Please stand by, we’re about to begin. Good day, ladies and gentlemen, and welcome to the Sun Hydraulics Corporation 2015 Third Quarter Conference Call and Webcast. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. David Lamb. Please go ahead, sir.

Good morning. Thank you for joining us for Sun Hydraulics’ 2015 third 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. The global business climate continues to be difficult. Demand in all regions is down and the strong dollar persists in creating headwinds for both sales and earnings. Our fourth quarter forecast notes additional softening in demand related to: weak or weakening end markets, macroeconomic conditions, and a strong U.S. dollar. Indicators signal today’s current demand levels will continue into 2016 with accelerating growth during the year. Given this outlook, we believe it’s not a matter of weathering the storm, but rather seizing an opportunity to capitalize on a slow period. Market share gains are made in the beginning of the business cycle and preparation requires planning and investment at the bottom of the cycle. So rather than concentrating on short-term cost-cutting, we’re keeping our attention on investments to drive future growth. We’re also keeping in mind the things that make Sun, Sun, our short lead times, the agility of our workforce, our responsiveness to changing business conditions, and our diverse product line are important to us. These and many other competitive advantages gives Sun its edge when compared to others in the industry. We saw initial signs of a softening economy in mid-2014, which continued into 2015. Most recently, distributor feedback, which is a key component of our market intelligence, indicates slowing demand in the market supply chain. This has resulted in destocking of inventories at distributors in Q3. However, we believe this to be a good scenario for things to come. As the cycle circles back around, shells will need to be refilled and it will happen quickly. Sun will be in a position to respond to customer demand as it recovers. Significant progress since our last webcast has been made on our new Digital Logic Valve or DLV. The introduction of the DLV…

Thanks, Al. The strength of the U.S. dollar continued to play financial results for Q3. The global economy is sluggish and some key end markets for our products remain weak. Many economists predict that the first-half of 2016 will be slow, but in the back-half of the year, the business cycle will turn back up. We do not have the visibility to see this far ahead, but we subscribe to this theory based on leading indicators like U.S. PMI and industrial production. Third quarter sales were $48 million, down 13% over Q3 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 $0.32, down 14% over last year. Earnings were reduced by $0.07 due to currency. And as a reminder, the Q3 EPS includes a one-time gain of $0.04 related to the sale of a facility in Korea. Turning to our regional results, demand in the Americas is down 14% over Q3 last year. European sales decreased 8%, 5% percent of which related to currency. Asia-Pacific demand dropped 17%, driven primarily by weakening of the South Korean economy. The strong U.S. dollar put pressure on margins in our subsidiaries, reducing our overall gross margin by 2% from 41% to 39%. SEA expenses we’re down slightly primarily due to translation. The provision for income taxes for Q3 was 33%, down 1% from last year. The Q4 tax rate is expected to be 34%. Net cash from operations was $12.6 million. Inventory turns improved to 10 and days sales outstanding were 32. The company declared a normal quarterly cash dividend of $0.09 per share payable as of October 15 to shareholders of record as of September 30. Looking ahead to the fourth quarter, please note that Q4 is a 14-week quarter and 2015 is a 53-week year, which will end on Saturday, January 2, 2016. Given that the last week of the quarter includes the New Year’s holiday, our international operations are shut down and our U.S. operations run limited production. Therefore sales in week-53 of the year are not significant. Q4 sales are estimated to be approximately $44 million, compared to $55 million in Q4 last year. The Q4 sales estimates assume that currency is responsible for $1.7 million of the decline. The overall decline in sales of $11 million is expected to impact gross margins, reducing them to approximately 35% in Q4. Earnings are estimated to be $0.17 to $0.19 per share. Q4 profitability is negatively affected by decreased demand and absorption of fixed costs at these revenue levels. Currency is expected to reduce Q4 earnings by approximately $0.05. As Al said earlier, we expect the fourth quarter to be challenging from a demand perspective. However, we look forward to the opportunity this downtime presents, as we focus our efforts on taking market share when the economy and end-markets recover. We would now like to open the call for questions.

Thank you. Today’s question-and-answer session will be conducted electronically. [Operator Instructions] Our first question comes from Mig Dobre with Robert W. Baird.

Good morning, everyone.

Good morning.

Maybe a quick question first on the quarter itself, so if I look historically, the last time the company missed the quarterly sales guidance by more than $0.5 million was back in the fourth quarter of 2008 when I think you missed by something like $1.1 million. This time you missed by $2 million. So, on that basis alone, I mean, you, generally speaking, have pretty good visibility into the quarter when you’re providing the guidance. The delta itself this quarter to me appears to be pretty significant. And I’m trying to understand sort of what changed in the quarter and the magnitude of the change, because if I’m looking for instance, you’re referencing PMIs. European PMI seems to be doing fine there, above 52. U.S. PMI still above 50, so what are sort of some of the moving pieces here?

Yes, Mig, one of the first items is related to our Korean operation, we’ve seen some significant decrease in orders related to our OEM business there, that happened in Q3 that was not expected. So that is a portion of the $2 million that we missed by on the top line. The rest of it is related to distributor inventories in the U.S., we saw as we said earlier significant destocking at our distributors, and that was over 10% of the total with our North American distributors. That significant for us, we don’t talk about distributor inventories a lot because they do fluctuate here and there, and the reporting of them sometimes take some time to get the information, and but this time it was more significant and we do feel that was contributing to the decrease that we expected for Q3.

That’s right, Tricia. And I would like to add one more thing, Mig, to talk a little bit about why PMI would indicate that the economy a strong and the results are not reflecting that, and this is probably the first time that’s happened in the history was following PMI. In fact this was a subject of discussion, this summer at the Economic Outlook Conference for the industry association. And I think one of the speakers presented on this very point, his view was that PMI through the middle part of 2015 into the third quarter, it was artificially high, because it didn’t reflect that a lot of what was going on in terms of production of new orders and hiring practices was going into inventory build in the channel, not only with the fluid power producers, but also with the end users. And so that inventory build given artificially strong signaled that to PMI. And that was supported by inventory numbers that available. Since then, we’ve seen a rundown versus like since August. We’ve seen the rundown of the inventory and as a result PMI has softened significantly since mid-year. In fact, it’s floating right around 50 right now. And the inventory component of that is the piece that first of all was not seen and it is now being readjusted for.

Okay. I appreciate that. In terms of your own discussion with distributors, you mentioned destocking, I’m wondering though if there is some perspective that you’ve got with regards to the point and which distributors will reach some balance vis-à-vis, where end market demand actually is in terms of their inventory. Is this - is there something they take three months, six months, a year, or how long does it take the correct? Given what you just said earlier about the channel inventory build?

I think it happens very quickly, in fact, I believe is probably already happened. And as the economy stabilizes and starts to grow that inventory will be built back up.

And if you take that view and you sort of extrapolated beyond your fourth quarter guidance, but I’m wondering is, is it fair to assume normal seasonal patterns and demand as we look into early 2016. Specifically what I am saying is, does it make sense to assume sequential revenue growth from the fourth quarter to the first quarter as normal seasonality would indicate?

I believe it is - I think the wildcard in this whole thing is mid-2015 - excuse me mid-2016, what’s going to happen there, because normally mid-year is when there is a softening. And if the economy does recover in the early part of 2016, the sequential softening going into the summer of 2016 probably won’t happen, but that something that we need to look at and watch very carefully going forward.

Okay. Only two more questions for me. The first one is on the implied gross margin, which for the fourth quarter; it seems to me that your guidance implies something in a low-30s. And I think to understand that a lot of this has to do with volume changes, Tricia maybe you can confirm this, but how should we’ll be thinking about gross margins on a little longer timeframe, should we expect these types of contraction call it early on in 2016, with a resumption in a back half or really any framework we’ll be helpful at this point?

Q4 has some interesting things in it that are affecting gross margin. For instance, as we talked about the 53-week year, we actually have six holidays that fall into that period, where we normally we’d only have four. And given that business is lower we expect a lot of utilization of vocation time. Certainly volume is a huge driver to that as well, we talked in the past about our fixed costs base and the revenue levels that we need to cover that. As we brought the new building on at 803 Tallevast, that added another $1 million dollars’ worth of costs to our fixed cost base. We’ve been making investments in our marketing efforts around the globe, which has increased our fixed costs base as well. When we get to the levels that we’re talking about for Q4, we’re starting to get into an area where it’s more difficult to absorb some of those additional fixed costs that we’ve added. Certainly as volumes increased hopefully in the first part of 2016 we’ll start to see the margins increase. But I think this margin that we’re talking about, which is 35% approximately for Q4. Is low based on a lot of factors other than just volume and I think we’ll see that increases we had into 2016. Assuming all other things are the same.

Okay. So just want to make sure I heard this is right, your guidance implies 35% gross margin in the fourth quarter?

Yes.

All right, great. And I guess, the last question is on SG&A, and I know that this is where some of your investments have been flowing through in terms of costs, is it fair assume that this line item is going to be relatively stable with, call it, an upward bias next year, given your ongoing investment?

Yes, we have an upward bias one for the investments, because we will continue to make the investments that we need for the future growth, but - well likely also go up based on translation as currencies comeback against the U.S. dollar, they’re spend some talk - the euro specifically will stay lower. And if that’s the case, you don’t get the translation with that, but certainly we’re seeing some translation effect on those numbers of this year relative to what we saw last year.

Great. Thank you, Tricia.

The currencies translation piece of it is very, very speculative in terms of what is the euro going to do or other currencies. We were sitting here a year-ago, I don’t think any of us would have foreseen, the euro weakening or the dollar strengthening to the level of we should have. So I have no confidence that we can predict was going to happen a year from now, relative to currency.

I totally agree, going back to the SEA numbers, as Al talked about we are going to have a CEO transition at end of the first quarter in 2016. And we will have some additional costs related to the agreements with Wolfgang and with Al that will increase our SEA as well.

Thank you for the color.

Yes.

[Operator Instruction] Our next question comes from Jon Braatz with Kansas City Capital.

Good morning, Allen and Tricia.

Good morning, Jon.

Good morning, Jon.

A couple of questions, I think Allen, you mentioned maybe was Tricia mentioned that you lost some OEM orders in Korea. Where those orders lost to another manufacturer or were the project cancelled or what can you tell me about that?

Primarily, we’re seeing OEM business related to excavator production decreasing in Korea. We believe it’s primarily related to equipment that would be going into China, and what the China economy down the way it is, it’s affecting those Korean orders.

Okay.

We did not lose on competition. Yes.

Correct. Many of the large OEMs in Korea actually are closing their plants for extended period of times, two, three, four weeks as a result of business conditions in Korea and in China and in Asia in total.

Okay.

It’s not lost business.

Okay. Allen, I was talking to an engineer who does a lot of business in China this weekend. And he said the headlines out of China seemed to be a little bit worse than what’s actually happening there. What’s your perspective on the economic outlook for China and what are you seeing and hearing from your people on the ground?

That’s a great question. I’m not sure that there is a clear answer, but I’ll do my best. First of all, transparency in China with macroeconomic and economic indicators is very suspect. It has been quite a period of time. I mean, I go to China some years three, four, five times, and I look around and I look at what they’re projecting as the GDP and the growth. And I just would sort of say, I don’t see it, it doesn’t make sense. But then, of course, China is a huge country. So, what you see in one place of China may not be reflective of what’s going on 1,000 miles away. And so you can see what’s around you, what’s going on, but you can’t see what’s going on a 1000 miles away. And their statistics, their government statistics don’t match what some of the banks put out for example. For example on PMI, there are two PMI numbers for China. There is the HSBC Bank and then there is the government statistics, and they’re not the same. So, there is a transparency issue is what, I guess, I’m saying. There is the underground economy as well in China that sometimes is not really reported. So all of this makes China very, very fuzzy as to what’s going on. Having said that, we believe by our people on the street talking to customers and we become embedded as like a local company. They look at us as a local player and we have access to opportunities in the marketplace that exist, that still exist. So, it’s a bit of dichotomy, which China do you want to talk about and it is mixed signals.

Okay. Should we - to be boiled down to be very simplistic, should we just sort of keep an eye on what the business outlook from Caterpillar as a good measure of how your business is improving or not improving?

No, no, I wouldn’t use Caterpillar, no.

No, okay.

They are a player in the marketplace, but they are a different kind of player in the local economy. What I would be looking at is I would be looking at the two PMIs. The government PMIs, HSBC PMIs and there is a slight difference between the two. Sometimes there is more than a slight difference, but right now it’s a bit of a slight difference. And I’d be - that’s what we look at as - and talking to our people in the market that kind of what we look at.

Okay, okay. And one last question and I know - I don’t want you to be a currency prognosticator, but if currency would just stay the same as it is right now, Tricia, when might the headwinds disappear, in the second-half, or would you still have some lingering headwinds?

They start to disappear actually in Q1 when we started to see the primary effect specially of the euro. So as we move into 2016, we’re going to see from a currency perspective much easier comparison.

Okay, all right, all right. Thank you very much. Yes.

Let me just add to that.

Okay.

You’re right. I probably shouldn’t be a currency prognosticator, but I can’t help myself get sometimes, right. So, the question I think that you need to answer is the dollar strong or is the euro weak. And if you look at it that way, I believe the euro is weak. And it’s a left - it’s hangover from their monetary crisis that occurred due to the Greek crisis and other things that were going on in the marketplace. And so, if you believe the euro is weak, you then can believe that the euro is going to get stronger. And I don’t see any reason that the U.S. dollar is going to get stronger or even stay at this level. It is artificially high when you look at all the sort of macro and monetary indicators. So, my belief is, we’re going to be heading back to where we were a couple years ago. We may be not go all the way back, but I think we’ll get back to where the euro was born, which was at 1/19, I think we’ll go back to that level fairly quickly. That’s how I’m looking at it.

So, in your retirement, Allen, are you going to be a currency trader now?

Probably nobody is going to pay me for that.

All right. Thank you very much.

Our next question comes from Tristan Thomas with Sidoti.

Hi, how is everyone?

Very good.

Hi.

I really appreciate all the color you have provided on the previous question. So, I just had one remaining question. Regarding the DLVs, could you maybe provide a little more insight into, I guess, two things: one, some of the markets you think you can target; and then, two, who would you be taking that business from, and then, what really the main reason customers would switch to that product?

Sure. I could probably give some specifics, but I’m reluctant to sort of to do that, because the customers we would be talking about are currently in prototyping and pilot production. So, I won’t get into specifics, but I will give you some general indicators. First of all, you have to look at what this product is. It’s smaller. It’s more compact. It’s less power. It’s faster. It has all those attributes of - I liken it to when Apple introduced the iPhone to sort of replace the old flip phones. This has the same game changing technology. It will replace conventional solenoid-operated valves in many, many, many applications. Yes, there’s still a few flip phones out there, but the iPhones has taken the majority of that market, whether it’s Apple’s or Samsung’s or LG’s or whatever. This product has got the same characteristics, game-changing characteristics. It’s not evolutionary at all. It’s totally a revolutionary product. And that’s what we set out to achieve, when we started doing product development and research about three or four years ago. So, some of the markets - to give you a little bit of flavor that would appreciate those characteristics, agricultural equipment; typically, there is a lot of solenoid-operated products on pieces of agricultural equipment that could use less power consumption, smaller and faster. Another example would be, we’re looking at applications on fire and rescue, emergency response, standby generators, examples like that. And we’re finding more as we go on. Our marketing approach to this thing has been to make it easy for customers that are at exploratory stage to find us, but for us also to go out and seek them. So, it’s a double-edged marketing approach. As I said, we just shipped our early pilot production units in October and we’re looking for a market release of one of the versions, there’s going to be multiple versions, but the first version we’re going to release will come out in December. So, I’m going to leave it at that for now other than to say that we’re very optimistic and looking forward to the new markets that this is going to generate. One last thing, we have found that every time we’re successful with an electrically actuated product. For every dollar of that electrically actuated product we sell, we generate about $10 of other product sales that go with it. It’s not just for selling this $1 worth of electrically actuated product. It’s the pull through effect of other products as well.

Okay, great. Just one follow-up question in terms of timeframe, this is something that would take a couple of years to be designed into some of these new products and a new piece of ag equipment. For example, what’s a good way to look at that?

Some of that will be very early adoption. I’m going to say approximately a third perhaps will happen quickly, because it’s so unique, it has solved so many problems and it’s not a high risk product. But I think the majority of the market, the two-thirds market will be designed in and tested, and be a part of the development phase of the end customer. So, it’s not a pop that’s going to happen overnight, but within the next two to three years I think we’ll see the sales of this product mature and there will be some very early sales which we already know of, because we’re shipping pilot production units to those customers.

Okay, great. Thank you.

And it appears we have no further questions in the queue at this time.

Okay. We would like to thank you for joining us on today’s call. Sun will be presenting at the Robert W. Baird Industrial Conference in Chicago on November 10, 2015. Following the conference, we will post a copy of our presentation on the Investor Relations section of our website at sunhydraulics.com. We look forward to speaking with you again after the fourth quarter release in late February. Thank you.

That does conclude today’s conference. Thank you for your participation.