Helios Technologies Inc (HLIO) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to today's Sun Hydraulics third-quarter earnings conference call. As a reminder, today's call is being recorded.

At this time I would like to turn the call over to Mr. Richard Arter. Please go ahead, sir.

Thank you, Elizabeth. Good morning and thank you for joining us. 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 21E of the Securities Exchange Act of 1934. For more information on forward-looking statements, please see yesterday's press release.

Allen and Tricia will now offer their prepared remarks, after which we will take questions from the audience. Allen?

Thanks, Rich. There were no surprises in the third quarter. Demand was what we expected, and we were pleased with the positive earnings. As we have stated, we believe the cycle bottomed in Q2 and we are now expanding.

Our outlook for the fourth quarter is sales of $26 million with earnings between $0.05 and $0.07. That will put us at $96 million for the year, with positive earnings of $0.08 to $0.10.

Looking forward to 2010, we are encouraged by the sequential growth that we saw from Q2 to Q3 and expect to see from Q3 to Q4.

An expanding economy lends itself very well to Sun's cost structure. We are able to leverage operating expenses effectively as sales increase. We are vertically integrated, highly automated, and have a knowledge-based workforce that is critical for our future success.

Throughout a difficult 2009, Sun has continued to generate significant cash. Our balance sheet is strong. We carry no debt, and our credit facility is intact.

In a difficult economy, Sun has continued its dividend policy. In fact, earlier this year we paid out an additional share distribution dividend, bringing the total for 2009 to $0.45 per share.

The signs of recovery are evident. Yesterday, the PMI was reported at 55.7%. This is the strongest reading since April 2006 and the third consecutive month of expansion in the manufacturing sector. PMI has historically been a leading indicator to Sun's order patterns, and we are encouraged by the continued upward momentum of the index.

Looking at internal signs of recovery, Sun's distributor inventories are at 2004 levels, and we believe we are now balanced with demand. Quoting and prototype development is strong, and our new products are being ordered and tested out by many customers. Expedited order activity has also been elevated throughout the downturn and remains so.

Throughout this downturn, Sun has refused to compromise our capabilities. We have been through tough economic conditions before and understand what will carry us through the next growth phase of the cycle. Our people, our processes, and our products have remained our focal point throughout the economic uncertainty of this year.

We believe that managing for the long term has positioned us well, and we feel Sun is poised to take advantage of the next upturn. We have the products and services, capacity, and mindset to increase our share of the market as the economy rebounds.

Tricia?

Thanks, Al. As Al indicated, we continue to plan for the future. Thus far in 2009, Sun has invested $4.5 million in capital. This includes $1.7 million for land adjacent to our current facility that will allow us to expand when the time is right. It also includes an upgrade to our heat treat furnace and a new ID grinder, both of which will allow us to complete processes internally that have been outsourced previously.

In the fourth quarter, we will invest an additional $2 million in equipment that will increase productivity as demand begins to ramp up again.

In the third quarter, our US operations achieved the full cost benefit of our furlough plan by reducing labor costs by $800,000. While the cost savings is beneficial for the short term, the real benefit lies with our ability to maintain our highly skilled and educated workforce that will be critical as demand rises.

Also in the third quarter, our UK and German operations initiated furlough-like programs to balance their production personnel to current conditions. In Korea our furlough program, which was in place for 10 months, has ended due to government regulations, so that operation is functioning on a normal schedule.

The furlough programs are scalable. And as we see increases in demand, we have the ability to end the furlough program on an employee-by-employee basis. This allows us to continue to balance our capacity with current business levels.

Sun went into this year with $35.3 million in cash. At the end of the third quarter, we had $37.7 million in cash and marketable securities. Even though sales have dropped 52% year-over-year, Sun has continued to generate cash flow. Total cash has increased $2.4 million since the beginning of the year, even after paying dividends of $6 million and investing $4.5 million in capital.

I will now delve into the details of the quarter. Third-quarter sales were down 48%, and earnings were down 93%. Foreign currency accounted for 4% of the third-quarter decrease.

Year-to-date numbers show similar results with sales down 52% and earnings down 98%. Foreign currency was responsible for 6% of the year-to-date decline in sales.

In the quarter, North American sales declined 50%, while Europe dropped 49% and Asia was down 41%. It's still our expectation that Europe will lag in the recovery behind Asia and North America.

Third-quarter gross profit was $5.4 million, a 64% decrease from the same quarter last year. As a percentage of sales, gross profit was down 10 points to 23%. The rolling furlough program added approximately $800,000 in cost savings for the quarter, resulting in 3.5 points to gross profit.

Our fixed costs, which are difficult to absorb at these revenue levels, were offset by lower material costs and elimination of overtime premiums. However, the declining revenue was the primary driver of the decrease in gross profit.

SEA expenses were down $500,000 or 10% over Q3 last year. We saw a general decline in SEA costs across all spending categories.

Sun's third-quarter tax rate is somewhat of an anomaly at 2.8%. We have a few items that contributed. First is the tax effect of the small operating gains and losses applicable in the different taxing jurisdictions; but there are also a number of discrete one-time items that came into play in the third quarter. These relate to a return to provision true-up upon completion of the 2008 tax returns, as well as adjustments to the R&D tax credit calculation. Before these discrete items were applied, the quarterly tax rate was 29%.

Net cash from operations through the third quarter was $11.3 million. Inventory and accounts receivable have declined throughout the year, creating operating cash flow.

Inventory turns for the quarter were 9 and DSO was 42. As in the past, we are not experiencing any significant receivable problems. Even at current business levels, cash flow remains strong.

Capital expenditures year-to-date were $4.5 million as we continue to make investments that will benefit Sun for the long term. Capital expenditures for the year are expected to be $6.5 million.

In the third quarter, Sun paid its normal quarterly dividend of $0.09 a share. Sun's Board is pleased to be able to continue paying dividends to our shareholders.

Looking ahead to the fourth quarter, our revenue estimate is approximately $26 million with earnings between $0.05 and $0.07. This represents a 21% decline in revenue over the fourth quarter last year and a 60% decrease in EPS.

For the year, we estimate revenue of approximately $96 million with earnings of $0.08 to $0.10, leaving us down 46% on the revenue side while remaining profitable.

Please note that estimates are based on a 14-week quarter for Q4 and a 53-week year for 2009. We anticipate that the quarter will have approximately 3 additional shipping days.

We appear to be on a slow growth trajectory as the economy steadies itself throughout this recovery. We are ready to capitalize on the opportunities of this emerging growth phase of the market.

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

Elizabeth, could we open for questions now, please?

(Operator Instructions) Robert McCarthy, Robert Baird.

Good morning. This is actually [Daniel Zutek] filling in for Rob. Morning.

In the release you mention a modest rebound in incoming order activity. Can you talk about how order activity progressed through the quarter?

Yes, we did see increases throughout the quarter of July, August, and into September. And those have sustained and even increased slightly going into October, which is what leads to the forecast that we have in place for Q4 at the present time.

Okay, great. Could you actually also repeat your revenue breakout by customer location? I didn't catch all the numbers.

Revenue forecast?

No, no, no. The breakout. I got Asia was --

Geographic.

Oh, geographically. North America was down 50%; Europe was down 49%; and Asia was down 41%.

Okay. Thank you. Then with regard to the furloughs, can you quantify how you expect these savings to be, going forward?

We will have very similar savings in Q4 to what we have in Q3 for furloughs, which was about $800,000. It will be slightly reduced because we currently have pulled back a small group of people that are highly cross-trained and able to work in a lot of different functions. And because of the increased order activity that we have seen, we are not keeping everyone on furlough. So that small group has come back.

I would say the savings is probably around $750,000, provided those are the only people that we do decide to pull back throughout Q4.

About $750,000. Okay, great. Thank you.

Kristine Kubacki, Avondale Partners.

Good morning. You mentioned that inventory at the distributors is at a level down around 2004 levels. What are your distributors indicating in terms of where do they think -- have they stopped lowering inventories at this point? And have they given any indication when they might start this restocking phenomenon we are all waiting for?

I think that's a very difficult answer to come to grips with collectively. Each distributor will make their own decisions based upon situations that include their own computer algorithms that they have already written into their system as to when to do replenishing. Some of it has to do with particular customer demand in their sectors.

So I think it's not going to be a one-size-fits-all answer. But my sense is that we have bottomed out on the inventory levels. There is a disincentive for distributors to not carry the inventory and have to order expedites from the factory, from a financial perspective. So I think they are looking forward and as soon as they feel confident in the recovery I think they will make adjustments to their inventory levels and start ramping back up, as we see incoming orders increase.

Okay. Then, a little bit on your end-markets. Is there any end-markets that are starting -- maybe the ones that fell off earlier in the downturn? What kind of end-markets are you seeing start to rebound? Is there any pockets of strength, either geographically or particular industries?

Geographically we are seeing the markets come back in the North American arena more so than we are seeing in Asia and Europe at this specific time. I mean that is pretty short-term look, but we are seeing North America geographically looking better.

But I think if there is one thing that we know, is that the aerial work platforms are not coming back. They were probably one of the first ones that dropped off last year, but they are still pretty slow.

I think expanding on that a little bit, areas that are tied to residential and commercial construction -- and of course aerial work platforms, but that is not the only one -- those markets are likely to remain flat for some time. Primary metals, mining, mineral exploration, petroleum, some of the heavy-duty construction, maybe road building, bridges, I think you'll see going forward that that will pick up first.

Okay. Then a little bit more of an esoteric question. I was just wondering if in this environment, has the competitive environment changed? Either competitors changing pricing, or gone out of business, or how do you see things coming into 2010 as things start getting better? Has the competitive landscape in any way changed that will either benefit or be a hurt as we think about the next cycle here?

We have not seen much in the way of pricing, either up or down. There may be some rifle shots with lowering prices to get pieces of business; but generally speaking that is not happening.

In terms of competition, I think many of our competitors have reined in their spending. Maybe some of it is because financially they need. Maybe in other cases it's just in their culture to do that in the downturn.

We've continued to invest. We've continued to maintain our workforce. So I think from a competitive standpoint we are probably as good or better than anybody in terms of being able to respond to what's going to come out of it going forward. I'm not sure all of our competitors are in that same position.

Okay. Thank you for the time. Appreciate it.

Joe Mondillo, Sidoti & Company.

Good morning, guys. First off, I am just wondering how much benefit -- or did you see any benefit from lower raw material prices? Are your suppliers -- did your suppliers lower prices at all? Or I mean increase prices, I meant. Sorry.

No, we haven't seen price increases at this point from suppliers.

Actually I meant lower prices. Are you seeing a benefit there or no?

No. We haven't seen price changes from our suppliers.

Okay. All right.

I think the situation in the marketplace is that you've got two things going on. One is that with the lower volumes there is maybe some material savings to be had in terms of raw materials and all that, but any savings that you have there is eaten up with the lack of throughput through the factories. So it's kind of a wash.

I think most companies and most businesses are seeing the same thing. While on the one hand you might save a little, on the other hand it's costing you more to produce.

Yes, and we know that many of our suppliers have the same types of furlough programs in place that we do, and they are working that balancing act of keeping their labor costs in line with what their production runs are looking like. So we all have the same issues.

Okay. Then just could you give some more color on -- with capacity utilization around the world at such a low level still, production levels so low, where is demand for new machinery that your products are going into? Where is that demand going to come from?

Why would new machinery be demanded any time soon with just how low capacity utilization levels are? Just if you could give some more color on how that's going to play out going forward.

A lot of the issues around the question is productivity of equipment. I think many customers that buy capital goods, ourselves included, we take a look at a piece of equipment and we say -- could we replace that with something that's more reliable, more productive, give us more throughput?

Are we reaching the capacity -- like at the end of the last upturn, were we reaching capacity with that equipment? Should we now take a look at replacing it?

It's a great time to put new equipment in operation, whether you're a hydraulics manufacturer or construction, roads and bridges. So I think it has to do with productivity, and each particular example will be decided on those factors.

Okay. Then just lastly, your financial position is pretty strong right now. It looks like -- I think you grew your cash position. What are your intentions of use of cash at this point?

We're pretty happy actually that we have the cash that we haven, and have been able to maintain it and grow it throughout this downturn. I don't think we are looking at doing anything too radical with it till we can get through this and see.

But we're always looking at opportunities that are out there. This is a time when opportunities will present themselves, probably at some pretty good prices. So we'll look at anything that comes along.

We're continuing to invest in the machinery that we need, like Al was talking about, that will make us more productive. And we are continuing to pay dividends to our shareholders. We aren't looking at anything too radical at this point for uses of cash.

Okay. Great. Thanks a lot.

(Operator Instructions) Fred Russell, Fredric E. Russell Investment Management Co.

Yes, good morning, everyone. How are you doing down there? Good quarter, but we don't like to worry about quarters. Good year.

When you make a $6.5 million capital expenditure, what level of revenue does this afford Sun? How much capacity does that give you in terms of revenue?

Well, the types of equipment that we put in this year will definitely increase the capacity off of where we were at the 2008 levels at about $180 million. So we know that we will be getting more capacity out of the equipment than what we were doing at that level.

Although I don't think that we were at full capacity even at the $180 million, so somewhere north of there, $200 million, $220 million. It's hard to say exactly where that will be especially until we are able to fully utilize what equipment we put in place for productive increased capacity.

A lot of the investments that we have made relative to capital have more to do with capability as opposed to capacity.

Right.

We know we were able to do $180 million. Investments that we're making will add to that capacity; but the primary driver is capability.

Whether its quality, whether it's new processes for new products, whether it's additional land for further expansion down the road, it's more about a capability issue than a capacity issue.

Okay. Can you expand on that phrase -- new processes?

Sure. For example, ID grinding. It's a process that's very critical to some of our new products. In the past, we've outsourced it. We did the best we could with managing a supply from a few suppliers out of the Chicago/Cleveland area. But it was a process that we need in-house to improve our capability of products and our quality. Some of our products need to go through that process, and it was difficult to get it through. So ID grinding is an example of a process development. But there are many others.

Of course. Okay.

A new heat treat furnace we just put in was a couple million dollar investment to do gas quench for heat-treated parts. That is another process improvement.

Okay. That's great. What type of acquisition -- if you were to do something radical, to use Tricia's words, what type of acquisition would be logical for Sun?

In 2007, we announced that we were proceeding with an acquisition of an electronics company, so I think you would likely find us moving in that direction. Something that takes us either into new markets or expands the markets we have.

We have some activity going in this area, and I don't think I want to get to a lot greater detail than just that.

Sure. What new markets would be of interest to Sun?

New markets meaning expanding the business that we currently have in the markets that we currently participate. So it's an expansion as opposed to a new market. Taking more. For example -- I'll give you a for example.

That would be good.

We know that for every dollar that's spent in electronic controls on a machine there are $6 spent on hydraulics. So the ability to sell an electronic module on a piece of equipment brings through $6 worth of hydraulic components on that module. So every time we're successful at promoting an electronic control, we drag a lot of hydraulics with it.

Okay. Great. I don't have any more questions. Keep up the good work. Thank you.

(Operator Instructions) Holden Lewis, BB&T.

Thank you. Good morning. I guess looking forward a little bit more, I guess in Q4 -- and this is generic, not looking for specific numbers. But would you expect that the Q4 revenue base represents the base heading into 2010? Because it's not unusual for you to see 15% increases in first quarters over fourth quarters in terms of revenue streams.

I mean would you expect that typical seasonality to play out, based on how the macro indicators look right now? Or is there some reason why maybe it would be somewhat slower than normal based on what you are seeing in the markets?

I think the leading indicator to watch, to get a handle on that -- and you can take that leading indicator and project any way you want --- but it's the PMI index. We just ended the month of October with a PMI index of 55.7%. As I said, it's the strongest reading since April of 2006.

If that trend continues at that level -- I would call 55.7% a very aggressive PMI for the month of October. That's probably a signal of what you might see in the first quarter of '10.

Got it.

On the seasonality side, I think it's going to be difficult to see normal seasonality throughout 2010. I think you are going to see that our orders will flow more with what the general economy is doing rather than regular seasonality.

I agree, and that goes back to my comments about PMI. It's more important to worry about or to look at what PMI is going to do as opposed to what season we're in.

Okay. I guess just when you talk about the fact that -- I think you said that your order levels were up in July and August, September, and that has carried through into October. When you look at the statements from machinery manufacturers, it doesn't seem like they are -- they are not really -- certainly through Q3 there wasn't any improvement in their production rates or anything like that. Maybe there is smatterings of suggestion that maybe Q4 will see a little bit.

But getting back to an earlier caller's question, it just seems like these folks -- you're not hearing the capital spending-type companies talking about real improvements in their production rates and things like that. But then you are sort of seeing your order rates pick up.

I guess it's just to me a bit surprising that a name that seems to go into capital goods is seeing their revenues move at a time when mostly its production and MRO revenues moving. Can you give any enlightenment or insights as to that?

I think there's a number of factors that go into it. First of all, the destocking factor that happened to us earlier in the year. So when you start looking at things sequentially, destocking has played out for the most part; and we're beginning to see more end-market demand.

Most of the people in our capital goods world I don't think saw a 50% or 52% drop in incoming revenues like we did. But many of them didn't have that destocking, so that is one issue.

Another issue is our ability to respond with short lead times is bringing us new business. I think in a lot of cases the customer -- yes, maybe they are only going to sell 4 machines instead of 8. And what's happening is that orders are coming in very unexpectedly, and they need to get it out now, and they need product now. We're able to deliver through our expedite program.

I think another example of new business that we are getting is prototypes. We're seeing a lot of action with some of our new products.

In fact, one of the products that we launched about three years ago, the last number I saw it looked like it was growing at 20% or 30% for the year. With our business being down nearly 50%, some of our new products are actually growing at 20% to 30% rates. So I think the prototype activity is helping us.

A lot of the information you read, the NAICS category, has to do with North America. North America is only 55% -- actually 45% of our business. 55% of it is outside of North America, and we continue to do well in places outside of the North American market.

So those are all factors, I think, that are contributing to what we are seeing and probably will continue to see in 2010.

Then in terms of the furlough programs, you have a little bit coming back in Q4 but really not much; but the revenues are ticking up. Would you anticipate the furloughed money coming back into the money in full in 2010? Or when will you expect those furlough programs to end?

I don't think they will completely end in 2010. I think until we get back to levels of $170 million, we will continue to have some folks on furlough.

We are bringing back our most cross-trained people first, because they can work in multiple areas of the Company. One of the things that we set out to do when we launched the furlough program was to make it scalable, so that if we sell an extra dollar we can bring back a few extra people.

We will continue to do that as we go through 2010, but I don't think it will end until we get back to 2008 revenue levels.

Got it. Okay. Then I think you had commented that the $800,000 was from North America; but you also said that UK and Germany initiated some, I think in Q3, and Korea had some. What is the dollar amounts that we are talking about in the other regions?

The other regions are relatively small. Their manufacturing staff are much smaller than what we have in the US because a majority of our manufacturing is conducted in our US facility. So monetarily the effects of the furloughs in UK, Germany, and Korea were small.

But it was doing the right things and the same things that we were doing in the US across the board. It's probably a number like $50,000.

Okay, a small number.

Yes.

Then comment about production. Inventories flat to slightly down in the quarter. Did you actually -- are you in the process now of increasing production from where you were at? Or is your existing production consistent with what you've been in prior quarters?

It's obvious that's a leverageable number. So what are you anticipating in terms of production versus where you've been in the prior quarter or two?

A little abnormality with the inventory levels that you've seen. As we mentioned earlier, we put a new heat treat furnace in, and we had shut down one of our heat treat facilities for some period of time. So we built parts inventory during the early part of 2009. We're still working off some of that inventory as we bring up our heat treat capability.

So the inventory change is partly because of that. We have a little bit more inventory because we are getting more expedited orders, so we are carrying a little bit more inventory also with that.

I think going forward we will continue to wind our inventory down a bit, but it's probably not going to change substantially over what you have in Q3.

Yes, I think the expectation is that we would be able to maintain or even increase our inventory turns as we go forward and there is additional productivity that we're able to get. We don't have finished goods inventory. We're holding mostly parts. We build to order, so we don't stock finished goods inventory like some of our competitors probably do. So we're able to keep our inventory levels lower than most people are.

And we will continue to look at the turns on a monthly basis and see if we can at least maintain them, if not improve them.

Got it. Then last thing, just comment on the weakening dollar. In the past, a weaker dollar has been generally good for you, being a US manufacturer. Are you seeing any impacts or shifting related to the US dollar, or any sort of pricing behavior? Any impact at all as a result of the fact that the dollar seems to have resumed its weakening trend?

No, I don't think we've seen a lot of changes. You're right, we do benefit from a weak dollar because we sell to ourselves in US dollars. So their cost of goods sold are affected by what the exchange rates are with the dollar. When the dollar is weak, their exchange rates go down.

So we have seen some benefit of that in Germany, specifically; but we have been hit with it a little bit in the UK. The UK is somewhat self-hedged in that they buy from us in US dollars and sell a large percentage, over 50% of their sales in US dollars. So they are hedging themselves a little bit in that regard against the dollar.

But I don't think that we've seen any pricing pressures or differences at this point relative to a weakening dollar.

But one would think that you would have a competitive advantage, right, over there? As you would have potential pricing benefits coming through. But you haven't seen any of that at this point?

It's a double-edged sword. You're right; you have advantages from a price standpoint. But they're not buying.

At any price, huh?

At any price.

All right, great. Thank you.

Joe Mondillo.

Actually I just a question regarding the currency, but you just answered it, so thank you.

Okay, great.

And with no questions remaining I would like to turn the call back over to today's speakers for any closing remarks.

Richard Arter; Well, thank you all for joining us today and we look forward to speaking to you again early part of the new year. Thank you.

Once again, that does conclude today's conference call, and we thank you for your participation.