Greetings and welcome to the Sun Hydraulics Corporation’s First Quarter 2017 Financial Results. At this time, all participants are on a listen-only mode. The question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star, zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to your host, Karen Howard, Investor Relations for Sun Hydraulics. Thank you, you may begin.

Thank you, Rob, and good morning everyone. We certainly appreciate your time today for our first quarter 2017 financial results conference call. On the line with me are Wolfgang Dangel, our President and Chief Executive Officer, and Tricia Fulton, our Chief Financial Officer. Wolfgang and Tricia will be reviewing the results that were published in the press release distributed after yesterday’s market close. If you don’t have that release, it is available on our website at www.sunhydralics.com. You’ll also find the slides there that will accompany our discussion today. If you look to the slide deck, on Slide 2 you’ll find our Safe Harbor statement. As you may be aware, we will make some forward-looking statements during this presentation and also during the Q&A. These statements apply to future events that are subject to risks and uncertainties, as well as other factors that could cause actual results to differ materially from where we are today. These risks and uncertainties and other factors are provided in the earnings release, as well as other documents filed by the company with the Securities and Exchange Commission. These documents can be found at our website or at www.sec.gov. I also want to point out that during today’s call, we will discuss some non-GAAP financial measures which we believe are useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We have provided reconciliations of comparable to GAAP to non-GAAP measure in the tables that accompany today’s earnings release, as well as in the slides. Wolfgang will get started with some highlights for the quarter and discuss the Innovation Controls innovation. Tricia will go through the detail of the financial results, and then we’ll turn it back to Wolfgang for her perspective on our outlook before we open the line for questions and answers. With that, it is now my pleasure to introduce Wolfgang.

Thank you, Karen, and good morning everyone. Please turn to Slide 3. We are pleased with the start to 2017. It is especially exciting time. We are experiencing growing economic conditions as well as a lot of energy within our organization as our teams coordinate to execute the integration plan of our Innovation Controls acquisition. First I’ll start with summarizing our results for the quarter. Sales grew 59%, reaching a record $81.4 million. Sales in all of our markets around the globe grew organically and we also benefited from the Innovation Controls acquisition, which closed in early December 2016. For each quarter throughout this year, we will isolate the Innovation Controls revenue so you have a basis for the organic comparison. In the first quarter, Innovation Controls contributed $26.6 million, reflecting 36% growth over its sales in the first quarter of last year. This growth is driven by strong demand in the recreational vehicle market, specifically all terrain vehicles, as well as rebounding end markets for construction and energy. The core Sun business grew 7% driven by market expansion as well as our penetration of new markets, particularly in Asia. Most of our businesses realized progressive growth as we moved through the quarter, and that trend continued through April. Earnings per share grew 24% to $0.38. Innovation Controls were accretive by $0.04, which is net of acquisition-related amortization of $0.10 per share and incremental interest expense of $0.02 per share. On an operational basis, excluding the amortization and interest expense, Innovation Controls contributed $0.17 per share. You may know that the Sun business has been known for strong cash flows. Our consolidated flow in the quarter enabled us to repay $16 million of the debt we incurred in December for the acquisition, leaving us with a $124 million balance outstanding.…

Thank you, Wolfgang, and good morning everyone. I’m starting on Slide 6. First quarter sales were $81.4 million, up 59% compared to last year’s quarter. This includes $26.6 million for the Innovation Controls business, indicating that the organic business grew approximately $3.8 million or 7%. We did not have any price increases in 2016, so pricing did not affect the comparability. Foreign currency translation had an unfavorable $1 million impact for the quarter compared with last year’s quarter. I will now touch on sales by region, which are designated here in the sales bar chart. You’ll also notice that we’ve once again inserted a chart in the back of the press release as well as the supplemental slides summarizing this information. Experiencing progressive improvement in all of our geographic markets since about September, we realized year-over-year first quarter growth in each. In the Americas, sales grew 91% to $47.3 million, driven by the Innovation Controls business as well as organic growth. The Innovation Controls business is heavily weighted to the U.S., driving our sales in the Americas market up to 58% of the consolidated total. EMEA realized 28% growth to $20.1 million, and Asia-Pacific region was up 32% to $14 million. Our organic business grew 2%, 9% and 16% in the Americas, EMEA and APAC respectively. We are especially pleased to see that the investments we’re making in China, Korea and India are proving fruitful. Turning to the bottom line, earnings per share were $0.38, up from $0.31 last year. The current quarter results included several acquisition-related items as follows: $4 million of amortization expense related to acquisition items which amount to approximately $0.10 per share. Of that $4 million, nearly $1.8 million of it is in cost of goods sold and $2.3 million is in selling, engineering and administrative,…

Thanks Tricia. Please turn to Slide 10. As Tricia indicated, we’ve seen improvement in all of our global regions since about September. This continued through April and gives us confidence in the guidance we provided for 2017. As I noted here, leading indicators are pointing to a 2017 business cycle rise in the U.S. market as well as most global markets. It is believed that the U.S. economy is currently in the early stages of a new business cycle rising trend, and most economies in the rest of the world are similarly poised for new business cycle growth. In particular, rising trends are anticipated in Europe, China, Japan and Brazil. Considering the industry sectors that are most relevant to Sun, the construction industry is accelerating in 2017 supported by strong recovery in industrial energy producer prices and recent investments in new energy projects. Further, the housing market is on the cusp of transitioning to accelerating growth. More broadly, the manufacturing sector is accelerating mildly, driving the overall recovery in the industrial economy. Growth in general commodity prices and increasing global demand will contribute to an upward momentum in prices and input costs. Specific to our electronic segment, the Institute of Printed Circuits Association reports that North American electronics business indicators are strengthening. All of these factors bode well for Sun through the remainder of 2017. Please turn to Slide 11 for additional thoughts regarding our outlook. As I’ve noted previously, the growth trends cited on the prior slide of course do not take into consideration changes in economic policy that might be implemented by the U.S. administration, which remain uncertain. Reflecting on recent presidential elections in Europe, there has certainly been a lot of tension and anxiety over the potential impact of nationalist and populist movements, but elections held in Austria and most recently in France this past weekend indicated strong support for the ongoing viability of the European Union, which I expect will be positive for the global economy. However, we still have a major election in Germany later this year, which we will be watching closely. Additionally, we are cautious about other geopolitical risks such as those in the Turkey-Syria region as well as the Ukraine-Russia region and North Korea, which potentially impact global trade. Please proceed to Slide 12 where we summarized our guidance for 2017. It remains unchanged from what we presented to you in February, and we want to caution you that while we are very bullish with respect to the start of our year-end economic outlook, it is normal for the first half year to outpace the second half as a result of purchasing patterns in our industry. Accordingly, we believe that our guidance numbers reflect our current outlook for the remainder of the year. So with that, let’s open up the line for questions and answers.

[Operator instructions] Our first question comes from Mig Dobre with Robert W. Baird. Please proceed with your question.

Good morning everyone.

Morning, Mig.

Actually, I have quite a few questions. I hope you guys can humor me on that. Want to maybe start with Innovation, and I guess--you know, this business is performing really better than what I would have guessed, ahead of my own expectations. I’m wondering how is it performing vis-à-vis yours, what you were thinking when you initially bought the business, and maybe you can sort of help us understand what are some of the drivers of any outperformance or underperformance versus what you expected, and also whether or not there is something special in the first quarter that could have driven the 36% growth that you talked about.

Sure Mig, good morning. Well first of all, we bought Innovation because we believed in the business model and the competency of the entire organization, so obviously the first quarter, as you pointed out, has been very positive, exceeding expectations. Nevertheless, we could realize that 2017 was shaping up well for Innovation for various reasons. First of all, I mean, the end markets they are serving are doing reasonably well. As you might recall, we have two lines of businesses there - it’s the power controls business, which is tied to a lot of the off-highway vehicles and industrial stationary equipment, and those markets have all significantly recovered so it’s not a complete surprise that we see a significant increase in business in those end markets. The second line of business is the vehicle technology business line, and there I’m not surprised as well because if you look at the key end markets there and the key segments they are serving, it’s all terrain vehicles, recreational vehicles, and marine. Those end markets have been doing well, and last but not least, I think it’s due to the efforts that have been made on the innovation side over the last two years in terms of product development and closed project work with those specific end customers in those segments. So all of that in a nutshell is pretty much--I see a reflection in the Q1 performance at Innovation. It’s a seasonal business - I think we have to take that into consideration, and we learned that already, so the first half of the year is historically stronger than the second half of the year, so Q1 is not truly representative so don’t you expect 36% growth rates on a quarterly basis.

Sure, right. So that’s kind of what I’m getting at, because I know your core business well but not Innovation, really, so I’m trying to understand if you can help us at all get a sense for what sort of the normal seasonality of this business is, what happens in the front half versus the back half, either as a percentage of full-year revenues or however you want to discuss it.

Yes, you might--you know Sun’s core business, the hydraulics side of the business quite well, Mig. I think it pretty much compares reasonably well to the historic business cycle and to curves that you have been seeing on the hydraulic side. As I pointed out, the only distinction is in vehicle technologies. I mean, that’s more a project-driven approach, so there you depend a little bit more on the performance of your individual OEMs you’re working with. Again, I think due to the technology competency Innovation Controls has, they’ve been doing well with their target OEMs, so that contributed definitely on top of the normal seasonality that you would see in their business during Q1.

Sorry to keep pushing you on this, but I think this is an important topic. I mean, if I look at what you have done in the first quarter, your electronics business did north of $27 million of revenue - $26 million and change was from Innovation. If I look at your guidance for the full year in terms of what you expect for the electronics business, then the remaining three quarters are basically guided for revenue that’s below $22 million. So what I’m trying to understand here is whether or not there is effectively conservatism that’s built into your guidance, which is fine if it is, or if because of these seasonal dynamics, we should be thinking that, for instance, at some point in the back half of the year sequentially revenues need to drop to the tune of 25% versus what we have seen in the front half.

Yes, I can’t tell you that, whether it will drop to the level of $22 million, but what I can tell you is we have varied visibility of the second half of this year. We have--to be quite honest, we have literally zero visibility for the fourth quarter of this year. Now, we have a strong indication what will happen in the third quarter, but as I said before, historically we know that the second half of the year is lower in revenue. Whether we will drop down to $22 million, I can’t tell you today. That would be sheer speculation, and I don’t want to do that at this stage.

Well I mean, you have a forecast out for the full year in terms of revenue, so I guess what I’m wondering is what’s embedded in that forecast, when you issued the forecast itself, how you thought about it and how the first quarter trended versus your initial forecast, which to me would look like the first quarter trended above what you were thinking initially when you issued the guidance.

Yes, that’s correct. The first quarter was stronger, as I said, given the reasons I stated. First quarter was stronger than expected, but having no visibility of the fourth quarter, I think it would be sheer speculation to sit and throw out the numbers. I don’t want to do that. I mean, we gave you guidance in February and we feel pretty confident based on everything we see and looking at historic business growth and business data at Innovation that we will be within that guidance.

Okay, fair enough. Then maybe you can help us understand how you’re thinking about incremental margins for this business, and we can talk about it on an adjusted basis if you would, meaning excluding amortization just to keep things simple. An extra, call it dollar or million dollars of sales, what sort of incremental profit pull-through would Innovation be posting normally?

Their incremental revenue dropped very similarly to what you have historically seen in the Sun business, which has been 40 to 50% drop on additional incremental revenue. They too have a fairly high fixed cost base that gets absorbed quickly with incremental revenue, whereas on the Sun side it tends to be at the gross margin level where the fixed costs are. With Innovation, it tends to be in the SEA section.

Okay, understood. Speaking of SEA, maybe we can also clarify a little bit as to your views in terms of the run rate for SEA going forward. You’ve done--you were pretty close to what we were guessing, maybe a little higher at $14.7 million, but as I understand, roughly $700,000 of that is going to be going away. Is it fair to think of $14 million as a run rate going forward, or is there something that could potentially be added to that number as the year progresses?

It’s a pretty good estimate for where we are right now; but that being said, we are continuing to make investments similar to the investment that we made last year when we added the regional application specialists, and we’re continuing to add sales and marketing efforts in Asia as well. So we’ll let you know when those things are happening, but given everything that’s in place right now, I think your $14 million number is pretty good, but realize that we are going to continue to make investments going forward as required for what we see in the market places in each region.

Sure, fair enough. Then the last question on Innovation for me is there a way to maybe parse out the impact of new product introduction, because I remember you talking about this being a growth driver when you announced the acquisition, so when we’re looking at this, call it 30%-plus growth, how many points of that would you say are owed to this new product initiative, really?

Well, it depends for the definition of new products, because that life cycle of products on the electronic side is obviously significantly shorter than on the hydraulic side. I think if you look at new products and you would look at the three-year time frame, so my guesstimate would be that probably 70 to 80% is new products, so revenue that you see today is probably, yes, two-thirds to three-quarters probably due to new products that have been developed over the last three years, and one-third is probably based on legacy products carried forward.

Okay, we can follow up offline for more there. Moving on to the hydraulics business, first Trish, historically you and I have usually talked about seasonality in this business on these calls. You know, my recollection is that just normal seasonality in your core business would have your revenues up to the tune of 7% sequentially in the second quarter from the first. I’m trying to understand as to whether or not that’s still an appropriate way to think about it, particularly given Wolfgang’s comments vis-à-vis demand continuing to improve through the quarter and into April.

I think it’s a fairly good assumption on the hydraulics side that we would see a bump in Q2 over Q1. We have historically talked about that being a normal seasonal pattern. As you’ll recall from our script, we were seeing growth in all of the regions, but the Americas was by far the weakest of all of those. We’re seeing a lot more growth in Europe, in Asia than we are in the Americas, so I think there’s still probably some opportunity for more growth in the Americas as we roll through into Q2. We’re seeing some recovery in the end markets and we’re getting good information about a positive marketplace from the distributors that we have in the North American markets, but it certainly is not at the level yet that we’re seeing in the rest of the region. So I would expect that we will see some bump in Q2 related to normal economic growth.

Okay, and on this topic of distributors, I guess I’m trying to get a sense if you’re--whatever you guys can share in terms of your view or what you’re hearing from distributors in terms of stocking levels, if there is a need for maybe restock in North America, and then also maybe parse out if you can OEM demand versus distributors. This acceleration, if you would, does it appear to be more driven by just pure OEMs, or is it distributors?

I think to the first question, Mig, so inventory levels, we poll inventory going to inventory servers on a quarterly basis, so inventory has come a little bit down in the channel, not significantly. The second question, whether it’s more OEM driven versus distribution business driven, I would say it’s across the board and it depends on the end market specific OEMs are operating in. I think oil and gas has recovered but is by far not as strong as the construction industry, so it depends on the OEM you are dealing with. But it grows across a spectrum, so it’s growth with large OEMs, with small and medium OEMs, and it’s growth with even some of the resellers.

I see. I know that you did not put through a price increase this year. I guess I’m wondering what your views are for price increases on a longer term basis versus what you were able to do historically from a competitive dynamic aspect. Do you feel as if you are still able to capture your typical price increases in the hydraulics business, and then what are you seeing on the raw materials front? Are you getting any pressure there, and is there really any way to offset it given that you haven’t really increased prices in hydraulics?

That’s correct, Mig, so we are going into the third year, third consecutive year without price increases. We feel comfortable maintaining this attitude at least for the time being. I don’t want to speak about 2018. With regard to suppliers, we have seen actually very little pressure for price increases so far, and in the conversations we are having with our suppliers, we expect them to do exactly the same thing we are doing, so launching continuous improvement initiatives to make up any potential cost increases through productivity and efficiency increases improvements. So as you know, we launched a major lean initiative here a year ago. I feel pretty comfortable that we still have a lot of room for improvement as far as the cost basis is concerned, so I don’t see an immediate need with regard either to price increases to customers, nor to absorb any price increases from suppliers, because we would expect them to align themselves with our way of thinking and do exactly the same.

I see. All right. I’ll ask one last question, and that’s really maybe your views on the optimal capital structure for the company, how you’re thinking about leverage. Obviously you’re paying down the debt related to the acquisition, but you do have a pretty aggressive goal as you look out to 2025 in terms of growing revenue. I’m wondering what is your tolerance for leverage at the high end, and how do you think about average leverage through the cycle?

Yes, obviously we have availability on our credit facility to go up much higher than we are currently, and if an opportunity were there, we wouldn’t have trouble utilizing that, and that’s why we put that facility in place. But certainly as you’ve seen, our goal is to pay down the debt as quickly as we can as well, so that we can lower that leverage. There are other ways for us to pay for acquisitions as well if we were to issue stock. That has been a consideration in deals that we’ve looked at in the past and certainly not ruled out by any stretch, but realizing that we do have that available as needed to pay of an acquisition that would come, that would potentially be very accretive to the business and also create the cash flow that would help us pay down the debt as quickly as we could.

Sure, I appreciate that. I--

Mig, if I may?

Sorry, go ahead.

I mean, we have quite substantial opportunities here to create free cash flow, as you can see from those numbers, and as we have stated during earlier calls, obviously the intention is to repay debt as quickly as possible. But on top of all of that, as Tricia said, other tools could come into consideration as we move forward from here, but in general the guideline is to generate as much as possible free cash flow to repay the debt as quickly as possible, and I think we have made big strides in the first quarter of this year. The other position from a balance sheet perspective we have to consider is we are sitting still on a tremendous amount of cash, particularly overseas, so if legislation would change down the road, that would provide other opportunities to deal with the debt situation.

I appreciate all of that. I guess to be maybe more clear on my question, if we’re looking for instance in terms of debt to EBITDA, and you think about leverage that way, right, what are you comfortable with given the dynamics that you know of your business in terms of cyclicality and everything else? Do you see yourself in a position where you could take leverage three or four times debt to EBITDA in order to do a deal? Do you think you have that kind of an appetite, or is there a specific threshold from that leverage standpoint where an equity issuance or other alternatives come into play?

We do have the opportunity under our current debt agreement to with an acquisition go to 3.75 times. We wouldn’t have put that in place if we weren’t comfortable with utilizing it with an opportunity that comes up. Certainly we’d prefer to stay below that, but we do have the opportunity to utilize that as we would see fit under our agreement.

All right, I appreciate all the color. Thank you.

As a reminder, if you’d like to ask a question, please press star, one on your telephone keypad. One moment please while we poll for questions. We do have a web question. Karen?

Thanks Rob. Yes, we have a question submitted on the webcast from Kevin Sonnett with RK Capital. It’s in regards to Innovation Controls. He says, please discuss the mix of the end markets, both product lines, a little more specifically, such as the breakdown of the mobile, off-highway, construction equipment, etc., the overlap with Sun Hydraulics. What are the biggest end market products in this part of Innovation, and the other part, the recreation end market, what are the biggest end markets, such as ATVs, marine and so forth, like boats, yachts. And with ATVs, he says, I believe OEMs have struggled here - too much inventory, low price, Asian competition driving prices lower.

Okay, maybe let’s start with Innovation Controls, and let’s start with the power controls business there. So the key end markets there are off-highway vehicles and industrial stationary equipment, so when we refer to off-highway vehicles, that’s been mainly--that’s about 40% is in construction, a small portion is in ag. A significant portion is in utility vehicles. If we look at vehicle technology, so there it’s, as I said before, all-terrain vehicles and recreational vehicles, that’s about 40% of the business and 60% of the business is marine. If we look at hydraulics, so I would say about a quarter of our business is in material handling, a quarter of our business--more, about a third of our business is in construction and mining, and the rest is equally split over industrial application, there is a bit of agriculture and forestry in there as well. The latter part of the question was with regard to OEMs having struggled, too much inventory, low price, Asian competition. Okay, I mean, historically we are not competing with those types of people. They are trying to enter customers and end markets we are operating in that historically Sun and Innovation Controls--I mean, we are premium products for very sophisticated applications, so we see actually less competition with low price Asian competitors across the board.

Ladies and gentlemen, we have reached the end of the question and answer session. I’d like to turn the call back to management for closing comments.

Thank you again for your participation this morning, and thank you to all of the hardworking Sun employees who are driving our results at the end of the day. We look forward to updating you on our second quarter progress in early August. Have a great day. Bye.

This concludes today’s teleconference. You may disconnect your lines at this time. We thank you for your participation and have a great day.