Sales Fell, Sun Invested

Sales Fell, Sun Invested

by Isabelle Gan | Contributing Writer

As companies continue to recover from the 2001 stock market crash, one Sarasota company is seeing much investor interest with its double-digit growth in the past three years.

Sun Hydraulics, manufacturer of screw-in cartridge valves and manifolds, estimates net sales figures of $116 million in 2005, up 22% from the previous year. Its stock price has doubled in the last year, from $10.63 a share to $21.7, a share. At one point, in August, its stock price was at a record high of $32.86 a share.

With two plants located in Sarasota and Manatee counties, the company produces valves that control the direction, pressure and rate of flow of hydraulic fluids used in hydraulic systems. Their products are found in a variety of equipment, from industrial manufacturing machines, to King Kong's hydraulically lifted arm at Universal Studios in Orlando, to Ferris wheels in Shanghai, China. In particular, the 35-year-old company has carved a niche for itself in the high-performance end of the fluid power market, distinguishing itself as a manufacturer of valves that can perform reliably at very high pressures.

"I think (Sun Hydraulics') advantages are its commitment to the high-pressure niche - which its larger competitors are not so active in - and its commitment to high product quality and reliability," says Westminster Securities Corp. analyst Will Lyons.

How did the company so deftly recover from the crash of 2001?

Sun's Chief Financial Officer, Richard Dobbyn, says the answer was spending more on the business at a time when competitors were cutting back.

Six years ago, the company faced a deep recession when capital goods spending slowed after the Sept. 11 terrorist attacks. The National Fluid Power Association recorded a 16.4% decline in the United States hydraulic industry in 2001 and the lowest U.S. manufacturing capacity in 18 years.

Those conditions resulted in a $15 million, or 18.7%, drop in Sun's net sales for 2001, to $65 million.

Instead of laying off employees like other companies, however, Sun kept all of the 100 plus factory workers who produced its cartridge valves in its local plants.

"We had about 35% more workers than we needed," recalls Dobbyn. "In order to economically swallow that pill, we limited people to 40 hours a week. And salaried people took 10 to 15% pay cuts."

In addition, Sun took advantage of the slowed demand and spent money on developing new and more efficient ways of producing its valves.

"In some cases we worked on more automation. We worked on some new processes. Some required design changes to the product, which required us to go back to engineering. That took a lot of money," Dobbyn says. "We were spending pretty good chunks of capital money when our sales were down."

On time deliveries

The company dipped into previous earnings and spent $5.9 million in capital expenditures, up 48% from 2001. That also went to funding a $1.5 million expansion of its facility in England.

The decisions weren't unprecedented. The moves were in keeping with the company's long-time philosophy of maintaining an experienced workforce and investing in its factory, so that when an economic recovery takes place, the company is poised to fill the demand.

Sun has proven very adept at learning how to position itself in an industry that is highly cyclical. Lean years in the hydraulic industry are usually followed by a quick upturn in demand.

"In this business, when you come out of a recession, you come out of it rapidly," says Richard Arter, of Sun's investor relations department. "We've learned that over the course of our 30 years."

For example, Sun spent more than $25 million in capital equipment in the late 1990s on factory capacity. It was in response to problems it encountered keeping up with three years of rapid growth that resulted in a 95% increase in shipments.

Also, the company has a record of resisting downsizing even during recessions. Sun hasn't had to lay off workers in a major block since 1975.

Fast forward to the end of 2003, when the economy finally started showing signs of recovery: Sun had its manpower intact and an improved automation system ready to go.

By 2004, sales reached $94.5 million, up 33% from $71 million in 2003.

Dobbyn says he attributes the company's continued success to distinct developments culled over the last six years: on-time delivery of products, a highly technical Web site, new products and a well-laid out distribution system.

Delivering goods on time was a direct result of the money the company spent improving its product designs and production processes, including automation. Now, Sun promises to deliver goods by the customer's request date, no mean feat considering the company's products are made on demand and that its assembly line manufactures five different series of cartridge valves for a myriad of applications.

To make sure orders are going out on time, employees meticulously keep track of a customer's desired ship date and the actual time the goods are delivered. That data is then reviewed on a regular basis.

"I can tell you within a dollar as to how much product we have that's overdue," says Dobbyn. "We know what our on-time delivery was last month, last week and yesterday."

Sun's president, Allen Carlson, pushed for better delivery times largely because it was a weakness in the company, says Arter.

Before the current system, the company sometimes got behind on deliveries during busy periods.

A complete valve package

In 2001, Sun Hydraulics also invested about $140,000 and five months into developing a technical Web site, www.sunhydraulics.com.

The company had previously relied on thick catalogs circulated through its global network of distributors. With the new site launched in December of that year, engineers had an easier time finding all the information they needed about the company's products.

"The Web site shows you how to apply a given product, what (the product) looks like, where to get it, how it performs and how much it costs," says Arter. "We believe if you tell a buyer those five things it puts them in a position to make a buying decision."

Over the last four and a half years, Sun has invested a total of about $2 million to improve the Web site.

Of course, it helps that Sun's continued introduction of new products attracts scores of engineers to the site, resulting in better sales figures. Dobbyn demonstrated some of the new product line for a recent visitor to Sun's headquarters on West University Parkway in Sarasota.

At the office, Dobbyn holds up an example of why customers keep buying from the company. In his palm is a cylindrical, steel valve about five inches long and an inch in diameter. He points to a black piece attached to the end, an electrical actuator called a solenoid, he explains.

The technology is not new. Akin to an on/off switch, solenoids allow electric control of the rate of pressure and flow of hydraulic fluid. "There were a lot of problems with them in the beginning and we didn't want to hurt our name," says Dobbyn.

But the company recognized there was a lack of valve-actuator products from high-end manufacturers. In 1999, the company started offering the solenoid valves.

In the last few years, Sun started offering proportional valves, which allow for more variable control of hydraulic fluid, much like a dimmer switch.

Most importantly, offering the valve-actuator combination has served as a springboard to developing what Dobbyn calls, a "complete valve package," a new product that's fueling a lot of sales.

To be able to offer that, Sun had to increase production at its facilities in Korea, the United Kingdom, Germany and China. Those company-owned overseas facilities also are a big part of Sun's success.

"I don't care where you are," says Dobbyn. "You can find somebody that can sell you a Sun valve."

The development of the company's worldwide distribution chain started in 1982 when Sun opened a facility in the United Kingdom to target the European markets. In the mid-1980s, it signed on independent distributors in the Far East, in Korea and Japan.

In the early 1990s, Sun founded a company in Germany, the second largest hydraulic market in the world outside the United States.

In the late 1990s, Sun focused its attention on the growing Asian market, purchasing its Korean distributor. In 1999, it set up a distributor in Shanghai through a 50/50 joint venture with a Taiwanese business.

The most recent expansion is a sales office in France, which opened in 2003.

What lies ahead now is aggressive expansion in the Asia Pacific region, particularly China. Currently, Asia accounts for 16% of Sun's sales and Europe goes for about 30%.

"We want to take more risks and grow faster (in Asia)," Dobbyn says adding that talks are underway with other Chinese companies.

The Web site will continue to offer new features, including 3-Dimensional graphics of Sun's cartridge valves that engineers can download directly onto their software. And finally, to fuel future growth through new products, Sun bought a 40% stake in WhiteOak Controls last summer. With the company, Sun has been developing a line of electronically controlled valves that are even more variable than the current products.

SUN HYDRAULICS: A CLOSER LOOK

For the year ended 2004 2003 2002 2001

Net Sales 94,503 70,798 64,545 64,983

Gross profit 28,535 18,486 15,964 14,625

Operating income 12,294 3,683 3,420 2,060

Income, before income taxes 11,732 3,277 2,592 1,312

Net income 7,830 2,176 1,778 950

Basic net income per common share 1.14 0.33 0.28 0.15

Balance Sheet Data:

For the year ended 2004 2003 2002 2001

Cash and cash equivalents 9,762 5,219 3,958 3,611

Working capital 16,723 12,663 12,828 12,778

Total assets 71,808 63,032 62,285 61,750

Total debt 12,254 18,207 9,611 10,663

Shareholders' equity 45,403 35,063 42,899 43,738

(numbers are in thousands, except per share data)

(Source: Sun Hydraulics' Form10-K filed with the SEC on March 24, 2005).