David Lamb - IR Wolfgang Dangel - President & CEO Tricia Fulton - CFO.

Mig Dobre - Baird Equity Research Christian Thomas - Sidoti & Company.

Welcome to the Sun Hydraulics Corporation 2016 first quarter conference call and webcast. Today's call is being recorded and at this time I would like to turn the conference over to Mr. David Lamb..

Good morning. Thank you for joining us for Sun Hydraulics' 2016 first 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..

Thank you David. Good morning. With the first quarter behind us 2016 has presented very few surprises. So this was slightly better than anticipated yet end markets persisting putting a drag on the hydraulics industry as a whole. Additionally the strength of the U.S. dollar continues to create headwinds for both our top and bottom lines.

Taking a closer look regionally the Americas and Europe were both down slightly year earlier while Asia felt the brunt of the comparative decline of the quarter predominantly due to slump in demand in the construction industry of that region.

From our perspective the environment continues to be uncertain with economic indicators signifying little trend movement either positive or negative we recognize that we cannot control microeconomic issues.

Keeping this in mind we know there are many elements of our business we can control like product development, increasing productivity, maintaining delivery liability and developing new markets and customers. Our industry is cyclical as economic conditions improve we expect the markets for equipment that use our products to expand.

I like to take some time now to review a number of initiatives currently in progress. We are continually making developments in our lean manufacturing technology and process automation by eliminating waste and automating process we produce product more efficiently and continually improve quality.

Investments in human capital are ongoing as we’re actively recruiting application and product engineers in all major regions around the globe. Growing the expertise, knowledge and technical skills of Sun's work force is vital to our future growth.

Through collaboration efforts with our sales channel partners we’re intensifying emphasis on target accounts by working directly with our sales channel we are able to make instantaneous decisions to overcome obstacles in our business and markets.

We believe working more closely with our distributors to provide market support and training will afford us new and better opportunities for growth. In the past we have discussed our agility in adapting to our environment and making quick decisions to better take advantage of available opportunities.

We're taking this one step further to develop the same agility with our channel partners. We are initiating conversations with [indiscernible] and machine design. Last month, strategic members of our team attended at [indiscernible] one of the largest trade shows for construction machinery equipment.

The show brings us together not only with other hydraulic companies but also with our global channel partners and OEMs who ultimately design and manufacture equipment on which our products are used. We are actively investigating new and existing geographic regions where Sun can grow.

To understand industrial landscape of each region we are preparing market studies to clearly define the prospects. We're going about this systematically but will act quickly to capitalize on opportunities. Last month we introduced a newest version of QuickDesign, our automated manifold design tool.

A request for a new design that can commonly take days or even weeks to complete by manual design is computer generated by QuickDesign in as little as 10 minutes.

The update adds an exciting new feature called SmartConnect which is a drag and drop point and click schematic design tool that streamlines the process of integrated package design from concept to solution.

The SmartConnect tool provides a more intuitive and natural way to define our circuit, expect to highlight on SmartConnect to be available on our website within the month. Since officially becoming CEO I’ve spent a significant amount of time meeting with our teams those domestically and internationally.

Sun's focus is headed in a variety of directions all of which are positive. We are looking at things with fresh eyes. We have a strong team here at Sun with a great knowledge and expertise. We are developing new skills and improved ways of communicating. We recognize opportunities in our markets we only need to exploit them.

I take comfort in the fact that Sun is an extremely agile company. We're able to replicate shift to adapt to changing business conditions. At this point in time it is hard to evaluate what the remainder of the year has in store.

These challenging economic times are difficult for everyone but the way Sun is structured and the relationships we with our employees, suppliers, distributors and customers help us to operate unlike most companies. Our focus remains firmly on exceeding customer expectations, growing our global presence and delivering strong financial results.

As further opportunities present themselves we will be ready. I will now turn the call Tricia to elaborate on the quarter's results..

Thank you, Wolfgang. First quarter sales were 51 million down 6% over Q1 last year. Currency negatively impacted the quarter by 1.4 million compared to the prior year. With no price increases in 2015 pricing did not have an impact on sales during the quarter. Earnings per share were $0.31 down 31% over last year.

Three factors contributed to lower EPS, decreased sales, the strong U.S. dollar and CEO transition expenses. We initially expected the CEO transition cost to fall into the second quarter but instead they reduced Q1 earnings by $0.01 per share. These costs were not included in our Q1 forecast provided in February.

The comparisons are further clouded by the onetime gain of $0.02 recognized in Q1 2015 for U.S. dollars held in our German entity. Turning to regional results for the quarter, demand in the Americas was down 5% over last year while European sales decreased 6% both attributable to the vulnerable end markets.

Asia-Pacific demand dropped 11% primarily driven by the continued weakening of the Asian construction industry. Gross margin for the quarter decreased by 1% from 39 to 38, the decline resulted from both the strong U.S. dollar placing pressure on margins in our subsidiaries as well and decreased revenue which hindered our ability to absorb fixed cost.

Selling, engineering and administrative expenses decreased 5% for the quarter primarily attributable to the aforementioned CEO transition cost -- CA increased 5% for the quarter. The provision for income taxes for Q1 was 32.7% similar to Q1 last year. The Q2 tax rate is expected to be 33%.

Inventory turns were up slightly to 10 and day sales outstanding were 35. Our balance sheet remained strong with net cash from operations of 8 million for Q1. 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 second quarter.

Q2 sales are estimated to be approximately 50 million compared to 54 million in Q2 last year. The estimate assumes currency as responsible for 1.2 million of the decline. Q2 earnings are up estimated to be $0.25 to $0.27 per share.

Earnings are expected to be reduced by $0.03 related to currency and then an additional $0.02 due to CEO transition expenses. The CEO transition costs will continue through Q1 2017. As Wolfgang alluded to earlier, the economic environment remains uncertain.

We continue to monitor economic indicators closely rather than waiting patiently for the next cycle we are accelerating investments in product development, operational excellence and marketing efforts around the world. By concentrating on things we can control we maintain our long term focus of creating lasting shareholder value.

We now like to open the call for question..

[Operator Instructions]. And your first question will come from Mig Dobre with Baird Investment Bank..

Maybe we can start with which really the demand progression and talking a little bit about your second quarter guidance and I guess the way I'm looking at it if I look at your guidance for being down 2% sequentially, that to me looks like a very unusual sequential progression when you look at the normal seasonality of your business.

Typically, the second quarter is up versus the first and if I look back historically the only years in which we have actually seen sequential declines in revenue have really been 2001 and 2009 and last year during 2015 where the decline was actually lower for what you're guiding this second quarter to be.

So I'm trying to parse out exactly what's really going on with demand and how you're thinking about whether or not there was some kind of a pull forward in Q1 that we didn't know at the time but now it's maybe a little more obvious or whether things are simply deteriorating as we're going into the second quarter..

You know you're absolutely right, Mig, we’re not following a normal seasonal pattern and when we looked at this last year which was one of the years that you brought up that we also did not see a normal seasonal pattern we were a bit confused by that as well.

This year I believe that a lot of this is driven by what we're seeing in the Korean Construction market that has been hit very hard and it's dropping our Asian numbers and we’re also seeing a bit of the slowdown in parts of Europe certainly not all of it but parts of Europe are slow for us.

We don't know if that’s right now economically driven or if it's a demand issue. We aren't far enough into it to be able to discern which one of those it is yet but we were hoping to see that normal seasonal pick up in Q2 but we aren't -- our North American markets are staying relatively strong but our other two major geographies are being hit..

That's interesting especially your Asia comments I think are interesting given the fact that we've actually seen pretty strong construction equipment sales in China in the first quarter.

So how do you think about that in terms of your outlook and really do you feel you have a sense that there is a disconnect between the retail sales and actual demand from OEMs?.

I think Mig, if we look down the road here we could probably be cautiously optimistic as far as that is concerned.

As I mentioned we just attended [indiscernible] the largest construction machinery exhibition back in Europe and also talked to Chinese and Chinese [indiscernible] manufacturers which are main end customers for some products and there is some cautious optimism as far as the second half of the year and as far as 2017 is concerned..

But is there any way to sort of equate the relatively weak commentary that you're providing for Asia in terms of what you're seeing real time with what were pretty darn strong retail sales that we saw excavators in a number of other equipment categories in China?.

I believe that we had a lot of our Korean business for that type of equipment that was being sold into China. And we're now seeing a decrease there because I believe some of the equipment is being made in China.

Our business tends to be with smaller and medium sized OEMs in China so it's possible that we're not seeing the effects of the macro yet, but we are seeking new customers on a consistent basis and looking at all sizes of customers as well in that region..

If I may add to what Tricia has been saying, so I think in China we have to be careful. So besides construction machinery and mining the two major target end markets for us are material handling and agricultural and both of those segments have been very soft during the first quarter still.

So I think what you're referring to is predominantly construction machinery equipment but not necessarily to material handling and agriculture..

And maybe going back to your opening comments. I've heard you mention several times responding to changing conditions and being flexible and that's a little bit different from what I've kind of heard historically from Sun Hydraulics.

So I wonder if you can maybe flush out this concept a little bit more recognizing that this year in both the first and the second quarter demand has been weaker than what normal seasonality would indicate. I mean you do have some optimism for the back half of the year but thus far the first half is really maybe not planned out as seasonally normal.

So I'm trying to understand what exactly thus flexibility mean as the year progresses if demand doesn't improve..

What I mean flexibility amongst other, it also refers to some of the internal initiatives we have launched here, Mig, if I point it out the lean manufacturing, a stronger focus is on improving processes, intensifying the collaboration with our channel partners.

We’re just coming out of distributor council meeting here where we had top distributors of North America here for three days, very constructive discussions.

So I think agility translates here into a little bit more activity driving from Sun towards its customers and channel partners but also some internal activities as I pointed out productivity and efficiency improvements, lean and so forth that’s what I was relating to..

Okay, you’re not thinking restructuring of some kind?.

No, not at all. I mean as you know, Sun is a pretty well-oiled machine. As I pointed out we have a very strong workforce here in place, very competent people. There is just I mean this is just accelerating in certain areas that you might not be used to but no, we would never restructure it, there was no need for that..

So I also wonder Tricia maybe you can give us some sort of understanding as to what raw materials are as a percentage of your cost of goods sold maybe some of the some of the key raw materials I would imagine in steel and maybe some other ones as well and I guess my question related to this is this we have seen pretty big movements thus far year-to-date in raw material prices.

What role did they play in a way you think about gross margin specifically going forward?.

Raw materials as a percent of sales tend to be somewhere between 32% and 33% and our raw materials might actually be a little bit different than what you're thinking simply because on the [indiscernible] side particularly we buy 98% of our purchased parts from suppliers using very high grades of steel.

So we don't tend to see the material fluctuations that you see with basic steel or even aluminum prices. We are making aluminum and iron manifolds as well. We do see some fluctuation there because we're buying bar stock but it's such a small part of the total cost of those products that it doesn't affect our margins significantly..

In terms of what you are purchasing from your suppliers though I mean is there -- how have those prices that you're getting from your supplier change historically with changes in commodity prices.

I'm looking at steel obviously to having a pretty big turn up sequentially from the first to the second quarter and I'm wondering at what point does that start to come through your cost structure?.

Mig, I just came back and I have visited the largest suppliers to Sun here in North America and I was actually quite impressed even though these people are seeing an increase in material prices quite correctly as you stated here. I see numerous productivity improvements in place.

So we haven't seen any price increases and I think it's also the mutual understanding between Sun and those suppliers that we would expect them also to lean manufacturing projects in place in order to counter any material price increases at this point in time..

And last question for me, Tricia can you give us a sense for what's embedded in your guidance for the second quarter in terms of gross margin?.

Yes, we're expecting margins in Q2 to be relatively close to what they were in Q1 at 38%..

[Operator Instructions]. Next we will hear from Christian Thomas with Sidoti & Company..

Just two quick questions, one I was just curious regarding QuickDesign who is really taking advantage of that, is that existing customers or first time customers?.

It's actually both. We monitor very closely who was taking advantage of it and who is utilizing the two and it's actually both. We're also seeing new customers utilizing the two, we have seen continuous upswing in participation as far as this tool is concerned.

So I'm positive that we will see more new customers predominantly out of regions outside of North America in future, but to answer your question at this point in time it's both..

And then are you seeing as maybe a little bit more proactive in terms of just sales getting out there.

Are you seeing an uptick in demand for some of the new products you've released recently any update on what?.

Well as you know I mean we are continuously releasing new product.

We are seeing quite some activity on some of the products we have launched recently but at the end of the day it's still an integral part of the entire market environment which is still soft in most of the end markets we are operating and so I think it's not to truly representative time to judge the product launches, I think with an upswing in the economy and in those end markets that we're operating in, I think we will see a significant upswing in terms of sales for our new products..

[Operator Instructions]. We will take a follow-up from Mig Dobre with Baird Investment Bank..

First and foremost it's Baird Equity Research, not Baird Investment Banking, but I want to go back to the seasonality issue because to some extent I understand you have some limitations in the way you're -- in terms of the visibility that you have but Tricia if I look historically, the back half of the year typically you see a seasonal downtick in revenues versus the front half of the year.

I'm wondering if internally you are preparing yourselves for this pattern applying itself to 2016 or if you have some reason to believe that we break that normal seasonal pattern to where the back half of the year revenues are actually going to be higher than that of front half..

I don’t have any expectation that we're in the middle of a seasonality shift here. I think it's more economic driven and we have some economic indicators that are pointing toward a stronger second half this year or at least the latter part of the second half maybe stronger and certainly into '17 show some promise as well.

But I don't think that we're diverging from our normal pattern here, I really believe that it's macroeconomic driven and we have a lot end markets that are being challenged, continue to be challenged and we also have geographical regions that are being challenged and it kind of depends on where those play out as we go through the year and at some point maybe they'll better align but right now it's kind of a mixed bag what we're seeing and it's a bit confusing as well going into the rest of the year especially with the lack of visibility that we have because of our short book to ship cycle.

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And there are no other questions at this time. I would like to turn the conference back over to management for any additional or concluding remarks..

We would like to thank you for joining us on today's call. Sun's 2016 proxy as well as the 2015 annual report entitled leadership was released in April. The annual report can be found on the investor relation section of our website at www.sunhydraulics.com.

We look forward to seeing you at our annual shareholder meeting on May 23 at our 803, Tallevast Road facility here in Sarasota. Thank you..

Ladies and gentlemen that does conclude today's presentation. We do thank everyone for your participation..