Helios Technologies, Inc. (HLIO) Earnings Call Transcript & Summary

Good afternoon. I'm Josh Pokrzywinski, Morgan Stanley's electrical equipment and multi-industry analyst. Thanks for joining this afternoon for continuation of our fireside chats as part of our 9th Annual Laguna Industrial Conference, virtual this year, of course. But up next, joining me, we have the management team from Helios, including CEO, Josef Matosevic; CFO, Tricia Filton -- Fulton, sorry; and Tania Almond, VP of Investor Relations. Before I toss it over to Tania, who's going to lead us off with some opening remarks before we get into Q&A, I do have a quick disclaimer to read. Just note that for all research disclosure related questions, please refer to our appropriate website, morganstanley.com/researchdisclosures, and for all other questions, please reach out to a Morgan Stanley salesperson. With that, folks, thanks for joining us this afternoon for Day 3 of the conference. Tania, I'll hand it over to you, and then we can dive it into Q&A after that.

Great. Good afternoon, again, and thank you for joining the Helios Technologies fireside chat. It's our pleasure to be with you virtually today. On Slide 2 of our supplemental presentation, you'll find our safe harbor statement. We will make some forward-looking statements today. 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. These risks and uncertainties and other factors are provided in our latest 10-K and 10-Q statements filed with the Securities and Exchange Commission. We will also discuss some non-GAAP financial measures, and we have provided reconciliations of comparable GAAP with non-GAAP measures in the table at the end of our presentation. And just to take a moment and give you a brief snapshot of who Helios Technologies is: we are a global leader in highly engineered motion control and electronic controls technology for diverse end markets. We are going through our own transformation from historically running the business as a holding company to moving to a future state of running the business as an operating company, leveraging our sales teams, our innovation teams and our manufacturing teams. At the end of our second quarter this year, on a trailing 12-month basis, our revenue was just over $700 million. And as of yesterday, our market cap was $2.7 billion. We have 2 business segments, which include Hydraulics and Electronics. Our Hydraulics segment produces market-leading components, including cartridge valves and quick-release couplers. Our cartridge valve technology can be used for heavy load holding equipment like material handling and construction. We also manufacture quick-release couplers and are a leader with OEM manufacturers of agricultural equipment. In our Electronics segment, we make digital control solutions, primarily for niche applications, and we are a leader with recreational vehicle OEMs. Last year, we closed a transformational acquisition of Balboa Water Group, that has proprietary technology that will help us expand into new and adjacent end markets. We opened the Helios Center for Engineering Excellence with the flywheel acquisition of BJN Technologies. They are an innovative engineering solutions provider. And combined with Balboa's complementary technology to our electronic solutions, this acquisition enables us to strategically expand our product portfolio in existing and new end markets in the Electronics segment, and then we plan to leverage it throughout all of Helios. Ending the second quarter, 65% of our revenues came from our Hydraulics segment, but we are on a multiyear journey to build out our Electronics segment into a top industry player. And between our strong organic growth, combined with our acquisitions, at our Investor Day in June, we pulled forward our goal of hitting $1 billion in sales by year-end 2023, with industry-leading adjusted EBITDA margins and greater than a 20% CAGR on non-GAAP cash EPS growth. Hopefully, you can tell we have an exciting story, and we're just getting started. So Josh, I'll turn it over to you to kick off with some questions.

Excellent. Thanks, Tania. So first question, this has sort of been the topic of the moment, but certain, maybe even topic of the year. Supply chain has been an area of discussion all week, and I think most management teams that we've had described the environment as a bit of a whack-a-mole. It's not one thing, it's managing a few different things at once. And price/cost is certainly part of the equation, but procuring materials, simple availability, as well as shipping and logistics on the other side, and they've all been areas that have been impacting companies at some level. Just maybe walk through what your experience has been like? What are the particular areas of focus? And then how you see that playing out over the balance of the year?

Certainly. Thanks for having us, Josh. Look, I think it's fair to say we're also going through a very similar journey here as most of our peers and colleagues. A couple of things that we have done to mitigate the risk is we saw certain things coming out of our way, in particular, been a pure-play in hydraulics and electronics. And so we pre bought a substantial amount of material a few months, north of north of $30 million that protected us pretty much through the year. But at the same time, as we really leveraged our manufacturing capacity and implemented our make versus buy process, it helped us add capacity and capabilities into our manufacturing facilities and allowed us really to further mitigate that risk. So yes, clearly, that's the flavor of this year and probably will continue through next year to some degree. It is times where our businesses go hand to mouth. But by and large, we have been well positioned and well protected and can operate with full capacity globally, and that would give us confidence to update our guidance in Q2 and actually increase it to what was announced. So we feel pretty good about the year, and we feel pretty good. We are close enough to our suppliers. We have invested some OpEx dollars and actually send folks north of 30 people within our core competency supply base throughout North America and throughout the world for that matter, so we are -- so we become a priority when we need to. And the last point I make here is we don't have to buy quantities like automotive pre-buy where they buy in millions. We buy a certain amount we need and then we can add other value-added activity, if it's heat treated, if it's hardening of the steel in our Hydraulics segment. So that's how we kind of mitigated our supply chain risk, but we do anticipate that to continue well into 2022.

Got it. And I know the OEM market is an important part of Helios' customer base. I would imagine if you're having a similar conversation with those OEMs that those folks might not be in quite the same position simply because they're sourcing from so many folks. It sounds like from what you're saying, maybe you're on, certainly, the right side of the equation for those folks, if not best-in-class. But how is their end demand or their order pattern from you sort of reflecting their own supply chain limitations? So for one of the $5 electronic part, are you being paused, even if you're unrelated to that on a particular piece of equipment?

Josh, we don't see it at all. It's actually just the opposite for us. One of the strategies we had going into this really to invest in our product costs and reinvest in our manufacturing operations and put our lead times to a industry best scenario. So we actually are benefiting from the journey right now. Our lead times are currently in average, 6 to 8 weeks, which is really [Technical Difficulty] need to see how the OEMs and also our distributors have responded with new orders. And we believe we're gaining market share for that matter. So we don't see any of the items you just mentioned in our portfolio.

Got it. And then just lastly, on price/cost. Generally, it's not been a significant issue for your company. But I think we're sort of in a world where looking at spot prices doesn't necessarily tell the story, there are contracts, purchase agreements, hedges, things of that nature. Does that -- is what you're buying today sort of reflective of the underlying environment? Or are you sort of living on a bit of a lag versus where things could go over the next 90 days?

Yes. So look, we have seen like everybody else, price increases in certain commodities. We have seen freight cost increases. And working with our customers, it was well understood that we are in a really unusual circumstances here, and we passed those costs through. Even with the OEMS, where traditionally, you have fixed firm contracts, they were also understanding and allowed us to pass those costs through. But then we also had a strategic play where we felt we had certain products where we [Technical Difficulty] good market share. We have very strong margins. And we felt this is the time where we could take advantage and targeted certain customers where we can take market share. So that's exactly what we did, and that's what helped us continue to fuel that organic needle and to help us to grow. So it was a 3-pronged approach, so to say.

Got it. Understood. So maybe just pivoting over to growth, because it's certainly an important part of the story at Helios over the past, call it, a year, 1.5 years. I know that part of that is focusing on new products, new customers, new applications, it's been a lot of the strategy under your tenure here. What are the couple kind of most exciting products, markets, applications, however you want to frame it, that you guys are looking at today? I know foodservice has been thrown out there. Clearly, Balboa got you into some new markets on the spa side. These recreational vehicles, personal recreational vehicle-type stuff has been an area of strength. Maybe just to still down kind of the biggest opportunities as you see them today?

Yes, certainly. Look, this is a very exciting journey for us, and we all here at Helios super passionate about this. When we started this journey, and I got to know the products, Josh, coming from the industrial sector that started to connect very quickly here that with our current brands, we have certainly an opportunity to diversify into new applications through new markets, through new customers, and we have targeted specific 3 customers for each segment that we're working with. And we are seeing the initial success of current products that are still in the infancy stages, single million type of wins. [Technical Difficulty] recognize if we truly want to be a global company going forward and truly diversify into more of a true niche, strong margin global company, we had some gaps in the system, and that's what drove the Balboa acquisition. Balboa offers us a good, better, best strategy, still with strong margins, and offers us a diversification in the diversified markets, but specifically into health care, health and wellness, and also helps us geographically diversify as well. So that was one area that we are laser-focused on. And then also, as we did our customer perception study on the OEM side, there was a clear data point that the focus of our customers is to really simplify their supply chain. So in this simplification journey, they really want to partner up with certain manufacturers who have broader capabilities versus just supplying parts. So that's where we kind of snapped on to it and got really, really aggressive, and proposed a product offering that's more of a systems approach. For an example, if you take -- I'm sure, you guys read Innovation Award we got from John Deere. If you just take a simple John Deere tractor that has couplings, hydraulics and electronics, just 1.5 years ago, we just sold the couplings. [Technical Difficulty] that obviously is now expanding into something much bigger and better. So there's another avenue where we are diversifying current applications. But then as the model changes for most of our OEM customers every 3 to 5 years, that's where we are as aggressive working with them. And we recognized we had another gap in the system. We really didn't have the proper talent to get us there quicker and faster, and that drove the BJN acquisition. So the 14, 15 folks, with no training needed, immediately hitting the ground, running in the electronics and hydraulics sites; their software engineers, their algorithm engineers, their simulation engineers. So we were able really to partner up with our OEM customers and very quickly demonstrate our capability and got some initial wins, but that's more the long-term exciting journey where we will see over time, because rocket is taking off as we get [ spec'd in ]. And as you know, once you get spec'd in, you tend to stay for a long period of time. So our pathway to organic growth is well-defined based on our strategies, well laid out, and we are just -- I tell you, we are super excited about that.

Excellent. What percentage of the portfolio, as best you can tell, is sort of ripe for that extra cross-sell attachment, the systems approach? Because you're right, the legacy of the company is really more on components and in some cases, components that seem like it could be pretty far apart in the value chain for a purchaser. It sounds like we're still in early innings regardless, but where do you see that opportunity in longer term?

Yes. So I think, to do it in layman's terms, all the ingredients for the cake have been put together and the cake is in the oven. So we are still in the initial stages. And quite transparently, we could have gone much faster, much quicker if we would have been beyond this pandemic stage right now and have a little bit more stable supply chain. But traditionally, that process takes 18 to 24 months. We are within that 18 months' time frame with the first customer base, and then we're going to penetrate this into additional markets. We wanted to earn our stripes to grow. And I think we are -- like I said, we see early success. As a matter of fact, there was a point of time, just a couple of months ago when we needed to pump the brakes on that, because so much -- so many new ones came our way, and we just quite can't do it with the supply chain constraints. You want to deliver the base business and protect the base business first.

Got it. And then on these new kind of applications, especially when it pertains to new customers, how are you going about calling on these new folks? Because in some cases, they're customers that may be in different end markets than what you've done historically. Does that require getting new sales talent in there? What else is sort of the requisite for showing up at those doors and saying, we have a product for you, even though you've never used this before?

Yes. Great question. So again, the 3-pronged approach. One was just by the virtue of leveraging our current customer base and relationships that our brands already have. I mentioned John Deere, Faster has a 20-year relationship with John Deere, but Sun Hydraulics was never an approved supplier or Enovation Controls was never an approved buyer. So leveraging that existing relationship cross-functionally was step 1. Step 2, coming out of that industrial sector, I have also some relationships in that area. So leveraging those relationships and opening up the doors for discussions also helped. And thirdly, we did restructure the sales organization. We now have a one [ belly button ] who will work across all the companies, and we partnered up and we really brought in, so to say, better hunters into the company, well balanced between OEM knowledge, distribution knowledge, product knowledge, and we have changed how we go to market and who do we want to target, and those guys are boots on the ground hunting. So those were kind of the 3 pillars that got us to where we are.

I do think it's been a little bit more difficult than we would have liked due to the pandemic. I think if Josef had his way, he would have been out probably Day 2 with Helios at these new customers getting in front of them with our sales teams and our development teams and really being able to start that a little quicker. It's been difficult to get into some customers, they're not admitting visitors right now, but we're doing what we can to contact them as we are today through Zoom or Teams or whatever other means we have. But that's starting to ease up now. It feels and people are opening their doors again. So I think we may be able to get more traction quickly and soon here.

I guess, just thinking of the catalyst for all this, on a company-by-company basis, this is a new product design, right? You don't really re-spec in the middle of a platform. Has the pandemic slowed the pace of some of these new model rollouts, such that getting those [ at-bats ] today is maybe a little bit more difficult and that should improve over the next maybe 12, 18 months? Or are you seeing those instances of new platform launches is supporting what you guys are trying to do?

Yes. So one of the really neat story is, when I joined Helios, I was anticipating that obviously due to the pandemic, there would be some cutback [indiscernible] earlier. But what actually happened is just the opposite. That R&D backbone continued to design and to develop. And we really -- all the products that we have designed in the electronics or co-designed or co-developed with our customers, nothing has been canceled. In some instances, it was pushed back by a quarter or 2 or 3, but everything is progressing exactly how we planned. The timing has shifted. So we are launching new applications in the Electronics segment between now and the next 2 years. And Hydraulics is a very similar story with the latest acquisition of NEM. It really gave us the final piece we needed between our current products, new innovations that we have designed, and NEM is giving us the electrification that we need to really have a system and execute our strategy of being a system provider in the niche sector with strong margins. So that electrification drove the NEM acquisition, Josh.

Excellent. And then just on the margin front, I think when a lot of folks in the industrial world hear systems, the word association game sort of gets to bundling that you're able to pull from different parts of the organization, get some G&A leverage there, and one of the things the customer asked for is sort of the value meal approach versus kind of the a la carte pricing. How has the experience been on systems profitability versus some of these individual component niches that you operated in historically?

Yes. So a very important point for our investors to understand is the system approach we are targeting does not reach out one size fits all. It is really targeted customers in the niche sector where we know that we are very tough to follow. So we know we have a mouse trap with our Sun Hydraulic business. We know we have a mouse trap with our Electronics Innovation segment. We have a good, better, best strategy offering with Balboa, and now we have electrification components. There's really nobody else out there who can deliver that system with the lead times that we are having. So in our case, when we ran our models, it actually does the opposite, it improves our margins, not deteriorate our margins. So we really didn't design the strategy to go wide very fast versus targeted application, targeted customers [Technical Difficulty] continue to organically grow, but improve the margins over time. And that's what drove us to really pull that initial 2025 strategy forward by 2 years, because we've got quite a bit of comfort from our customers.

And I think in this case, we're focused on maintaining or growing the gross margin, even with these systems. And then you see the tremendous leverage that we can get on the fixed cost of the business with the additional revenue. So that's really how that drives the margin for us.

Got it. And how should we think about the output here in terms of capacity or other capital that funds this? I know that there were some investments made over the last few years. Those are probably getting well utilized now. But how does that CapEx or other kind of capacity-based outlook look here over the medium term?

Capex, we target somewhere between 4% and 5% of sales on average. And we believe that those investments are the right ones to make from a manufacturing technology perspective in almost all cases. So a good example of that is when we bought Balboa, we invested some capital that the business needed that has really ramped up capacity in that business and provided us the foundation for us to have the level of sales that you've seen out of that business in the last couple of quarters. So we're continuing to invest in all of the businesses right now from a CapEx perspective, and we expect that those will lend themselves not only to enhance technology, but also to growing the capacity in each of the locations.

Got it. And then just thinking about the composition of the portfolio, you've obviously had some businesses that have been very strong through the pandemic. The consumer-facing stuff or something that ends up in the consumers' hands eventually, certainly being the tip of the spear there. Are the -- how would you characterize what percentage of your businesses are kind of back to or exceeding prior peak versus stuff that still has a way to go to get back to 2019 levels?

Yes. Right now, all of our business are exceeding pre-pandemic levels. And we've seen some really tremendous growth in demand across all geographies and end markets over the last few quarters especially. The macroeconomic indicators would point toward a strong 2022 as well. And I've read a few that also project that we'll continue to see growth into 2023. So we're preparing ourselves for that growth level across all the businesses.

Got it. And then maybe just to kind of apply that discussion to Balboa specifically. I mean, you guys have caught lightning in a bottle on the timing, especially, relative to when you acquired it. What gives you the confidence that markets that probably didn't have that level of volatility up or down over the last, call it, 5 or 10 years, that this can be the new normal? Is it something on replacement? Is it some other macro indicator you look at? Low inventories? I don't want to presuppose the answer, I'll let you guys fill in. But what keeps the growth flywheel growing there?

Yes. So look, once again, Josh, we really -- do we enjoy a certain level of volume due to the pent-up demand? Yes. Our strategy is not designed around pent-up demand. Our strategy is designed around organic growth and what tactics do we have to put in place to continue to grow this segment. So like Tricia said earlier, Day 1 -- that's probably the most powerful comment, Day 1, we recognized we have not only a good business, good product offering, but we have a low-cost manufacturing and supply chain operation that we needed to invest in and optimize and really structure that product cost around the sales and marketing engines. So once we did that and increased our capacity, we reduced our lead times. Then we worked on a market study globally to see how much is really tied into the pent-up demand versus new way of living your life, so to say. So we saw a really significant amount of shift in the European market where the Europeans are now more into the health and wellness in their backyard or in their home, so we enjoy a nice piece of business coming from Europe. But then we diversified that product offering very quickly with potential new customers, and we're working with those customers directly. I think we can honestly say that those discussions are going well. We are targeting the health care market much broader than we ever had before. The health and wellness application goes way beyond just hot tub and spa. So we feel pretty good that when that pent-up demand trues up that we will maintain a certain level of growth based on what we communicated in our Investor Day.

Excellent. I see we're out of time. So we'll leave it there. I appreciate you guys' time. As always, good to see you all. Hope to do it in person here real soon. Thanks, everybody, for tuning it.

Thank you, Josh.

Thank you.

Bye-bye.

Bye.