Sun Hydraulics' (SNHY) CEO Wolfgang Dangel on Q2 2016 Results - Earnings Call Transcript

| About: Sun Hydraulics (SNHY)
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Sun Hydraulics Corporation (NASDAQ:SNHY) Q2 2016 Earnings Conference Call August 4, 2016 9:00 PM ET

Executives

David Lamb - Investor Relations

Wolfgang Dangel - President and CEO

Tricia Fulton - Chief Financial Officer

Analysts

Mig Dobre - Robert W. Baird & Co.

Operator

Good morning ladies and gentlemen and welcome to the Sun Hydraulics Corporation 2016 Second Quarter Conference Call and Webcast. Today's call is being recorded. At this time, I would like to turn the conference over to David Lamb. Please go ahead, sir.

David Lamb

Good morning. Thank you for joining us for Sun Hydraulics' 2016 second quarter conference call. Wolfgang Dangel, 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 Wolfgang Dangel.

Wolfgang Dangel

Thank you, David. Good morning. Second quarter demand was slightly better than anticipated, gross profitability remained in line with company estimates. Regionally, Europe and Asia were each down only marginally. The Americas experienced the greater part of the decline year-over-year primarily attributable to the continued impact lower oil prices and lack of investment in the mining sector.

Looking forward, Brexit and the geopolitical climate impair our visibility of the future. We are encouraged however, by increased demand in selected markets throughout Asia Pacific with considerable sales to China, Australia, India and Japan. We feel the success in these markets is directly attributable to our increased marketing efforts in these regions.

Despite today's uncertainty, we continue to make investments that will strengthen Sun's market position now and looking forward. We are accelerating the manufacturing efforts, expanding our electronic and digital capabilities, acquiring talent to complement our current competencies and acting on opportunities where we can grow in both new and existing geographic regions.

We have two exciting marketing initiatives that we have announced recently. Our online QuickSelect load holding selection tool and Spanish language enhancements to our website. We are renowned for the breadth and depths of our product portfolio especially with regard to load holding products. These products are used to move or suspend load in the air, familiar applications include cranes, aerial work platforms and buckets on utility trucks.

Our broad load holding product line consist of over 180 base models to fulfill the demands of the most sophisticated systems. While our offerings allow for diverse customized systems, the options can be overwhelming. The QuickSelect tool is an easy to use resource that gains an understanding of a system designer’s needs to the use of survey questions to fulfill the available options.

We continually release tools to educate and simplify complex processes for both our customers and channel partners. The QuickSelect tool is available on our website today, we welcome you to visit our website to experience the tool for yourself. As previously mentioned, we also released a Spanish language version of our industry acclaimed website. In recent years, significant investments have been made to enhance our web presence.

We identify the need to better serve our Spanish speaking customers around the world and we felt this was a great way to reach this new audience. Tools such as this facilitate our global market penetration and make us more relevant to customers. In addition to Spanish, our website also currently supports English, French, Chinese and German.

Before moving to Tricia’s prepared remarks regarding the financial results. I would like to address one last time. Our 8-K filed yesterday makes note of a larger credit facility replacing the five-year facility, which just expired. The new credit facility would enable us to act quickly and strategically should the right opportunity present itself through our continuous investigation of M&A, joint venture and other expansion opportunities and their potential contribution to our long-term vision.

Finally, the environment remains sluggish, but we are optimistic about the future. We have experienced individuals in the right position throughout the company and our team has a renewed focus on sales, global presence, quality, lean initiatives, premium service and development of mine share with our business partners. Our emphasis on these efforts will be the key drivers of our gross going forward.

I will now turn the Tricia to elaborate on the quarter’s results.

Tricia Fulton

Thank you, Wolfgang. Second quarter sales were 51 million down 6% over Q2 last year. Currency negatively impacted the quarter by 200,000 compared to the prior year. With no price increases in 2015 or 2016, pricing did not have an impact on sales during the quarter. Earnings per share were $0.26 down 25% over last year. The lower earnings was different primarily by reduce sales and CEO transition costs.

Turning to regional results for the quarter, demand in the Americas was down 10% over last year while European sales decreased 3%. Asia-Pacific demand decreased by 1% but as Wolfgang mentioned there were great spots.

Sales growth has been identified in various region and we feel this growth is directly attributable to our increase marketing efforts. Q2 sales to China were up over 16% compared to Q2 last year. Continuing this trend, Australia was up 19%, India 6% and Japan 7%.

Unfortunately, these increases were offset by decreased demand in the Korean construction industry. Korea’s Q2 sales were down over 20%. Gross margin for the quarter decrease by 3% from 40 to 37, the decline resulted from decreased revenue, which hindered our ability to absorb fixed cost.

Selling, engineering and administrative expenses increased 16% for the quarter primarily attributable to be aforementioned CEO transition cost. The provision for income taxes for Q2 was 34% similar to Q2 last year. The Q3 tax rate is expected to be 33%. Inventory turns remained at 10, and day sales outstanding were 35.

Our balance sheet remained strong with net cash from operations of 11 million or 23% of sales for Q2. Our cash balances and continued cash flow allows us to take advantage of opportunities that arise for investments that will drive future value.

Looking ahead to the third quarter, Q3 sales are estimated to 46 million compared to 48 million in Q3 last year. The estimate assumes currency is responsible for 200,000 of the decline. Q3 earnings are estimated to be $0.19 to $0.21 per share, compared to $0.32 last year.

For comparative purposes, please note that last year’s Q3 earnings included a one-time gain of $0.04 on sale of our building in Korea. The 2016 estimates include additional expenses incurred for the growth initiatives compensations.

These expenses are expected to negatively impact earnings by approximately $0.04. CEO transition costs, which will impact earnings through Q1 2017 reduced third quarter earnings by an additional $0.01. Currency is not expected to materially influence earnings for Q3.

As previously touched on by Wolfgang, we entered into a new credit agreement on July 29. The need for the new revolving line of credit was prompted by the expiration of our existing credit facility at the end of July.

The expired facility, which was obtained in 2011, was intended to fund short-term cash needs and potential growth opportunities. Five years later, our proven financial performance significantly enhanced our capacity to borrow.

Today's economic environment has made credit more acceptable at cost effective rates for companies with fund excellent profile. The new facility has a five-year term making $100 million immediately available with an additional $75 million accorded in future.

The versatile unsecured credit line is not limited in its use and provides access to a variety of currencies. While the new credit facility is not tied to an immediate need it allows us to act quickly if one arises. We were opportunistic and took advantage of our strong balance sheet and cash flow to provide flexibility of funding for future opportunities.

We would now like to open the call for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. And we will take our first question from Mig Dobre with Robert W. Baird.

Mig Dobre

Good morning, everyone.

Tricia Fulton

Good morning, Mig.

Wolfgang Dangel

Good morning.

Mig Dobre

Tricia, maybe I'll just start by asking a small clarification question on a gross margin performance, I appreciate the year-over-year color, but I’m wondering if you can talk a little bit about what happened with gross margins sequentially, it was down about 100 basis points on collaboratively flat revenue. Is there some material costs that is creeping higher, what are some of the puts and takes here?

Tricia Fulton

It's not really related to material as much as it's related to some of our costs for labor and benefits that at some point in the revenue cycle becomes fixed costs. So we are not able to absorb as quickly as we start to see revenues decline on the top-line. We will see this continue into Q3 margins, do decline in Q3 we are estimating 34% to 35% gross margins at the revenue level we have estimated for the third quarter.

Mig Dobre

Okay. I appreciate it and that's helpful because you anticipated my question about the third quarter. And then, I’m looking at normal seasonality, and if I look at your top-line it does make sense that the third quarter would be lower than the second in the way you are guiding. It does seem to me though that the step down of call it 9.5% to 10% is a little bit in excess of that normal seasonality. So maybe you can comment on that a little bit, and related to this, please correct me if I am wrong, but it looks to me like the fourth quarter should see an additional downtick revenue from the third, if that's the case, how should we be thinking about the gross margin in a fourth quarter.

Tricia Fulton

I don’t believe that our seasonality patterns are holding up this year. They also did not hold up last year and some of that is simply a macroeconomic driven and as we have become more global, the seasonality I think isn’t going to be as relevant going forward. I don’t know at this point, we don’t have a good estimate for Q4. So I don’t know what to tell you about what to expect for they revenues there.

We had anticipated that in the second half of the year, we would see some sort of uptick that would begin. At this point, given the macroeconomic indicators and what we are seeing an incoming order rate. We don’t know what that’s going to happen.

If you look at PMI for five months, PMI has been above 50, which would indicate that we should be coming into some type of expansions since it’s been a leading indicator by about four to 12 months for us. But that could push it even into 2017 barring no other big global events that would keep the economy on a global basis from growing.

Mig Dobre

Well, I see that. But if you would humor hypothetical. If for instance we were to see additional sequential volume decline in the fourth quarter. How should we think about detrimental margins, on a gross margin level? Because obviously we are seeing a pretty healthy down take in the third quarter. Should we think about that similar to what we are seen in the third quarter?

Tricia Fulton

Right now, we are not expecting the fourth quarter sequentially to go down as much as we saw Q2 to the Q3 estimates, but again with our short book to ship cycle that’s hard to guarantee to you. But if we start to see additional decline on the top-line, it does directly affect margins because of the fixed costs base that we haven’t place, that doesn’t mean that we couldn’t take measures to adjust some of that, but we have not planned those specifically at this time.

Mig Dobre

Okay, thanks. And then, maybe turning into end market, I appreciated the color from Wolfgang earlier. I’m wondering maybe we can get a little more color as to. What is really driving this North American weakness, because frankly mining has been weak for a long-term, this is a new, and I think oil and gas has been weak for a long time, that’s not really new either? So what sort of surprise versus your assumptions or versus what you would have expected the market to do at this point?

Wolfgang Dangel

I think Mig, it’s not actually real surprise, I mean, if you have been following economy and if you see how Sun is aligned in terms of their end-market. Some of the other end sectors that we operating in have been soft for quite number of quarters already, agriculture, forestry, material handling, softening even the contraction sector has shown some recent signs of weakness. So if you look at the portfolio and the way we aligned up to these end-market, is actually not a very big surprise.

Mig Dobre

Okay. I guess the last question that I’m going to ask is back to the credit facility. You talked about using that facility primarily to drive growth. But I’m wondering, if at a point in time there is also a component returning cash to shareholders whether through a buyback or through some kind of a special dividend and using the balance sheet that way.

Wolfgang Dangel

Mig, we are continuously looking at all options, so as I pointed out I mean obviously investigating M&A on a continuous basis, but also the other options that you mentioned are under constant consideration. And if you look at the track record of Sun, we have done either so it's been always as well as strategy here and the same will apply for the future.

Mig Dobre

Thank you. Good luck going forward.

Wolfgang Dangel

Thank you.

Tricia Fulton

Thank you.

Operator

[Operator Instructions] And we appear to have no questions in the queue at this time. I would now like to turn the call back over to David Lamb for any additional or closing remarks.

David Lamb

We would like to thank you for joining us on today's call. We look forward to speaking with you again after our third quarter release in early November. Thank you.

Operator

And that does conclude today's conference. Thank you for your participation and you may now disconnect.

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