Helios Technologies Inc (HLIO) 2010 Q4 法說會逐字稿

Good day everyone and welcome to the Sun Hydraulics Corporation Fourth-Quarter and Year-End Conference Call. Today's conference is being recorded. After today's prepared remarks there will be a question and answer session. Instructions will be given at that time. At this time I'd like to turn the conference over to Mr. Dennis Tichio, Corporate Finance. Please go ahead, sir.

Thank you. Good morning. Thank you for joining us for Sun Hydraulics 2010 Fourth-Quarter and Year-End 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. 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, and good morning everyone. Sun finished 2010 on a very strong note and we gained back more than 50% of the sales lost in 2009's recession. The fourth quarter was our busiest of the year, which is not typical of our seasonal order pattern. That momentum continues into the first quarter, where our forecast is a robust $50 million in sales, with earnings of $0.50 to $0.53 per share. I have to admit, we were a bit surprised by the strength of the recovery. We have said this before, but I feel it is worth reiterating.

This is a time in the business cycle when market share is gained by companies that can respond quickly. We knew that maintaining workforce readiness was key to our ability to respond to a quick rebound. We would not be in the position that we are today with delivery, if we had not invested in our workforce, and our business throughout the downturn. I'm delighted to report that we are seeing strong demand for our products, and we are responding effectively.

As I mentioned last quarter, some of the 2010 growth was fueled by new customers from around the world. In the fourth quarter, and now in the first quarter this year, we are beginning to see our traditional markets and customers get busy. Mining equipment, construction equipment and aerial work platform manufacturers are all increasing their orders. Conventional and alternative energy businesses are also busy.

We are experiencing a broad-based, capital goods recovery all over the world. Most of the signals that we watch, as predictors for future conditions, are good. The primary indicator for Sun is the US Manufacturing PMI, which reported in at 61.4 a week ago. This is the 19th consecutive month that PMI indicates an expansion in the economy, and is the highest reading dating back to 2004. Sun's business direction and momentum followed the PMI by an average of six to eight months, so these lofty numbers bode well for Sun's near-term future.

I will now turn the call over to Tricia for more detailed commentary on the quarter and we will rejoin for questions. Tricia?

Thanks, Al. As quickly as the topline came back, so did our operating leverage. We finished the year with gross margins of 35%, and operating margins of 21%. We really didn't anticipate our operating leverage returning this quickly, but on the other hand, we aren't surprised.

At the higher revenue levels, we are realizing productivity improvements which were put in place throughout the downturn. Our operating leverage allows us to drop considerable profit to the bottom line, as revenues continued to climb. We are currently running two 10 hour shifts, and have added a few additional shifts to cover areas where we see production constraints. Most production employees are working about eight hours of overtime in areas where it is needed.

We have the ability to add alternative shifts to add capacity. Our workforce model is very flexible and allows for a considerable agility between departments to accommodate fluctuations in demand. Order rates have accelerated in the first quarter. As Al mentioned, our traditional markets are getting stronger, joining some of the new business we picked up last year. In two weeks, we will be exhibiting at the IFPE show in Las Vegas, which is part of the larger Con Expo Construction Equipment Show. From our understanding, all exhibitors are excited about the current business conditions.

I will now discuss the year-end results. Our profitability grew tremendously, as demand for our products rebounded. With the large increase in income comes the question of how to share the success with Sun's stakeholders. As you will recall, we introduced the concept of the shared distribution in 2008 as a way for Sun to share its profits with both shareholders and employees in years when Sun's financial results are good.

Therefore, based on our 2010 results, the Board declared a shared distribution, which includes an $0.11 cash dividend to shareholders, and a 9% contribution of salaries to all eligible employees, most of which will be paid into retirement plans. Through the shared distribution, Sun will share $2.7 million of our 2010 profit with employees, and $1.9 million of our cash with shareholders. In addition to the shared distribution dividend, the Board also declared a normal quarterly dividend for the first quarter of $0.09 per share.

Turning now to the numbers, for the year, sales were up 55% to $151 million compared to 2009. Earnings were up more than eleven fold, to a $1.26 per share. Foreign currency had virtually no effect on the year as a whole. Gross profit as a percentage of sales increased twelve points to 35%, compared to 23% in 2009. The operating leverage that we get on the incremental sales increase is evident in the margins that we have achieved throughout 2010.

SEA expenses were up 7.5% to $21 million compared to last year. The change is related primarily to the share distribution which was discussed earlier, as well as marketing costs in Asia. We continue to ramp up our efforts in China and India, and have seen positive results as we work with new distributors and new customers in both regions. The provision for income tax for 2010 was 32%, compared to 8% in 2009. The prior year provision included the tax benefit recognized in the US. We expect the Q1 tax rate to be approximately 34%.

Net cash from operations for 2010 was $25 million. Inventory turns for the year were 10.6 and days sales outstanding were 32. Cash flow remained strong, and we finished the year with $45 million in cash and investments. Our cash flow allows us to make the investments necessary to insure the future growth and success of the company.

Looking ahead to the first quarter, our sales estimates have returned to 2008 levels when we experienced our highest levels of demand in Sun's history. As Al pointed out, the macro economic indicators, such as PMI, point to a bright outlook for Sun into 2011. First quarter estimates include sales of $50 million, with earnings of $0.50 to $0.53 per share. We are prepared to not only meet, but exceed these demand levels, as orders for capital goods and equipment rise. We look forward to the prospects that 2011 can bring to further grow our business. Thank you, we will now open the call for Q&A.

Thank you. (Operator Instructions) We will pause for just a moment to assemble the queue. We will go first to Robert McCarthy with Robert Baird.

Good morning everybody.

Good morning, Rob.

I wonder if you could talk about your profitability in the fourth quarter and to what extent rising material costs affected gross margin?

Sure. We were concerned to hear some grumbling of increasing material costs but we really haven't seen any specific actions being taken at this point. So, there was not an impact to our Q4 results.

Okay. That means then, Tricia, you're not expecting any meaningful impact in the first quarter then?

That is correct.

And, the contribution in the quarter from your price increases in mid-2010, would have been comparable to the third quarter contribution?

Yes. Somewhere between 1.5% to 2%.

Okay. And, that is the most recent price increase? Or have you taken any action here at the beginning of the year?

That is the most recent price action in July of 2010.

Yes. Okay. All right. And so then, after the strong performance in the fourth quarter, and your comments about operating leverage returning more quickly than you had anticipated. Does this bring you back to the assertion you were making last quarter that we are looking at probably peak gross margin levels currently?

Gross margins for the year were at 35% and that's high level on an annual basis. And, we know that we are in our sweet spot with margins in the mid-30% range, and obviously, we are operating there now. We can squeeze small amounts out in continuous productivity improvements beyond that. And we can absorb our current fixed costs at these higher revenue levels but at some point it becomes necessary to make additional investments in people, processes, bricks and mortar, to get the job done beyond where we are now. And --

That's why I asked the question, because in your opening remarks there was discussion of the increased overtime that people are working etc. I mean, it raises the question of sustainability I guess. I mean, how confident are you that you can continue to generate gross margins at this level as we go through 2011?

I think we are able to sustain where we are at right now. Once you get up into the higher 30% range, it becomes less sustainable, and that's when you need to make investments, and those obviously add to your cost base and therefore reduce your margin.

Yes, okay.

Let me just add a little bit to that, Rob. Yes, we are working some overtime right now in selected areas, however, we are also adding people, and we are finding that the workforce, is readily available to us. During the peak of 2008, we had some swing shifts, like a weekend shift, for example. We have yet not added a weekend shift to get more capacity. So, there is still plenty of opportunity to drive capacity out of the footprint we have.

And, that is a nice segway, Allen, too. Can we ask what you are expecting to invest in terms of capital spending in 2011? And, do we face the prospect of needing to think about incremental capacity this year?

We believe that the CapEx Q1 '11 will be between $1 million and $2 million at but at this point we can't offer an estimate for the full year of 2011. I know that might appear vague because we have in the past done that, but I believe there are some uncertainties that lie ahead. When we are looking at CapEx spending, there are five main factors that we evaluate to assess a CapEx spend. That's increasing capacity, increasing capability, reducing hassle, complying with government regulations and improving safety. If a capital expenditure addresses any of those issues, we generally make the investment. With the level of growth that we saw in 2010, and what we expect in 2011, we feel there is a level of uncertainty related to future capacity needs. As long as the capacity issue remains unknown, we really can't properly estimate total CapEx for the year, at this time.

Which if I understand correctly means that you may need to do something more substantial, but you can't say whether that's the case at this point?

Correct.

Okay. Great. I will let somebody else go. Thank you.

And part of that is related to where we are with our revenue. Q2 '08 was our highest shipment quarter in history of Sun at $51 million. Our estimates for Q1 2011 are right there, and we are able to ship $170 million in 2008, out of our existing facilities. So, we know we can at least do that much, and probably quite a bit more, given the productivity levels that we are currently running at. With that being said, we are conscious that we are approaching the levels where we need to consider capacity for the future, and we will be ready when we need to push the go button on that.

Okay. All right. Thank you.

(Operator Instructions) And we will go back to Robert McCarthy of Robert W. Baird.

Back for a second round, Rob?

You know me, I always have more questions. There was no recurrence of the third quarter pension adjustments in the fourth quarter?

There were pension adjustments in the fourth quarter that were related to the shared distribution. The adjustments in the third and fourth quarter were about equal to each other. Half was accrued in Q3and half in Q4 for the shared distribution that relates to retirement.

Okay. And, was there anything else unusual in terms of expense recognition in the fourth quarter?

No, I don't believe so.

Okay. Tax rate. Can you give us the sales, by sales destination, geographically for the fiscal year?

Yes, I can, just one second.

Okay.

For the year, North America represented a little over 50%, I'm sorry, North America represented about 45% of the total.

Okay.

Europe was 32%, and Asia-Pacific was 22%.So, obviously we are seeing some expansion into the Asia markets from what we've seen historically.

Well, and that's the next question. Are we seeing any impact yet, which I assume not, from increased distribution in China? Or, is that, you know, ultimately the question is, when will we see that and can it have a material impact in 2011?

I think we actually did see the impact of our work in Asia on the 2010 numbers. We saw significant increase sales related to the system integrator's that we signed on in 2011. And, now that we have our first distributor in China, which is related to us divesting of our China JV there, we believe that market is still pretty wide open for us.

Okay. But to the degree that you are able to develop additional, conventional dealers, distributors in China, that is still in front of you then?

We still have more work to do in that area, absolutely. However we saw significant gains in market share in China in 2010. And, we also saw our Korean operation recover quite nicely in 2011. So, if you took a look at Sun's sales of 2009 versus 2010, you know, I think our Asian numbers were significantly less. For example, in 2009, our total Asian business the $17 million. And, in 2010 our total Asian business was $30 million, so that's an increase of 74%.

Oh, is that all?

We're working -- sorry to disappoint you, we'll see if we can do better 2011.

Okay.

Part of that also is India. With the opening of our liaison office there we've identified several new distributors that will be continually adding to our sales base there going forward, as well.

I'm sorry, one last little nit, fourth quarter currency effect on sales, Trish, I guess was what?

It was about 1%. Downward. We lost about $400,000.

It was about $400,000? Okay.

Rob, going back to your question earlier about provisions for the accrual of the pension plan that we announced with the shared distribution.

Yes?

That accrual was made, as Tricia said, about equal amount in the third and fourth quarter.

Right.

So, you can see that we had a pretty spectacular fourth quarter.

Oh, yes. I -- yes, it kind of comes through. In line with our conversation about gross margin and its sustainability, et cetera. You know you finished the year with operating expenses around 14% of revenue, you know, you are able to hold that below 13% in 2007 and 2008. I have an idea that you would expect, based on a variety of productivity initiatives, to be able to do a little bit better than historical levels on the same level of revenue?

I think when you're looking at the operating expenses, one of the things that you need to consider are going forward, I think engineers are going to be key to our business, and we are going to need to bring on more engineers both from the design side, the process side, as well as the marketing side. Most of our marketing individuals around the world are really technical salespeople with engineering degrees. So, going forward, bringing on engineers of all different kinds is going to be key and is included in those operating expense numbers. But, there are other investments that I think, for the future of the company, will be necessary at that line.

Trish is absolutely right. And in fact, during the course of 2010, we have added a fair amount of technical people because they were available in the downturn. So, part of our investment in the downturn is not only, you know, investing in process improvements and productivity gains, but also in picking up some talent during the downturn. I view that as an investment and not an expense.

Okay. Thank you.

We will go next to Holden Lewis the with BB&T Capital Markets.

Thank you and good morning. This is John Cooper on for Holden.

Hello John.

Just a quick question, for Q1 '11 your expecting a 34% tax rate, is that right?

Yes, that's correct.

Okay. And then, I guess are there any other kind of embedded pension expenses or anything like that, kind of like we had seen in Q3 and Q4 moving into Q1 based on like the special distribution or anything like that?

Yes. There are some costs into Q1 estimates related to a potential shared distribution. Obviously that at the board's discretion, but management does have a range at its discretion, to provide for accrual for that throughout the year, and we have put in an accrual in our Q1 estimates. I don't think we are prepared to share a percentage at this point.

Okay. But would it be about on terms with what we've seen?

Probably. I mean, the range is fairly broad, but you're probably pretty close.

Okay. And then, if you guys are expecting to do somewhat of around a 35% gross margin, stable around there, and you see a nice ramp in sales and we're doing a 34% tax rate -- really what he was hitting on a little bit earlier is that operating leverage really has got to kick in. And, it looks, I mean, unless there's, you know, even if you get to like the 50%, the bottom end of your EPS range, you know, you'd have a 35.5% gross margin, it looks like SG&A as a percent of sales is only like 10%, is that out of the ballpark? Is that a little weird?

Our operating expenses are relatively fixed at this point. Until you add large lumps into that number. We don't have a sales force, which is where you tend to get the variability with sales at the operating expense line. So, we don't have the variable piece of the operating expenses a lot of other companies see. So, I don't think it is unusual to have those numbers be lower and I think that, you know, we are at 35% margins through 2010. I do think we have a little bit of room at the revenue levels that we are expecting for Q2 for upward, I think you're in a range of 35.5%, potentially maybe a little bit more. But our leverage has really already kicked in. Once we were able to fully utilize our employees, that's where we really picked up the large amount of leverage at the gross margin line anyway. And, now that they are working overtime, we start to see that go back just a little bit. You lose some of that when we kick in for the overtime.

Right. Okay. And, I just lastly on topline, are you guys expecting more of a seasonality, normal seasonality to play out this year? Are you expecting sales to kind of ramp? How are you looking at the top line?

We don't know.

Okay.

There's a lot of uncertainties, and to try to speculate on what that is rather difficult, and probably not too useful. Our whole approach is, to running our business, is to focus on constraints, and also to look at opportunities in the marketplace. And, at the same time, keeping our workforce agile and flexible, so that we can respond accordingly either up or down. That's been the recipe for almost a decade.

All right. Thanks guys.

Thank you.

(Operator Instructions) And there are no other questions coming into queue at this time.

All right. Thank you very much.

Thanks for joining the call.

This concludes today's conference call.