Helios Technologies, Inc. (HLIO) Q1 2012 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Sun Hydraulics Corp. 2012 First Quarter Conference. As a reminder, today's presentation 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 would like to turn the conference over to Ms. Tricia Fulton, Sun's Chief Financial Officer Corporate Finance. Please go ahead.

Good morning. Thank you for joining us for Sun Hydraulics 2012 first quarter conference call. Allen Carlson, Sun's CEO and President, is traveling in Australia and will not be participating in today's call. Al sends his regards and reports that business is strong in Australia, notably in the Mining and Energy sectors. Dennis Tichio who is part of Sun's finance group will be joining me on the call today. 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. Turning now to the first quarter. Orders rebounded nicely in the first quarter compared to the demand we experienced in Q4. We are seeing the same patterns as others in the industrial sector, with strong North American demand sequentially and year-over-year. European and Asian demand, which softened in the second half of 2011, returned to levels similar to what we saw in Q1 last year. Our second quarter estimate reflects consistent demand sequentially, but doesn't demonstrate our normal seasonal pattern of a stronger second quarter. While the North American market is expected to grow from Q1 to Q2, European and Asian markets are expected to be flat in Q2. As we discussed last quarter, we believe the second half of 2012 will be better than the first half, a mirror image of what we saw in 2011. This scenario is dependent on strengthening in China and some resolution to the economic malaise in Europe. However, U.S. PMI numbers, which fund tracts [ph] reflect strength in the domestic manufacturing economy and we are encouraged about the remainder of 2012. Sun has always taken a long-term view of our industry and business. We attempt to make decisions that will benefit all of Sun's stakeholders over time. To this end, we began planning for manufacturing expansion in Sarasota several years ago. In 1999, 2007, and 2009, we purchased land adjacent to our word Tallevast Road facility. Last year, we upgraded our infrastructure to service our existing Tallevast facility and added enough capacity to also serve a new factory. In January of this year, we announced our plans to begin site work on this new factory. In April, we began the construction process. The building in its entirety is expected to be completed in mid-2013 at a total cost of approximately $16 million. The new facility will add 60,000 square feet of manufacturing space and 18,000 square feet of office. The additional capacity will augment Sun's ongoing growth. We are optimistic about the future of our business, both short and long term. We expect this business cycle expansion to continue and believe that the timing is right to add capacity. Given the cycle of commercial construction, building this facility now seems opportune, given the availability of construction materials and the current costs to build. Long term, our goals remain the same, to deliver differentiated products at superior service levels to our customers when and where they need them, anywhere in the world. I will now turn the call over to Dennis and will be back for Q&A.

Thanks, Tricia. The first quarter ended stronger than we expected, with increased demand in March in both the U.S. and Korea. Throughout the quarter, order rates grew from January to February and February to March then softened in April. While demand from North America remained strong, Asia and Europe are relatively flat constraining our Q2 forecast. Overall, the first half of 2012 will be strong and we look to the second half of 2012 gaining strength. Let's look now at the numbers for the first quarter. All prior-year EPS figures reflect the 50% stock dividends recorded on June 30 of last year. The first quarter sales were $55.3 million, up 9% over Q1 last year and our largest quarter ever. Earnings were up 8% over last year to $0.41 per share. First quarter results were affected by the inclusion of HCT, which was not part of last year's numbers. HCT was acquired in September of last year and developed electronic control solutions for hydraulic systems. Integrating HCT's electronic controllers with Sun's line of electrohydraulic valves allowed us to satisfy more customer needs, with smaller and more compact solutions, making it a strategic acquisition for Sun. HCT accounted for approximately 25% or $1 million of the Q1 year-over-year sales increase. Earnings were negatively affected by $0.01 per share due to the combination of the operating loss in HCT and currency effect related to the euro and Korean won. Gross profit as a percentage of sales remained at a high level increasing to 40% for the first quarter compared to 39% for the same period last year. FTA expenses increased 9% compared to the first quarter last year. The change is related primarily to HCT FTA costs which were not present in the prior-year period. We will have a few more quarters where HCT costs will continue to influence the year-over-year comparison. The provision for income taxes for Q1 was about the same as last year at 32.5%. We expect the Q2 tax rate to be approximately 33%. Net cash from operations for the quarter was $11.7 million. Inventory turns were 9.3 and days sales outstanding were 36. Capital expenditures for 2012 are expected to be approximately $13 million which include approximately $6 million for the new U.S. factory and $2.5 million for an update of our U.K. facility. The remaining expenditures consist of purchases of machinery and equipment. A shared distribution dividend of $0.12 per share was paid on March 31 to shareholders of record on March 22. Additionally, a quarterly dividend of $0.09 per share for the first quarter was paid on April 15 to shareholders of record on March 31. Sun is proud to have paid a dividend every quarter since going public in 1997. Looking ahead to the second quarter. Demand is expected to continue to be strong in North America and relatively flat in Europe and Asia. Sales are estimated to be $56 million, up 2% over Q2 2011 sales. This estimate is positively affected by the addition of HCT sales and negatively affected by currency rates, which essentially offset each other. Earnings are estimated to be $0.41 to $0.43 per share compared to $0.41 per share last year. At this time, we would now like to open the call up for questions.

[Operator Instructions] And our first question comes from Mig Dobre with Robert W. Baird.

So first and foremost, a bit of clarification around guidance. Obviously, you guys already commented on the seasonality and the normal uptick which is not reflected in your guidance this quarter. And I'm wondering how should we think about the trends that you're actually seeing in Asia and in Europe? How have order rates progressed through the quarter and into this 1? And I'm wondering as I'm reading your press release, I'm getting that you guys are guiding towards a bit of a stabilizing environment and that just not seems to be what I'm understanding when looking at the guidance itself and the numbers sequentially? How should I think about that?

Yes. Looking at the orders, I think in Dennis' prepared remarks, he commented that order rates throughout the quarter grew. So January grew -- or February was higher than January, March was higher than February. We did see a small decline in April orders, but it's difficult to tell when you only have a few weeks in there to look at. I do think that the second half is -- or first half is going to be relatively strong if you look at the combination of our Q1 and Q2 estimates. But we do expect to see some growth in that in the second half of 2012 which, really, throughout the year, is not a normal seasonal pattern for us. It's difficult to tell because we don't have a lot of visibility, what those order rates are going to do going forward from here. We really only have about 4 weeks in our book-to-ship cycle. So it's difficult to project beyond that but, macroeconomically, our feeling is that the second half will be better than the first.

So looking at last quarter's comments in which you sort of expected China demand to improve in the second half of 2012, some of your pure companies were out, I think, with slightly more bearish comments expecting that improvement to really move, perhaps, towards 2013. Are you still sticking with your initial thoughts and outlook in that regard or...?

Yes. At this point, we're sticking with what our initial thoughts were. We haven't really seen too much to change that. And with the increase sequentially that we saw in Asia Q4 into Q1, we believe that we could still see that same pattern.

And 1 last one for me. And how should we think about the additional capacity coming into the new facility versus the current capacity that you already have available? I guess a different way to ask this is, the new facility, what sort of additional volume of sales would that be able to support as we're thinking about your growth going forward?

By the time we bring that capacity on of the new building fully in mid-2013, that capacity will help us grow to the next level. Just as if you look at when we brought other buildings on in the past. The last building that we built was in 1997, so we're looking at a 15-year time period of growth. And with a compound annual growth rate around 20%, we believe that building could take us well into the future and really to the next level, possibly even doubling the business that we saw in 2011.

[Operator Instructions] And we'll go next to Jon Braatz with Kansas City Capital.

Little, couple questions on the working capital. Your inventories in the gold mine are up a little bit. I think the last 2 quarters, your inventory growth has preceded your sales growth, are you -- can you talk a little bit about your inventory levels and your comfort with the inventory position at this point?

Yes. We believe we have the right amounts of inventory on hand to continue to deliver product to the customer when they need it. There's a fine line, I believe, between on-time delivery and the lowest possible inventory levels and I think our production people are very comfortable with the inventory that we have right now. That's obviously something that we look out on a very consistent basis. And we, in finance, when we're looking at the numbers side of it, are conferring with the production people and making sure that everybody is on the same page going forward with regard to inventory. But delivery really is the primary driver of why we would have more inventory on hand.

Okay. Okay. And margins in the German operation were probably the weakest. Is there anything you can do to tweak that margin or is it something that you want to leave alone and business will come back? Is there anything you want to do in the interim in a weaker environment?

We really don't try to manage that too much. A lot of it's affected by currency and the weakness of the euro to the dollar. They're buying all of their goods from the U.S. in U.S. dollars. So we do see some effect in the currency related to that. We take the benefits on the upside when the euro was strong and we take some hits on the downside, but we have not gone to the length of creating elaborate hedging contracts to try to correct that. You don't mind, really [ph].

And our next question comes from Kristine Kubacki with Avondale Partners.

My question is, and I'm just kind of trying to make sure I understand, you're talking about the seasonally -- going against, kind of, the seasonal norms in the second half. And I know you guys see a pretty broad [indiscernible] of end markets there. I'm just wondering, one, are you seeing anything that gives you confidence that you're already -- that we will see that kind of going against the seasonal piece maybe in China and Europe? I mean, can you give us kind of what the take is on some of the end markets? What's weaker than you would have expected and maybe what's stronger than you would have expected, especially in those 2 end markets?

In the end markets -- that's a really difficult question for us to answer because of our route to market. We don't have a good handle on where all of our products are going at any given time because we're, as a manufacturer, a little further down the food chain. We are not seeing any specific end-markets that are not doing well. Al did comment since he's in Australia that he is seeing the Mining and Energy sectors there remaining very strong. And I would guess that in all markets, there's probably a different end-use market that is stronger than others. In Korea, I know we have a lot of excavator business there and we've seen some pick up there, at least in Q1, as well as in the special vehicle market. But because we are so diversified those are -- have very small effects on the total outcome of Sun. Turning to seasonality question, I think we've had a lot of trouble over the last 3 years of really looking at our normal seasonality, if you will. 2009, obviously, wasn't bad. 2010 wasn't bad. We saw some variations in 2011 that we didn't fully understand, especially toward the end in Q4. And now the pickup, I think it's difficult to read. I don't know that we're in a normal pattern, given the global economic situation that we're in.

Okay. And then I'd just make sure I understand, did you say that sequentially month-to-month, you're seeing an uptick in North America through the first quarter and then even into April?

Yes.

First. We received a couple e-mailed questions and we'll go ahead and answer those at this time. Since you are expanding manufacturing, can we assume you're close to full utilization in your plants today?

Well, capacity as we've discussed many times is something that is constantly changing for us and we manage our business to the constraints that we see within our production areas at any given time. So that we can eliminate that constraint and free up that capacity. We are not currently at full capacity. But we believe that now is the right time to build for the future growth of Sun. And if we wait until we're at full capacity really bringing on a new building, it's too late at that point.

Should we expect some leverage on margin expansion particularly as orders seem to be moving higher?

Yes. At the higher sales volumes, especially if you look at what we experienced in Q1, we continue to operate at very high level with respect to margins, leveraging our assets and our fixed costs. Heading into Q2, we expect those margins to be very similar.

Will site work be capitalized and therefore not too much of a hit on EPS? Yes. All building costs, including site work, will be capitalized. How many shifts is Sun currently running in the U.S.?

We have several shifts that we're running now. We have 2 10-hour shifts in most areas, 4 days a week with overtime available on the fifth day, in other areas we're running 3 8-hour shifts, we also have a few people on a weekend shift. So these varying shifts allow us to really take a look at the manufacturing constraints that we talked about later and move resources there.

And the last e-mailed question was relating to currency. Is currency an issue for Sun? Should we anticipate a drag due to a higher dollar and hence higher prices for U.S.-made products making Sun products a competitive disadvantage?

Yes. Currency has had an impact on our financial statements. Part of that was in our prepared remarks. As a result of our international locations, buying in U.S. dollars. If the dollar strengthens, their cost of goods sold goes up. But there are also a lot of products that are sold directly to distributors and integrators around the world, out of our U.S. operations in U.S. dollars. So the strengthening dollar can make our products more expensive at least short term in those international markets. We don't anticipate any significant drag in demand. However, due to a strengthening dollar the [indiscernible] brought to our product line coupled with our performance and our ability to deliver really creates demand for Sun's products. We believe the slowdown in Europe and Asia is primarily related to the general economic slowdown in those regions and not related to pricing or the strength of the U.S. dollar.

We'll go ahead and turn it back over to the callers, any other questions?

There are currently no other questions in the queue. [Operator Instructions] And we do have a follow-up from Mig Dobre with Robert W. Baird.

Yes. Just a quick modeling question, can you guys detail the currency impact in the quarter?

Sure. It was 1%, I think, on the top line and about $0.01 on the bottom line related to both the currency. The $0.01, I think was in Dennis' prepared remarks, it was related to the combination of the HCT loss as well as currency with $0.01.

And at this time, there are no further questions in the queue. Miss Fulton, I'll turn the call back to you.

Thank you, Drew. I'd like to remind everyone that Sun's annual reports and proxies were mailed on or about April 20. Please make sure to vote. Sun's annual meeting will be held Monday, June 4 at 10:00 a.m. at our Tallevast Road facility in Sarasota. Thank you for joining today's call and we look forward to speaking with you next quarter.

And ladies and gentlemen, that does conclude today's presentation. We thank you for your participation.