Helios Technologies Inc (HLIO) 2008 Q4 法說會逐字稿

Good day, and welcome to today's Sun Hydraulics fourth quarter 2008 year-end conference call. Today's call is being recorded.

At this time I would like to turn the call over to Mr. Dennis [Tiesio]. Please go ahead, sir.

Good morning. Thank you for joining us for Sun Hydraulics 2008 fourth quarter year-end earnings conference call. Allen Carlson, Sun's President and CEO, and Tricia Fulton, Sun's Chief Financial Officer, are participating in today's call.

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. We will take questions once we have completed our prepared remarks.

It is now my pleasure to introduce Allen Carlson.

Thanks, Dennis. Good morning everyone. Sun had a tremendous year in 2008. The financial results surpassed any other year in Sun's history, but equally as important was our continued ability to reliably deliver highly differentiated quality products and services to our customers. We launched new products in April at the International Fluid Power Exposition, which were well received by the marketplace. New products are key to maintaining and growing our market share.

2008 started with strong demand that continued through the third quarter, however in the fourth quarter we began to see a precipitous drop in order rates, and there was no good news on the horizon. Current order levels are now around what we saw near the end of 2003 and the beginning of 2004.

We are cognizant of the impact this recession has already had on our customers, and what a protracted global downturn will mean for our business levels going forward. We have taken steps to mitigate the financial impact of the weak demand. Overtime in our factories has been eliminated in all shifts, and 2009 salary increases have been postponed for 30 members of our leadership team.

Our manufacturing plants were temporarily idled around the holidays, and we have reduced discretionary spending on items, such as consulting services, outside services, and supplies. That said, we will not sacrifice investments that will enable us to grow our business in the future. Our focus remains on being prepared for the next growth cycle, developing new products, and enhancing productivity.

Our balance sheet is strong, and we have ample cash to continue investing where we believe it is necessary. Sun prides itself on having a long term vision and approach to running our business. We believe it is important to share our success with employees and shareholders. 2008 was an excellent year financially, and Sun's Board has elected to once again declare a shared distribution.

We first introduced the concept of a shared distribution in March 2008. It allows for an additional cash dividend for shareholders, and additional retirement plan contribution for employees. Based on 2008 results shareholders will receive a one-time $0.09 per share dividend later this month, and employees will receive an additional 9% contribution to their retirement plans, including the Sun Hydraulics ESOP.

The cash dividend for shareholders is in addition to the normal quarterly dividend. The majority of employees will receive their share distribution in the form of Sun stock. While a shared distribution might not be available every year, we felt it was appropriate for shareholders and employees, to benefit from the financial success Sun achieved in 2008.

Tricia will now discuss the specifics of the fourth quarter and 2008. We will then take questions. Tricia?

Thank you, Al. All comparisons will be to the same period last year. I will first review the fourth quarter.

A dramatic drop in demand led to the fourth quarter decrease in sales of 20%, which resulted in a 52% decrease in net income. Foreign currency fluctuations were responsible for 5%, or 1.8 million of the decline in sales. Basic and diluted earnings per share were $0.15, a decrease of 52%. The employee portion of the share distribution which Al mentioned, accounted for additional expense of $0.06 a share in the fourth quarter. EPS before adjustment for the share distribution was consistent with our guidance at $0.21.

Sales for the fourth quarter were down in every region across the globe. Sales to North America posted the smallest decline at 11%. Europe decreased 22%, and Asia was down 46%, resulting primarily from a drastic slowdown in Korea.

Turning now to the annual results for 2008. Sales were up 7%, as net income rose 16%. Foreign currency had very little effect on the sales for the year. Basic and diluted earnings per share were $1.55, up 15% and 16% respectively. Sales grew in all regions for the year, North America increased 6%, Europe rose 9%, and Asia was up 2%. Please note that these numbers reflect sales to each region. The sales reported in the segment information of the press release represent sales from each geographic operating unit.

Gross profit increased 7.8% to $59 million. Gross profit as a percentage of sales was up 0.5 point to 33.2%. Margin increases were achieved largely by the additional sales volume. 2008 margins were very strong in Q1 and Q2 at 35% and 37%. We saw some deterioration in Q3 when margins slipped to 33%, and the sharp decline in Q4 sales resulted in gross margins of 25%. Sun's fixed cost base worked to our advantage over the last few years, when we were able to leverage these fixed costs against consistently rising revenue, however the inverse is true in periods of rapidly declining sales.

SG&A increased 7% to $22.7 million. The increase was driven primarily by higher retirement plan costs, related to the share distribution, professional fees, and compensation. Our effective tax rate was 31.8% compared to 35.6%. The lower tax rate is due to the decreased tax rate in Germany, as well as R&D tax credits, manufacturing deductions, and temporary differences in the US. Net cash from operations was nearly $38.5 million, up 10 million from last year. The increase was due to higher net income of 3.6 million, offset by working capital changes. For the year, Day Sales Outstanding were 30.

We have not had nor do we anticipate any issues with collectability, even in this difficult economic environment. Inventory turns for 2008 were 11. Our manufacturing leaders continue to do a great job of managing inventory levels, which can be particularly difficult in a period of declining sales.

Capital Expenditures for the year were 10.9 million. These purchases consist primarily of machinery and equipment, but also include 2.5 million for land purchased in Sarasota. Capital expenditures for 2009 are estimated to be 7 million. A quarterly cash dividend of $0.09 a share was declared in the fourth quarter and paid in January. The Board also declared a share distribution on February 27, 2009, for a special dividend of $0.09 per share that will be paid on March 31, to shareholders of record on March 15th.

Taking a look at our outlook for 2009, first quarter sales are estimated to be approximately $25 million, with net income estimated to be on the positive side of breakeven. This represents a 49% decrease in revenue from Q1 last year. The effect of currency on the Q1 estimate is approximately $2 million.

While this is a substantial decline in both revenue and earnings, we know this business cycle will turn back up, and we will be ready when that happens. When we look back at the previous business cycles, it is evident that the investments we continued to make throughout the cycle, translated directly into new business opportunities.

This resulted in market share gains that fueled both our revenue and earnings growth for the last five years. The first quarter numbers are not where we would like them to be, but looking longer term, we know that when the business cycle turns back up it happens quickly, and we will be in a position to take advantage of the recovery.

Thank you. Angel, you can now open the call for Q&A.

Thank you. (Operator Instructions). We will take our first question from Jon Braatz from Kansas City Capital.

Good morning Tricia, good morning Allen. A couple questions, Allen, you referenced 2003/2004, and in 2004 when I go back and look at the numbers, your gross margin was about 30%, and in the fourth quarter here, I think your gross margin was around 25%. I know you employ a lot of operating leverage, but when you compare 2004 to 2009, are you that much more leveraged operationally, such that while we have these tough times, we will see that gross margin 3, 4, 5 percentage points, a little bit lower than in 2004?

I will take a stab at answering this and then I will turn it over to the financial types, maybe they can provide a little bit more color to it but in my mind, I don't equate 2009 to 2004. I equate 2009 more to like 2001 or 2002.

Okay.

2008 perhaps is, or maybe even the average of 2006, 2007, and 2008, might be more like 2004, but certainly 2009 is more like the bottom of the last cycle which was at '01 and '02, not '04.

Okay.

Tricia, anything you would like to add?

No. I agree with that and when we were making the comparison as far as order levels, we were just trying to give you an idea of on the revenue side where we stand, but Al is right. When you look at the effect that the recession is having, as far as what it is doing to margins, the '01/'02 timeframe is much better.

Tricia, Allen, are you doing anything differently in this down cycle than the last down cycle, any additional costs that you can take out of the business, or is it pretty much sort of similar in what you are doing compared to 2000/2001?

I think the effects of the recession at the bottom of the cycle is very much like it was, and I think how we got there was a little different. In 2001/2002, we didn't do it to ourself. In this downturn I think we have done it to ourself, but the effects are very much the same, and I think it is going to play out very much like it did in the previous cycle as well. We will come out of it, and we will come out of it strong.

One last question and I am being a little bit lazy here. Did you pay a dividend back in 2000/2001 and if so, during the downturn did you cut the dividend, or scale back at all?

No. We did pay a dividend. We have actually paid the dividend every quarter since we have gone public in '97. We did not decrease the dividend at that time it was a flat dividend through that period, we didn't increase it, we did toward the end of the last downturn, but we did not decrease the dividend at all during that period.

Okay, thank you very much.

Next we will go to Kristi Kubacki of Avondale Partners.

Good morning, everybody.

Hi, Kristi.

I just had a couple questions, in terms of the investments I was wondering if you could give us a little bit more color around that, in terms of both people and plant, and how are you looking at capacity ahead of the next cycle?

Okay. In terms of investments in people, we have got a lot of training going on, cross-training in our production areas, some outside training in machining courses, the State of Florida has some course work that is available for manufacturing people. That is the investments that we are making in our people, besides maintaining the workforce, so that as we come out of it, we have a full slate of production ready people, and better people.

We are rolling out a wellness program, so that as we come out of this, again we will have not only more capable and more capacity but our employees will be healthier employees, which will also help us with our healthcare costs going forward. Those are the kinds of people investments that we are making.

The second part of your question I think had to do with what other areas we are making investments, is that right?

Yes, and then I guess on the back end of that would be how are you looking at capacity? Is that part of the investments that you are looking at at this downturn?

Okay, well our approach on capacity really hasn't changed for nearly 10 years. We take a look at what the constraints are, where they might be. We do some look forward if this happened, what would our capacity constraints be, especially true today, because you don't see any constraints at all, so you have to do a little bit of role playing, to predict if this happened where might you have capacity constraints, but we are always looking at constraints, root cause, corrective action, and where we have limited capacity making an investment, but only after we have checked with the marketplace, to make sure that that capacity is going to be required going forward.

That is the approach. We don't do a theoretical capacity planning per se, a classic capacity planning. We saw in the last business cycle that we would have exceeded maybe by a factor of 2 times our theoretical capacity, and we did that by addressing constraints in our system.

Okay, and then kind of a bigger picture question, trying to focus on maybe finding something positive. Globally, is there any market that you see out there that is perhaps not as worse as the others, and what kind of markets can you see globally, either geography or by end market, that perhaps would we look to to see recovering in the return of the economy?

We continue to do very well in China as an example, even though our business in Asia was down, that was primarily the result of what is going on in Korea, but business in China continues to be strong, and we continue to see growth in that area. Is there a bright spot? Probably, I would have said three or four months ago in the energy sector, but I am not even sure that the energy sector is a bright spot right now, with the price of oil dropping to where it is. I think it will come back, and I think there are investments that are being made.

The stimulus package is going to have an effect on infrastructure type projects, and any time that something is being built or torn down, our products are used in that activity, so there is a bright spot. It is the stimulus package when it plays out to investments in infrastructure projects around the world. China also passed it's own version of the stimulus package, and I believe theirs is going to take effect quite rapidly, and it is almost all on infrastructure type of projects.

Any guess as to when would you see any impact in the US of stimulus?

I don't know that I am very qualified to make that prediction, but my gut tells me that we are well into the bottom of the cycle, well into it. We are well like probably six months into it, and typically these cycles last about a year. I don't think this one is going to be significantly different, and so if you kind of look at it from that perspective, we should start seeing some changes in momentum sort of around mid-year, third quarter, and going into 2010.

By the way that is also pretty consistent with what I have read by a lot of the economists, a lot of what is going on right now is a psychological factor, and we have got to get beyond the psychological factor, and I believe once we do, the economy will start going forward.

I hope so.

That is my view.

Thank you very much for your time.

Okay.

Next we will go to Chris Weltzer of Robert W. Baird.

Good morning, everybody.

Hi, Chris.

I was wondering if you could talk a little bit about your distributors inventory levels, and whether the 49% revenue decline you are expecting this quarter, is in any way a function of inventory destocking going on there?

We don't have any hard numbers. We will towards the end of March, we do that inventory analysis quarterly. There was a slight dip towards the end of the year, but it wasn't significant, so I don't have any hard numbers to share with you. But I can tell you that I have just come back from an Industry Association Conference, the Spring National Fluid Power Association Conference, and it was an opportunity to talk with many manufacturers in the fluid power industry, many of the distributors and the suppliers, whether they are our distributors, or some other brand distributors, and the sense that I got from those conversations was that yes, indeed, there was destocking going on.

It is one of the few levers that distributors have at their disposal during tough times. They have two things. They have inventory and they have employees, and they would rather cut their inventory than cut their good employees, so I believe there is destocking going on.

When I talk to other manufacturers in the industry, it would seem that Sun's drop in sales was sooner and probably deeper, faster, than what we have seen with what I saw in the conversations with other fluid power manufacturers, and one of the big differences is that we have a distributor channel. That distributor channel typically racks quickly on the way down, as well as on the way up, so I will have some hard numbers around the end of the month, but my sense is that there is some significant destocking, and by the way it is not just in North America. I believe it is taking place in Europe as well.

That is very helpful, and a good segue to my next question. Can you talk broadly about how the industry is reacting to the slowdown? Have you seen competitors getting more aggressive on pricing? Because I realize not everyone is quite as nimble as you, and able to cut production as quickly.

The competition to some degree is more severe, pricing is obviously in a down economy, whether you are selling groceries at the grocery store, or hydraulics at the hydraulics market, pricing is more of an issue in this kind of economy. Having said that, our approach has always been to sell a premium product, and provide a quality service, and a quality product at a fair price, and so we don't play a lot in the pricing game because of our approach to market. We don't discount.

The analogy I like is the automotive analogy, while Ford, Chrysler and GM are discounting everything, some of the upscale products, like BMW and Audi, and some of the others, they don't shave their prices during the downturn, because they can command a premium for their product. It is a fair price. Kind of where we are positioned in the marketplace. There are always a few exceptions to that rule, but for the most part, that is it.

The other thing that is happening in the market I guess is a positive thing. There are a fair number of our competitors who have disappeared. That happens in a down market. The strong survive and the weak don't, and we know that there is some integration going on in the marketplace.

That is very helpful as well, and then just a real quick one. Do you have expectations for tax rate in '09?

We are looking somewhere between 32 and 33%.

All right, thank you very much guys.

Okay.

Next we will go to Joe Mondillo of Sidoti & Company.

Good morning, guys.

Hi, Joe.

Two quick questions, a lot of my questions were covered already, but first off, do you have a sense of how much the after market is associated with your sales?

Almost none.

None?

No. The only after market that we have per se is when a customer decides to completely revamp a machine, let's say he takes a 30 to 40 year old piece of equipment, and the frame and the basic equipment is okay, but it needs to be refitted completely with hydraulics. Oftentimes, cartridge valves and manifold systems are used for that retrofit, but as a drop-in replacement, our products typically don't sale in the field.

Okay, and then in terms of the CapEx, do you have a sense of where that could be for this year and what your maintenance level is?

It is going to be around 7 million for 2009. Maintenance on that is a small percentage of the total.

Okay. All right, thanks a lot guys.

Okay.

(Operator Instructions). Next we will go to Fred Russell of Frederic Russell Investments.

Good morning everyone.

Hi, Fred.

Hello Tricia and Allen.

Hello, Fred.

Good morning. You say I think you may have been unnecessarily harsh on yourself, but you say that 'we have done it to ourselves this time'.

I am referring to the economy in general.

Oh, okay, all right.

My comment had to do with the last recession, we were heading south prior to 9/11, but 9/11 really sort of put the nail in the coffin. This particular recession I think has been triggered by banking problems, and I would say to some degree, our own government's actions over the last 20 years, or maybe even longer.

What do you mean by government actions? That sounds like a sweeping indictment of both parties. What do you mean?

(laughter). I don't think it is good to get into my political philosophy over this call.

Okay, all right we'll reserve that one for in visit. Okay, well, we will reserve that one for an in visit. You have got a lot of cash. You are in a wonderful position, about $35.3 million on the balance sheet. Are you tempted to buyback stock, or would that be more exciting, more succulent to make an acquisition, and if so, where would that be?

Well, first of all, in terms of a stock buyback, there are no plans for a stock buyback. That is at the discretion of the Board, so I am really not in a position to comment, as to whether or not, that is something the Board would entertain. Relative to opportunities going forward, we have been making investments in acquisitions. W ha've got one scheduled for later this year, early next year to complete, which is the High Country Tech acquisition. We are finding that in today's world, electronic controls and hydraulics are partners, on many, many pieces of equipment.

Oftentimes the hydraulics takes the lead, but oftentimes the electronic controls takes the lead in terms of how the machine is designed and laid out, so we want to be able to position ourselves to play on both platforms, hydraulics and electronics, and to collaborate on the integration of the two technologies for our customers, so I think you will see more activity in that area.

So would that suggest that the growth rates for electronic controls would be more dynamic, more powerful than it would be for the positional cartridge valve?

Yes, there has been a study done, and that shows for every $1 spent on a piece of hydraulics, on a piece of machinery, there are $4 spent on electronic controls.

Looking at some of your competitors that are falling by the wayside, Sun's competitors, is there any commonality to them? Are they in a particular servicing a particular industry with a particular niche, or a particular strategy, or is the failure across-the-board?

I think it is generally speaking they don't have a strong enough balance sheet, to survive this part of the business cycle.

I see. Well, it is not Sun's problems. That is good. What happened in Korea? China very strong, but Korea a little disappointing. Are you able to elaborate on that?

Sure. It is a very simple story. Our Company in Korea, we have owned them now since '98, has had four major customers, and they are in correction equipment. And those four major customers all went south at the same time.

Now we have known that they were vulnerable, and have been for the last 10 years, finding new Markets and new customers. That continues to be what they are doing, and they are making progress in that area, but it is very difficult when I don't know, 70% of your customers, their business goes down 50% or more.

And we started seeing that last July and August.

Right.

Okay. I know this is not your conventional question, and I applaud your efforts in this area. What specifically are you providing, does Sun provide in it;s wellness program for it's employees? I think it is a great idea.

We are in the process of bringing in a nurse practitioner on site. The nurse practitioner is able to dispense I believe it is 50 of the most common drugs directly, so the drugs are purchased in bulk.

Our employees then don't, let's say they get a cold or sinus infection, or something minor, that they would have to go to the doctor for, they can go directly to our on-site nurse practitioner, and she can dispense the drugs, or determine whether or not an office visit is actually necessary. It saves time for our employees, it saves our employees cost, and it saves a significant amount of cost for us. That is just one example of the wellness program that we are rolling out. There are other elements of it, and we are very convinced that it is good for everybody.

I think that is right. Okay, thank you very much.

Okay. Thank you, Fred.

Thanks, Fred.

You are welcome. Thank you.

Next we will go to Mr. Brett Hendrickson of [New Commerce] Capital.

Thanks for taking my question. Just want to know if in the past I think you guys have gained market share in a downturn, with the thought that maybe the wait time to get your product versus the competitors product goes down, and so therefore, people choose your product. Do you see that happening right now?

We don't see it at this part of the cycle per se, but we will see it as we come out of the cycle. I don't think we are losing market share. We might be gaining a little bit of market share because some of the competition perhaps isn't as strong, and able to respond even at the downturn, but we continue to make investments in our employees, and our processes, our products continue to get better. We add capability, we add capacity, and as we come out of the downturn, we come out of it very strong. Many of our competitors actually come out of it crippled.

And the hydraulics divisions of both Eton and Parker Hannifin, would you call them direct competitors? Sorry, that is probably a dumb question.

I don't know that they are a direct competitor. They are a competitor in certain areas, and they are also a very good customer around the world. When they run into challenging applications where they need additional product that they don't have, they are great customers of ours, so I am not sure I would classify them as competitor.

Two things I think I just missed. One you said you would lean towards acquisitions versus share buybacks, right? Did I hear that right?

I said that the share buyback is at the discretion of the Board, and that there are no plans at this time. I can tell you that the management team, myself included, are very much involved in looking for acquisitions that are strategic, and the right fit for Sun.

Okay. And then another thing just in the beginning of the call, did you say you see this cycle much like other cycles I think in terms of length?

I believe so. I guess it will play out and we will see, but when I look back over the last 30 to 40 years, typical recessions have lasted anywhere from 8 to 16 months, I believe that this is going to be very typical.

We are about eight months into it, maybe a little longer, depending upon geographically where you live or what, if you are in automotive it would be a lot longer than eight months, but overall I think we are in our eighth or tenth month, and if it plays out like other ones, we are looking at 16 months as the average, maybe a little longer, maybe a little less.

I hope you are right. From my perspective, this seems like quite a doosey.

This is the 100-year storm.

I am sorry?

I said this is the 100-year storm.

Okay, I would agree. And then last question, just on your business in Europe, can you characterize how much of it might go towards Eastern Europe for all of the infrastructure that they were building there, versus central and Western Europe? Do you have a good sense of the end markets for your customers there?

We have a sense for it. I don't know how precise we can be, because a lot of the product that is produced ultimately going into Eastern Europe, might be produced in Italy or Germany or Austria, so it is very difficult, but my sense is that Eastern Europe might be 10 or 15% of the market.

10 to 15% of your Europe business?

Yes. I think that is a fair number, and probably growing. 10 years ago it was essentially zero and it's 10 or 15% now, and as their economy grows and becomes stable, there are opportunities for our products.

Okay, well great. Thanks for your time today and good luck.

Thank you.

(Operator Instructions). Next we will go to Chris Weltzer of Robert W. Baird.

Hi, everybody.

Hi, Chris.

A quick follow-up. The $0.06 contribution into employee retirement accounts did that all fall in the US segment?

No. It was across-the-board. It will go to the retirement portion of the share distribution will go to all employees, so it was obviously with the majority of the employees being in the US, the majority of the cost was in the US.

Okay, and remind me, does that all end up in SG&A, or is some of that in COGS as well?

Most of it is in cost of goods sold, a smaller portion probably 20 to 25% is in SG&A, and 75 to 80% is in cost of goods sold.

That is very helpful. And then you talked broadly the weakness you saw in the Q4 as far as orders continued into January and February. Can you talk about any difference international versus domestic? It looks like the US was holding up a little bit better on a relative basis in the fourth quarter. Has that changed at all?

No. It is about the same. We are pretty much seeing everybody down, if you are looking at December order rates versus January and February, they are spread about the same geographically.

Okay, very helpful. Thank you, guys.

Okay.

With a follow-up question, we go to Kristine Kubacki of Avondale Partners.

Thank you for taking my question. Two quick questions. In terms of trends from the fourth quarter into the first quarter and what you have seen sequentially, January to February, has there been any improvement, or has it stayed pretty stable, in terms of incoming order rates?

January order rates were higher than what we were seeing in December, but February order rates dropped again off of what we saw in January.

Okay.

Let me comment a little bit on that. Yes, that is true, but when you dial in the noise that is out there with the distributor destocking, I am not so sure that that is really the trend. I mean it could be, but there is so much noise out there and the difference between February over January wasn't huge, so my answer to that question would be, I don't see a lot of difference between the last three or four months. We are kind of bumping our heads along the bottom.

There is not a lot of consistency from week to week per se. So his comment about bumping along is a good one.

Okay. And then in terms of how you are looking at the US dollar, or if it is important at all into your forecast, the dollar has risen pretty quickly here. I was wondering how do you expect it to impact your business, in terms of top line, and then even on the operating side?

Well, on the top line if you are looking at the Q1 estimate, we can compare that with the exchange rates that we had last Q1, and it does have a downward effect of about $2 million built into that 25 million for Q1, so it is a pretty substantial effect at least on the top line.

On the bottom line, it affects us primarily in Germany and Korea, from the standpoint that they buy from us in US dollars, so as the US dollar gains against the Euro and the Won, their cost of goods sold goes up.

Okay. I appreciate that. Thank you.

Okay.

With no further questions, I would like to turn the call back over to Allen for closing remarks.

Thanks, Angel. And thank you all for dialing into our fourth quarter and year-end conference call this morning. And for your continued interest in Sun Hydraulics. We know we are in a cyclical business, and we find ourselves today at the bottom of the cycle. And we have prepared well for what we are currently facing. Nonetheless these are difficult times. Nearly every customer in every market, and in every geography has been severely affected, however it is times like this that good companies get even better.

Our approach is quite simple. To set and maintain a steady course, to invest in our employees, our products, our processes, and our capabilities, and to position Sun to take advantage of the better times that are ahead. Thank you again.

That does conclude today's conference. You are now welcome to disconnect your lines. Have a wonderful day.