Allen Carlson - President, Chief Executive Officer Tricia Fulton - Chief Financial Officer David Lamb - Investor Relations.

Tristan Thomas - Sidoti & Company Joe Grabowski - Robert W. Baird Brian Rafn - Morgan Dempsey Capital Management.

Good morning ladies and gentlemen and welcome to the Sun Hydraulics Corporation 2015 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..

Good morning. Thank you for joining us for Sun Hydraulics’ 2015 second quarter 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..

Thank you, David. Good morning everyone. The global business climate continues to be difficult. Demand in the Americas and Europe is down, and the strengthening dollar creates headwinds for both sales and earnings. Asia-Pacific demand is a bright spot with China bolstering an increase over 9% when compared to the same quarter last year.

We’re pleased with the increase in demand in this region, particularly given the slowing growth of its economy. We feel the increase has a direct correlation with our recent sales and marketing investments in China.

Our third quarter forecast indicates additional softening in demand related to weakening end markets, macroeconomic conditions, and the strong U.S. dollar. Additional indicators signal weak second half of 2015 for manufacturing, but we see an accelerating growth in 2016.

Given this outlook, we continue to focus on investments that benefit Sun for the long term, which include quick design, the development of our digital logic valves, and the additional of worldwide marketing personnel.

QuickDesign, our design tool that enables users to instantly configure a custom integrated package, is gaining traction in the marketplace. Design requests that can commonly take days or even weeks to complete by manual design is now computer generated by QuickDesign in as little as 10 minutes.

We have seen a 46% increase in individual users whose designs ultimately result in a sale. This is a positive sign regarding the future of this customer interaction tool. Additional efforts are underway to further improve QuickDesign’s interface and functionality. These significant upgrades will improve the ease of use and ultimately increase adoption.

Product development efforts are ongoing with a focus on electrically actuated valves. Our technology collaboration announced last November continues to make strides. Sun will be the first to bring digital logic valve technology for the fluid power market.

These products, the first of which we expect to release later this year, will be smaller in size, lighter in weight, use less power, and operate faster than similarly electrically actuated valves. We have completed the initial design and prototyping phases of product and beta testing with customers has begun.

We feel this is a game changer for the fluid power industry and we’re excited about the level of initial interest. Partnerships like our digital logic valve collaboration are viable options for outsourcing R&D and gaining new technologies.

We continue to look for new partnerships and M&A opportunities where we can acquire new technologies and products that enhance and expand our offerings. Globally, we continue to invest in technical marketing capability to further service and support customers in their respective regions.

Field application engineers were added during the quarter in both Asia and Europe. New focus has also been placed on Sun’s business development functions which will further ensure coordination of our marketing efforts across all regions.

These investments in integrated package business, product development and global marketing efforts will be the key drivers of our growth. I’ll now turn the call over to Tricia to talk about the quarter’s results..

Thanks, Al. As with last quarter, foreign currency had a negative impact on our financial results for Q2. Looking forward, the strength of the U.S. dollar is expected to continue, causing a drag on our Q3 estimates. Second quarter sales were $54 million, down 12% over Q2 last year.

Currency negatively impacted the quarter by $1.8 million compared to the prior year while pricing accounted for roughly 2.5% of sales. Earnings per share were $0.35, down 24% over last year. Earnings were reduced by $0.05 due to currency, with the remaining decrease attributed to decreased demand.

Turning to our regional results, demand in the Americas was down 14% over Q2 last year. European sales decreased 13%, about half of which was related to currency and half resulting from decreased demand. Sales in Asia Pacific as a whole were down 2% in the quarter but demand in China was up 9%, despite slower growth in the Chinese economy.

The strong U.S. dollar put pressure on margins in our subsidiaries, reducing our overall gross margin to 40% for Q2 compared to 42% last year. SEA expenses remain flat when compared to the second quarter last year. The provision for income taxes for Q2 was 34% and consistent with the prior year.

The Q3 tax rate is not expected to change significantly from Q2. Net cash from operations was $14.5 million. Inventory turns improved to 10.6, and days sales outstanding were 33. The company declared a normal quarterly cash dividend of $0.09 per share payable as of July 15 to shareholders of record as of June 30.

Looking ahead to the third quarter, sales are estimated to be approximately $50 million compared to $55 million in Q3 last year. The Q3 sales estimates assume that currency is responsible for $1.9 million of the decline. The overall decline of $5 million in sales is expected to impact gross margins as well, reducing them to approximately 38% in Q3.

Earnings are estimated to be $0.32 to $0.34 per share and are affected by currency and a one-time gain in our Korean operations. While currency is expected to negatively impact Q3 earnings by approximately $0.04, we also have a one-time gain of $0.04 resulting from the sale of a building in Korea.

This building previously housed a portion of our operations in the region and was vacated at the end of 2014 when all Korean operations were consolidated into a new larger leased facility. In this challenging economic environment, we are concentrating on things we can control.

We are accelerating investments in product development, operational excellence, and marketing efforts around the world. This long-term focus will continue to create lasting shareholder value. We would now like to open the call for questions..

[Operator instructions] Our first question comes from Tristan Thomas with Sidoti & Company. .

Hey, how is everyone?.

Good, how are you?.

Not bad. Just two quick questions. Could you go into a little more detail in terms of what specifically you did in China to drive this demand, and then also if you could touch on what you’re seeing in the South Korean construction industry..

Sure. I’m going to back up chronologically almost five years. From 1998 through 2010, we had a joint venture in China. That JV was a 50/50 JV, and we sold the 50% ownership we had to our joint venture partner with the intent of opening an office in Shanghai to cover all of China to basically increase our bandwidth in that region.

As I said, that office opened in 2010, and since that time we’ve added three or four additional people, I guess maybe even five people in that office. Additionally at the same time or shortly thereafter, we’ve assigned one of our personnel from Sarasota as an ex-pat working in the region.

He relocated there in 2014, but actually began working late ’13, early ’14 in that capacity. So we’ve added a lot of additional horsepower and talent in the region. Relative to Korea, we see a very strong headwind in that market with the construction people driven by the Chinese economy.

A large amount of the exports that comes out of China in construction machinery goes into China, and that market is very difficult right now..

Okay.

With your DLV technology, could you maybe provide some type of either time frame or maybe what your expectations are for that to kind of fully ramp?.

Sure. We started development on that in ’14 and accelerated at the end of ’14, actually signed a technology transfer agreement with Sturman Technologies. We began development in late ’14 that continues on. We have prototype hardware functioning in our lab. We have some beta test units going into the field.

Looking forward, we should be in a position to begin some, I’ll call it pilot production with some key customers in late this year, early next year, and beyond that it’s very difficult to see how fast the market will be adopted..

Okay, so we’re probably looking at ’17 for maybe it’s meaningful.

That’s kind of a safe assumption?.

Yes..

Okay, great. Thank you..

We’ll take our next question from Mig Dobre from Robert W. Baird..

Good morning. It’s Joe Grabowski sitting in for Mig this morning. .

Hi Joe..

Hello Joe..

Hi, good morning. I guess my first question is, Al, last quarter you mentioned that you didn’t think you were seeing destocking and that the decline in orders and revenues were sort of in line with the decline in demand.

I just wanted to see if that was still the case this quarter, or if you think maybe there has been a little destocking in the channel..

We have not seen any destocking in the channel at this point. We don’t track to the dollar what the inventory in the channel is, and really only have visibility in the North American market, but we do not believe there is destocking at this time..

I would agree with that..

Okay, all right. I guess my next question - looking at the Q3 guidance, the implied operating margin is about 22.5%, which would be the lowest operating margin in a few years. I know some of it is the impact of currency, but just maybe talk a little bit about other things that might be impacting the margins in the third quarter..

We’ve talked about the investments that we’re making. Most of those hit in the SEA line related to where they are for margins, and certainly we have some additional expenses related to those investments; but we still feel that those are the right investments to be making at this time to drive future growth.

We talked about investments in marketing and sales personnel in China. We’ve also added marketing and sales personnel in Korea as well as in Europe over the last three to six months, so those will be additional expenses that will come into the operating margin line on a short-term basis.

But on a long-term basis, we believe they will drive growth and profitability. .

Okay, thanks. I guess my final question would be there was a mention in the prepared remarks that you were expecting accelerating growth in 2016. I was just wondering what you’re seeing on the horizon that makes you feel better about 2016..

There is a number of, I’ll call it macroeconomic trend reports that we follow, and they are all pretty consistent that 2015 will be sort of the low point in this cycle, and we’ll see acceleration in 2016 and going also into 2017.

Some of the factors that the trend reports look at is that consumer demand will begin to drive some capital investments in areas like mining and minerals, which hasn’t happened yet to date. The mining market has been down now for about three or four years. The expectation is that that will begin to come back in 2016, as will ag.

The dollar is not expected to strengthen; in fact, the long-term view of the dollar is that it will probably weaken, especially once Europe has their act together relative to Greece, and I think that is behind us at this point in time and I think you’ll see a strengthening of the euro going forward.

China is kind of at its low point, and the Chinese government is taking actions to increase demand in the Chinese market, which will improve not only the Chinese market but the Korean market, as well as perhaps markets for some of the U.S. manufacturers that ship into China. So for the most part, things are going to look better.

A couple of other factors that just came to mind, GDP in the first quarter in the U.S. was, depending on how you want to look at it, was either negative or slightly positive - let’s call it zero. I don’t think that’s likely to continue. I think we have an election year coming up, which will be positive regardless of what the results are.

The PMI Index continues to hover just north of 50, but I believe we’ll begin to see that strengthen as well going into ’16. So most of the macroeconomic indicators are kind of at their low point and looking forward are probably going to increase..

Okay, great. Thank you. Good luck in the second half..

As a reminder, if you would like to ask a question, that is star, one at this time. We’ll take our next question from Brian Rafn with Morgan Dempsey Capital Management..

Good morning everybody. .

Good morning..

Just a question relative to the logic electric actuated valves.

Do you have any sense, and I know you have very fragmented [indiscernible] markets, any sense as to what areas, high tech [indiscernible] areas might be an early adopter of that valve?.

Yes, there’s a number of leading indicators, people who have expressed an interest from the early days, and the markets that we’re seeing right now that have shown an interest are construction equipment and ag.

Both of them could drive significant volumes of this product, and of course that’s what we’re looking for to kick it off, is to find a few key targeted customers that can drive some volume. One of the questions earlier from Tristan at Sidoti was do we expect to see some additional volumes or some meaningful volumes.

My answer was 2017, but with some of the initial work we’re doing, it could be as early as mid, late ’16. But I’m very confident that 2017 will be some significant volumes. This is a very unique product, so it does take a little while for the market to get its head around it..

Yes, well on your engineering designs, you guys have some pilot manufacturing, some prototype in testing.

Do your end user, or some of your end user customers, do they get involved with that pilot manufacturing, or do you share details on that or it is strictly proprietary for you guys?.

No, we work very closely with the end market users in making sure that the product sort of hits the mark for what they need.

Some of the units that are in the field, while I would say it’s 95% Sun’s view on what the product should look like, there is about 5%, maybe in the area of coatings, rust preventative coatings, the electrical connections, the seals, the things that they need for their specific market. So yes, we work as close as we can with the end customers..

Let me ask you, Allen, from an engineering design, the digital component of that, is there applications due to--you know, from a robust design, like vibration or heat or thermals, that maybe this digital might be more sensitive to because of the precision, or is it as robust as the analogs?.

It’s more robust than the analog product because it’s got fewer parts, and it’s only got two states - it’s on or it’s off. The analog valves have all the range from full on to full off, so the digital aspect of this product is going to make it more robust and more reliable.

The other thing I should mention, since you’re asking these detailed technical questions, we should be viewing this as a range of products. This is not going to end up being one product; there is going to be a family of products that will come out of this.

There are some customers that say, you know, the most important thing in my world is I want the least expensive product, and then there is the other application that says no, I need high speed and low power consumption.

Then, there is another one that says I need this attribute, so I think we’re going to see at the end of the day a range of products that look very similar but have either different embedded electronics because some of these products do carry electronics embedded into them. So it’s very, very customer or market specific at this time..

Yes, okay. Then on the SG&A side, you guys were very creative in the 2007 - ’08 mortgage meltdown relative to furloughing people, extended vacations. You guys were very creative that way.

Is that at all being used in this mini-downturn, or are we really not at the same dramatic level?.

We are not seeing dramatic changes related to that, with the exception of we have the ability to flex overtime down. We generally work about 45 hours a week, and we can flex that down to 40 as needed in the areas that don’t have bottlenecks or constraints in them. We’re pretty much at zero overtime right now, given the demand levels that we’re at..

We also have a number of projects going on within the company where we use some of our hourly employees in terms of productivity improvements, quality improvements, et cetera, so we’re not even close to where we were in 2007 - ’08 with an overabundance of direct hours. .

Okay, good.

Then Tricia, what percentage of sales were expedited sales? Was that about normal?.

It stays pretty consistent period-over-period at 15% of our sales. We’ve been tracking that now for a while, and we’re always pleased to see that it’s kind of become a built-in part of the business at 15%..

Okay, thanks guys. Appreciate it..

Thank you..

Again, if you would like to ask a question, that is star, one on your telephone keypad at this time. Again, star, one. That concludes today’s question and answer session. At this time, I’d like to turn the conference back to Mr. David Lamb for any additional or closing remarks..

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..

That concludes today’s conference. We appreciate your participation..