Sauer-Danfoss Inc. Q2 2008 Earnings Call Transcript

| About: Sauer-Danfoss Inc. (SHS)

Sauer-Danfoss Inc. (NYSE:SHS)

Q2 2008 Earnings Call

July 31 2008 10:00 am ET


Dave Anderson - President, CEO

Karl Schmidt - EVP, CFO


Amit Daryanani - RBC Capital Markets


Good morning. My name is Kerry, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sauer-Danfoss Q2, 2008 Earnings Results Conference Call. (Operator Instructions).

I would now like to turn the conference over to Mr. Dave Anderson, President and CEO of Sauer-Danfoss. Thank you. Mr. Anderson, you may begin your conference.

Dave Anderson

Thank you, Kerry. Good morning and good afternoon ladies and gentlemen. Welcome to Sauer-Danfoss' conference call to review the second quarter 2008 results. Participating with me on the call today are Karl Schmidt, Executive Vice President and Chief Financial Officer, and Ken McCuskey, Vice President and Chief Accounting Officer.

Before we begin, I'd like to inform you that this conference call contains forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. The Company's reports are on file with the Security and Exchange Commission, providing more detailed description of these risks and uncertainties.

We're pleased to report record revenues and increased earnings for the second quarter 2008. These results are highlighted by increased sales in all three of our business segments; Propel; Work Function and Controls, as well as in all three of our geographic areas; Asia-Pacific; Europe; and the Americas.

At the same time, we continue to improve operating margins in all three of our business segments. In addition, we recorded a record $114 million in cash flow from operations for the first six months of 2008, up from $59 million for the first six months of 2007.

The strong cash flow, resulted in a significant improvement in our leverage ratio to 40% at June 30th, compared to 43% at December 31st of 2007. I should note that this improvement was made at the same time but we continue to invest in expanding our capacity, primarily in our European plants, to meet both current and future product demand. We are making good progress with this expansion and it will continue into 2009.

I'll be sharing with you an overview of our second quarter sales by region and market, including the status of our new orders and current backlog. Karl will then review the details of our overall financial results, and I'll conclude by commenting on our 2008 outlook before we open the call for questions.

As I've already stated, our second quarter sales were a record for the quarter, increasing 21% compared to prior year, and 12%, excluding the impact of currency and divestitures. Our growth is once again, well in excess of what we have seen in the growth of the underlying markets in all of our regions.

Though we are operating in the US economy, which has clearly softened, sales in the Americas were up 5% compared to last year's second quarter. However, they have fallen short when compared to the 8% sales growth in the Americas that we reported for the first quarter of this year.

Sales in the Americas were up in all markets with the exception of construction, which was flat for the quarter, and turf care, which was down 17%. The softness in each of these areas was primarily due to a weakening US economy, particularly as it relates to home construction, which was down 30% from previous year's levels and reduced spending in the consumer turf care market.

Non-residential construction, while slowing, has remained strong. Road building was up 3% in spite of high energy and asphalt costs, which are keeping the road building activity across the country at, or in some cases, below 2007 levels.

The ag market is by far the strongest market in the Americas, with sales up 42% for the first quarter over last year. These increasing sales continue to be driven by high commodity prices, as well as a number of new business wins going into full production.

Our sales in the material handling and specialty market were up 5%. This market has benefited from the relatively strong commercial construction market and strong OEM export sales. However, at the same time, we're seeing signs of a slowing in this market segment, with some OEMs reducing build rates and are slowing in the European markets, which will affect export sales.

Sales of distributors, which continue to make in roads with small to medium sized OEMs, outperform the overall market with sales up 10%. Sales growth remained favorable in Europe, up 13% for the quarter, excluding the effects of currency translation rate changes and divestitures.

All of our major market segments have contributed to this growth. Sales in the ag market, grew 28% in the quarter, which ags in the Americas reflects the favorable economic environment for farmers, along with new program wins going into production. Recent wins in Eastern Europe in particular have contributed to this strong growth.

Sales into the road building and construction markets were up 10% for the quarter. However, there are indications that construction will begin to decline in the second half of this year to 2007 levels. While the road building market in general, is level with last year, new projects are providing us with our growth opportunities.

Material handling and specialty market sales increased 6%. However, we're seeing significant reduction in the production of material handling equipment and we do expect slower growth for the second half of the year.

In Asia-Pacific region, our growth continues to develop very favorably with sales up 47% for the quarter. This growth is being driven by sales increases in the construction, road building, material handling, and specialty equipment markets. The strong Chinese market, in combination with a major new customer win in the past year, are the major contributors to our strong growth.

During the second quarter, we continue to see an increase in both new orders and backlog. These increases are an indication of the demand that we're experiencing in all of our markets, but particularly in the European and Asia-Pacific regions. I would however, like to remind everyone as I have previously, that part of the increase in our backlog is due to our customers placing orders with increased lead times to ensure that their needs are met. Having said this, our backlog increased 35% from June 2007 to June 2008, excluding currency translation rate changes.

Karl will now provide some additional comments on our financial results.

Karl Schmidt

Thank you, Dave. For our second quarter 2008, we reported strong earnings of $0.47 per share compared to $0.37 per share for the second quarter of '07. Second quarter '07 earnings included restructuring costs of 7:14, $0.05 per share sic ($0.06 per share).

We also reported record revenues of $611 million for the quarter, compared to revenues of $503 million for last year's second quarter. Our operating margin improved to 7.6% for the quarter, compared to 6.6% last year, and we are pleased to see margin improvements in all our segments.

The falling value of the US dollar versus the Euro left its biggest mark in the very low margin of the Work Function segment, because many of its products sold in the US market are manufactured in Europe. Without impact from currency, the Work Function margin improvement would have been more than twice as large.

Our cost associated with our SAP business system implementation has been declining over last year as we near the completion of the project.

For the second quarter, we have recorded some cost relating to our global procurement project that is offsetting this decline. We expect the global procurement project to produce savings, which will balance its project cost, starting in the fourth quarter of this year and we expect that to be fully accretive to our earnings in 2009 and beyond.

Concerning our margins, we recently announced a surcharge to customers to offset the increasing cost that we are experiencing from our suppliers in an effort to protect our margins for the year.

Our pretax earnings show a significant improvement from $0.43 up to $0.70 per share. The effective tax rate for the second quarter 2008 was at a much more normal level of 33.7%, and that is way up from last year's unusually low level of 15.5%, partly due to a statutory lowering of the Danish tax rate last year.

In connection with our planned capacity expansion, our capital expenditures were $84 million for the six months, up from $53 million for the first half of 2007. Our all-time record cash flow for the first six months of $114 million compared to $59 million last year, has allowed us to increase our investment into production capacity, while still bringing our leverage ratio down to the normal seasonal level of 40%.

Let me now turn the call back over to Dave.

Dave Anderson

Thank you, Karl. We're pleased with what we have been able to accomplish in the first six months of this year, particularly given the economic climate in North America. As we look ahead, we are seeing signs of slowing in many of the European markets and economies, along with continued weakness in North America.

However, as we have demonstrated for many years, we are able to outgrow our markets, and therefore, we're remaining with our outlook for the full year, and that is sales growth of 9% to 11%, earnings of a $1.50 to $1.65 per share and capital expenditures to be approximately 7% to 8% of sales.

I'd now like to open the conference call for questions.

Question-and-Answer Session


(Operator Instructions)

And our first question comes from Amit Daryanani with RBC Capital Markets.

Amit Daryanani - RBC Capital Markets

Thanks a lot. Good morning, guys.

Dave Anderson

Good morning.

Amit Daryanani - RBC Capital Markets

Just sort of I guess the question maybe to start off with, it sounds like you guys are talking about a little bit of slowdown that you're seeing in the European site, specially in road building and material handling segment. Given that back drop of -- can you just talk about maybe have you evaluated options to delay the capacity expansion at least longer demand and stretch them out over time?

Dave Anderson

Yes. That is a good question. And we look at that really, product line by product line. And the expansions that we're making are really in specific areas that, even under today's current demand levels, are really under-capacity, forcing us to operate over time that we wouldn't want to utilize operating to -- forcing us to operate really at a level of efficiency that's suboptimal.

So we still need to be making those kinds of investments. I think, what's important to point out is that we're talking about machine tools and productive capacity; we are not talking about bricks-and-mortar here, too.

Amit Daryanani - RBC Capital Markets

Fair enough. And then when I look at the backlog, it's been pretty strong. It's I guess 37% this quarter year-over-year, organically. Is there a way to maybe parcel out the part that's due to extended lead times?

Dave Anderson

You know, we have tried to do that. It's difficult to get a real grip on it. So, I don't know. The delta over last year, if I was just to pull a number out of the air would be -- it might be that it's 50% higher than what we might expect, but we are -- we still have a backlog that, even under normal conditions, is greater today than it was last year at this time.

Amit Daryanani - RBC Capital Markets

Fair enough. And then, looking at the pricing surcharges. How much per headwind has this commodity inflation been for us, maybe in Q2 or even going back to the first half of '08? And given the fact you've actually announced this, sounds like, to your customers, have you seen any pre-buying that may have helped Q2 out a little bit?

Dave Anderson

Karl, you want to put some detail to that?

Karl Schmidt

Yeah. I think, we have seen this avalanche of material price surcharges we've come through in the second quarter. May and June, we saw incoming materials affected by surcharges, and that led us to react pretty quickly. I don't think there is any significant impact in the P&L from that, because it takes a while until those material rolls through the inventory and into the finished product and then into cost of sales.

So, what we see is that the second quarter is somewhat clean of any effects, in that, with the announced material surcharges that we are processing to our customers, we see the ability that for the year, that should bound out and hold us somewhat harmless at the margin level.

And the way it was introduced, certainly pre-buying -- any pre-buying activity is very closely monitored, and certainly to that extent that will not be accommodated. But, I think the industry as such, on many of our customers, are used to the fact that material costs are coming through based on the commodity pricing levels that we have seen everywhere.

Amit Daryanani - RBC Capital Markets

Alright. And how big is the surcharge, Karl?

Karl Schmidt

What we announced nominally-- but keeping in mind that many of these surcharges have to be individually processed with each OEM, and to some extent, individually negotiated -- we announced a nominal increase of 3%. And again, that should help us to offset what we would expect in an equal amount come through on the incoming side.

Amit Daryanani - RBC Capital Markets

Fair enough. And this is my final question, and I'll hop off after that. The tax rate you think about it as 33%, going forward?

Dave Anderson

That's a good tax rate. Yeah, 33% to 35%, Amit.

Amit Daryanani - RBC Capital Markets

Perfect. Thanks a lot, guys.


(Operator Instructions). At this time, there are no further questions.

Dave Anderson

If there are no further questions, I'd like to thank all of you for taking your time to join us today on the conference call. And if you do have questions that come up later, and you'd like to follow up on them, I hope you'll feel free to call Ken, Karl, or myself directly to have them addressed. Thank you very much. Have a great day.


This concludes today's conference. You may now disconnect.

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