our electro-hydraulic product introductions which help us see more integrated package opportunities. To further this effort, last week we announced our intention to take an equity stake in high Country Tek Incorporated. High Country Tek designs and manufactures ruggedized electronic hydraulic control solutions for mobile equipment markets. Their products include digital valve controllers and a patented suite of software products that complement our electro-hydraulic efforts including our earlier investment in White Oak Controls. High Country Tek will help us get closer to our customers so we better understand their design requirements. This is especially important as we move more towards total system solutions. We expect our relationship with White Oak and High Country Tek will help further increase Sun's market share.

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

Thanks, Al. All comparisons will be to the same period last year. EPS figures reflect the 50% stock dividend recorded on June 30, of this year. Sales were up 16% to $41.8 million as growth continued in the third quarter. Europe and Asia experienced significant increases with sales up 33% and 30% respectively. North American sales were up 1%. Incremental sales allowed additional profit to flow to the bottom line with earnings up 33% to $5.2 million. Basic and diluted earnings per share ended the quarter at $0.32, an increase of 33%. Gross profit increased 25% to $13.3 million. Gross profit as a percentage of sales continued to be strong, up 2.5 points to 32%. Margin increases were achieved through productivity gains and absorption of fixed overhead costs by the additional sales volume.

While year-over-year our margins have increased, we have experienced margin erosion throughout 2007. We have continued to see our cost escalate since our last price adjustment in July 2006. Cost increases related to energy, material, and fringe benefits including our employee health insurance. While we constantly strive to improve our internal efficiency and productivity, we're unable to offset this cost escalation completely with productivity gains. Therefore, we are implementing a price increase effective January 1, 2008. This is a selective price increase that is expected to result in approximately 1.5% additional revenue next year.

SEA increased $600,000 to $5.3 million. The increase was driven primarily by higher costs associated with stock based compensation and professional fees relating to tax and legal matters. Our effective tax rate was 36.6% compared to 33.6%. The increase was attributable to the completion of the Company's 2006 U.S. tax return which resulted in a provision to return trueup. We expect our fourth quarter tax rate to be approximately 34.5% and the overall 2007 rate to be 35%.

Net cash from operations was $19.8 million, up $4.6 million from last year. The increase is due to higher net income of $4.6 million coupled with working capital changes. Days sales outstanding were 40 and inventory turns were 10.1. We continue to look for ways to drive further working capital improvements.

Year-to-date capital expenditures were $9.4 million and our estimate for the year is $11.5 million. Third quarter purchases were primarily for new machinery or equipment in the U.S. A quarterly cash dividend of $0.09 a share was declared in the third quarter and paid in October.

Fourth quarter demand is expected to remain strong. Sales are estimated to be approximately $40 million and earnings per share are estimated to be in the range of $0.28 to $0.30. This represents an increase of approximately 14% in sales and 26% in earnings per share over last year. 2007 sales will be approximately $166 million, a 17% increase over 2006. Net income per share for the year is expected to range between $1.31 and $1.33 compared to $0.99 for 2006, up 33%. Thank you. Rich will now open the call for Q&A.

Okay, if we could take some questions from the dial- in callers, now would be the time.

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Chris Weltzer with Robert W. Baird & Company Incorporated. Please proceed with your question.

Good afternoon.

Hi, Chris, how are you?

I'm doing well. A couple questions for you. Do you have the currency impact on revenue growth for the quarter?

Yes. The effect for Q3 was $730,000 which represents 1.7% of sales.

Okay, thank you. And then could you give us an update I guess on what you saw in the way of order trends in October and early November, specifically any difference in the domestic environment versus international?

We continued to see the international orders up above what we're seeing in North America but the order trends for October are up over last October by about 33%.

Okay, wow, okay.

October was very strong, and we would think that November and December perhaps may not be quite as strong but we're looking forward to a very strong year-end, and October sort of started us out for the quarter in a good position.

Excellent. And then it seemed like North American revenue growth maybe slowed a bit in quarter. Could you talk about where you're seeing the slowness specifically and what markets got incrementally weaker quarter to quarter?

We really don't look at it that closely so for us to give you any information that would detailed out something useful for you would not be accurate.

Okay, no problem. And then how do you feel about your current inventory levels at distributors given the slowness in North America?

We just completed the third quarter inventory analysis, and the inventory at the third quarter compared to the second quarter was the same and the third quarter this year compared to third quarter last year was also the same. So there's been no movement in inventory which is good news.

That's absolute levels of inventory?

Yes.

So on a day sales basis it's actually gone down?

It's gone down. It's actually gone down for about five years if you looked at it at a days sales outstanding because the numbers remained pretty constant. And I think maybe a year or so ago we addressed it but it might not be a bad idea to refresh everybody's memory as to why that is. It's our ability to ship product from our factory to customer request. Our distributors around the world can find inventory amongst themselves or get it direct from the factory on an as needed basis with a high degree of confidence that that will happen.

And then one more and I'll jump back in queue. Can you talk a little bit more about High Country Tek, particularly what it adds to your product portfolio and your motivation for taking a stake and then a little bit about the structure of the deal, when it should close, et cetera, how you think it should -- will impact your financial results?

This is Al. I'll take the first part of the question and turn the second part over to Tricia. We've been aware of and been working with High Country Tek for perhaps a year and throughout the most part of this year, we've been working on structuring a deal such as this. The motivation behind it is that we see each other at customers and at some key distributors, and our customers and distributors are looking for solutions, a total solution to their control needs, and today, we provide a part of that solution and other packages and systems integrator people like High Country Tek would provide another. So we see High Country Tek as being additive to our ability to focus and get closer to the customer, in a meaningful way. So it's -- for us it's a strategic initiative. It's important because it not only brings us closer into the marketplace but it gives us an idea of what people are looking for and perhaps we'll create some new solutions jointly that will be exciting in the marketplace for customers and distributors. Trish? Would you like to take the second part of that?

Sure, I think you had two parts to your question. One was on the structure and one was on the financial side. As far as the structure goes we can't really give a lot more detail than what we did in the press release since it has not been approved the shareholders of HCT yet. They will have a shareholder meeting in mid November to approve the transaction and at the end of November we're expected to sign the closing documents but we really can't give a lot more detail than what we have. The total purchase price is again about $2.4 million and it will give us 48% of the Company initially and on a fully diluted basis for outstanding options and warrants it would give us about 36%.

Turning to the financials, given that HCT is a private company, we can't really divulge any of their financial information at this point but from the effect of what it will do to Sun's financials we will be combining them through the equity method so there will be a one line item of any profit or loss from that operation that will hit each quarter, we expect it to be minimal.

Okay, thank you. I'll hop back in queue.

Thank you. Our next question comes from the line of Will Lyons with Westminster Securities. Please proceed with your question.

Hi, guys. Congratulations on another good quarter.

How is it going, Will?

Excellent. How are you?

Great.

I have one question based on your comments that Europe and Asia were especially strong. You mentioned the, I'll call it the macroeconomic situation in those regions but what sort of contribution was there from things that are internal to Sun Hydraulics? New products, additional people? Give us some flavor for what you've done on a proactive basis to make some of that happen?

I'll try to paint the picture and I'm not sure I can support it with hard financials or numbers, but for example, a couple years ago we added some new salespeople in Germany, and the incubation period for those new salespeople has passed and they're out delivering new orders with new customers in new markets. That's one example in Germany. We've got a similar situation going on at some of our other locations. In, I believe it was in 2003, we started a joint venture -- not a joint venture, but we started a wholly owned Company in France and that's beginning to show some new business in that market. I think our business in France may be up 50, 60% compared to what it was before that. Similar is in China. Similar situation is in Korea. We've opened a new office in Pusan in the South part of Korea. While that hasn't yet done anything for us because it just opened last quarter, initiatives like that are going to contribute to both the top line and the bottom line. In, I believe it was in October, we, or September we announced the opening of a new office in India. So there's a lot of initiatives that are going on that are contributing to our success on an international basis. Could I segregate it and try and paint a more exact picture, it would be very difficult.

On the product side, earlier this year, we introduced at Hanover Fair, embedded electronics and some valves with censors. While that's just beginning to generate some business, it certainly has created some interest in our product, for those particular products but the pull through effect of other products. Our Korean business as I said earlier is doing very very well. On top of that, I think what's driving the underlying element of this is our website. Our website puts us on an international stage, open 24/7 and today in multiple languages. We have German, we have some French and we're currently working on a Korean website. So all of these things come together to help drive our growth.

What percentage of your orders are then coming through the website?

We don't take orders from the website. The website is there to provide information so that our products can be specked around the world. It's a delivery mechanism for technical information for our customers. Our distributors around the world do fulfillment.

Right, and finally, so now, what percentage of your, let's just do it by terms of dollar revenue, is produced outside the U.S.? Roughly, I realize you may not keep track of it dollar for dollar?

58% is outside the U.S.

Yes.

Are you talking product production?

Production, that's right. Not sales, production.

Production. That would be manifolds in remote locations as well as field products in England.

And local value-added services, my guess is probably 15, 20% production.

Interesting. All right, that's all I had. Thanks a lot.

Yes.

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

Good afternoon, everybody.

Hi, Brian.

You guys talked about on your CapEx side your budget was $11.5, you said you put some, I'm assuming tooling or machinery. Could you kind of describe what you installed and was it capacity or more throughput productivity?

It's both. Most of the equipment that we've put in are CNC machining centers. I think we've put in four maybe this year.

Two in the UK.

And two in the UK for a total of six. It's primarily for capacity but at the same time, we take out older pieces of equipment that perhaps have half the productivity on a per hour basis, so we end up getting capacity and productivity gains at the same time and usually, within the same floor space.

Okay, within the same floor space. You talked about the price hike that's going to be affected. Did I get you right that you're looking at about 1.5%?

That's right.

You broke out, you talked about energy oil and gas. Can you give us a sense maybe individualized from a cost basis what you're up, you say year-over-year in steel, ductile iron, health insurance, energy, can you give us a sense, what the inflation, how it kind of segments out all across your cost base?

Not really. We run operations around the world in multiple locations and during the course of the year, it changes. Earlier in the year, it was aluminum. Later in the year, it perhaps healthcare costs so very difficult to put a number on each one of those elements.

Okay. What are you guys seeing just take U.S. Health care? Everyone is kind of annualizing their sign up programs. What are you seeing year-over-year just for the U.S. workers down in Sarasota?

We're seeing about 10 to 12% which I think is at or below the industry average. We run a self-funded plan which helps keep the costs down from the fully insured plans but we are seeing increases year-over-year in that, but that is also with some additional workers. We have about 60 more people than we had last year at this time.

Right.

So it's about 10% more.

Okay, that's good. How many shifts are you guys running down in Sarasota? What's kind of the--?

Whatever we need. We've got multiple shifts. We've got some working four ten hour days, we've got some working five eight's, we've got a weekend shift, we've got a night shift, ve've got a crossover shift. We're a very flexible and agile workforce and that's one of the advantages that we have that allows us to continue to meet our incoming order rate and providing reliable production. Our workers are flexible and the ability to get things done on an as needed basis. Do you have a lot of transition with -- from a lifestyle standpoint, people being maybe cross-trained going from five to eight daily to the weekend shift as people age and kids, that type of thing, do you do that or are they pretty structured in their slots? No, it's not structured at all. They're free to sort of move around. We've got Summer people that got kids at home that during the Summertime, they may want to work the weekend shift and the rest of the time not. We try to accommodate them and they try to accommodate us. It's a team effort and as a result, we get what we need and they get what they need.

Okay, can you tell us, talking about the website traffic and the specification functionality and you talked about delivering technical information, what has your cycle time compression say from today versus five years ago in doing an engineering specs and talking with the customer and getting that technical information versus getting orders and shipping. Can you give us a sense in magnitude, maybe the last say three to five years?

Probably been cut in half.

Okay.

Round kind of number.

Okay, and today an order might run what? Days, weeks, trying to get a sense as to what and obviously different orders are different by size.

Our average lead time is about four weeks on average, but I know last week, for example, 23% of our incoming orders were booked at less than four weeks. Some of it due today, came in on last week Friday, so all of our orders are entered to customer request, whatever they need. On average, we would probably be four weeks.

About four weeks. Okay, can you talk, Allen, as to what sense do you guys have in total when you talk about system solutions, total integrated hydraulic packages? What would that constitute of total sales versus just manifolds and cartridges, you're talking about total solutions with electronic controllers.

No, I don't have a handle. I know it's growing. It's probably doubled in the last five years.

Well, could you give me a sense of scale? Is it less than half, a third, 20%?

20%, round number.

Okay, I'll get back in queue. Thanks, guys.

Thank you. Our next question comes from the line of [Tom Whitecap] with Value Holdings Management.

Hi, good afternoon.

Hello.

Looking through your segments, Germany represented the only quarter-over-quarter acceleration in sales growth. Is that something to look deeper into or is there any explanation behind that? Just how the numbers fell.

Yes, are you looking Q2 to Q3?

Yes.

We generally see a decrease from Q2 to Q3 in all business segments. Q2 is historically if you go back five years the highest quarter that we have, so it would be expected that we would see decreases in each segment quarter to quarter sequentially.

Well I guess my question is, that is the case in all, but the German segment--.

Germany put in a new software system earlier in the year and so they've changed their ordering pattern and they now place their orders more on an as needed basis as opposed to entering large orders at the beginning of the year so some of those orders that historically would have been entered January, February, March are now being entered in September, October, November. So it's just a software implementation that's smoothing out the input of orders throughout the course of the year. You'll probably see it in the fourth quarter as well.

Okay, and in terms of the new India venture, can you give any sort of update on how that's going?

No.

Nothing too material in the last two months?

Too early. It's too early. The whole approach with our India venture is to do some prospecting, understand what's going on in the marketplace, it's homework. It's establishing where we're going to go and painting us a picture, a road map for the future, so after 29.5 days it's a bit early to get that picture.

All right, fair enough. And in the press release for the High Country Tek, I guess call it equity investment, you talk about contemplating purchasing the remaining stock by 2009. What sort of contingencies are out there that would either inhibit you or enable you to go ahead and buy out the rest of that stake?

The whole idea with High Country Tek is to give us two years for us to understand the business, to work in a relationship that's closer, and essentially to give us eight quarters to figure things out and decide where we go from here.

Okay, and kind of piggy-backing off one of the earlier questions, can you kind of elaborate a little more on the strategic direction that this investment takes you? And I realize that it's going to be more complete control solutions but can you kind of describe incrementally on top of your manifold and valve offerings right now what this investment may offer you?

It gives us the opportunity to go to the customer and say to the customer, your control system, your censors , your program logic, your control system looks like this. The output of that control system drives your hydraulic components and we believe by working together, the component selection as well as -- from both the electronics as well as the hydraulic hardware to provide better, smarter, faster solutions to the total control system. Additionally, the High Country Tek package is software -- is a piece of hardware but can be tailored for a variety of applications through software development. So we believe that not only will we be able to provide a shorter solution, a better solution to the customer but the time to get that solution in their hands will be quicker. Today, most customers are looking to consolidate their supplier base, and most people that we've talked to said the ability to deal with a Company that can do both controls, software, and the hydraulic hardware and to be able to come to the table as a team and paint us that picture to do that is a real plus.

I know you may not be able to comment on this, but I'll try it anyway. Does this kind of allow you to make other bolt-on acquisitions towards allowing a more complete system solution? Is there anything in the pipeline in terms of acquisitions of other equity investments?

We're always looking to be able to paint that picture more complete with our customers, and so I wouldn't say that there's anything that's going to happen in the next 30 to 60 days but we're always looking for the ability to do more for the customer.

Without getting into specifics can you kind of elaborate on what the next step may be in terms of add-on product offerings to your systems?

No, not really. Not at this time.

Okay, and then one last thing. In terms of end market applications, are there anymore niches within the mobile equipment market that the HCT investment will enable you to go after? Or is this just kind of a holistic investment that will allow you to just get a better control system out there?

There's some elements of the second part but I think it's going to take awhile for it to play out. I think when we roll up our sleeves and start working with customers and distributors and the High Country Tek people, there will be some things that will shake out of it that won't be the holistic control that may be a control solution for a particular market segment. We already see some of those segments beginning to show up but I really don't want to elaborate on what they would be right now.

Okay, great. Thanks so much and good luck next quarter.

Thank you.

Thank you. Our next question is a follow-up from the line of Chris Weltzer with Robert W. Baird. Please proceed with your question.

Hi, guys.

Hello.

Just a couple quick ones. How should we be thinking about a tax rate going into 2008?

I think that the overall tax rate that I stated, the 35% for 2007 will carry forward to 2008. That puts us pretty much at the top of the tax rate brackets in the U.S. We may see a small decrease from the tax changes that are being implemented in Germany that might take us down to 34.

Okay, and then how about CapEx? I mean, do you continue to, or expect to continue adding selected machine tools?

I think CapEx will be a very much like 2007 for 2008. As we continue to grow, our approach to manufacturing is identifying constraints and resolving those constraints. Part of the resolution typically means that we need CapEx to do that. So as we continue to grow at the rate we're growing , I think the CapEx will remain about the same.

Okay, thank you very much.

Thank you. We have another follow-up question from the line of Brian Rafn with Morgan Dempsey Capital Management.

Yes, down in Sarasota, you guys certainly with -- I think you talked on the CNC side about adding productivity and efficiency in the same floor space. Are we knocking any walls out either for cartridges or manifolds in the factory down in Florida?

No. We're not knocking walls out, not the external walls. There are a few internal walls that flex a little bit. For example, we've just consolidated some of our manifold CNC machining to a footprint that perhaps is 10 or 15% less to create some space for some automation equipment that we're putting in, but there's no bricks and mortar going up right now.

Okay, so can you kind of say, Allen, maybe medium term next few years would that be about the same? As far as being able to use your current footprint and factory to certainly deliver the production?

2008, I don't think you'll see us adding any bricks and mortar for 2008 and we continue to monitor that as we go forward. As we continue to grow, we'll see what we need.

Okay. Does your acquisition of High Country Tek, are there any mutually exclusive customers? I mean, you talked about adding certainly electronic controllers and solutions and integrated turnkey packages. At the same time, their customers would give your hardware size. Does that at all leverage it, or are there customers that they have that you don't have or are they all pretty universal?

No. It's pretty much true. There's customers that they have that perhaps have never experienced our product and I think it's also true, we've got customers that perhaps are looking for control solutions that have never heard of them and that's from a domestic standpoint. High Country Tek really is a U.S. based company only, so one of the pluses for them going forward is they look at our 58% of our businesses outside the U.S., with that opens up a whole new world to them that they couldn't get to without our involvement.

Okay. Thanks, guys. Appreciate it.

Thanks, Brian.

Thank you. At this time think are no further questions. Do you have any closing comments?

No. We would just like to thank everybody for joining us on the call. We will be presenting tomorrow afternoon at the Baird 2007 industrial conference, that's why we're here in Chicago. So if anybody is in the area come on over and see us. Thanks a lot.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.