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

Greetings, and welcome to the Helios Technologies' Second Quarter 2023 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tania Almond, Vice President of Investor Relations and Corporate Communications. Thank you. You may begin.

Thank you, operator, and good day, everyone. Welcome to the Helios Technologies' Second Quarter Financial Results Conference Call. We issued a press release announcing our results yesterday afternoon. If you do not have that release, it is available on our website at hlio.com. You will also find slides there that will accompany our conversation today. On the line with me are Josef Matosevic, our President and Chief Executive Officer; and Tricia Fulton, Executive Vice President and Chief Financial Officer. They will spend the next several minutes reviewing our second quarter results, discussing our progress with our augmented strategy, reviewing our updated outlook for the second half of 2023, and then we will open the call to your questions. If you turn to Slide 2, you will find our Safe harbor statement. As you may be aware, we will make some forward-looking statements during this presentation and the Q&A session. 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 have been provided in our latest 10-K filing, as well as our upcoming 10-Q to be filed with the Securities and Exchange Commission. You can find these documents on our website or at sec.gov. I'll also 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 GAAP with non-GAAP measures in the tables that accompany today's Slides. Please reference Slide 3, 4 and 5 now. With that, it's my pleasure to turn the call over to Josef.

Tania, thank you, and thanks to everyone joining us. Our global team has stepped up to the plate and delivered. We had strong sequential growth in the quarter with revenue up 7%, including 6% organic growth over Q1. Operating margin increased 140 basis points while we continued investing to integrate our acquisitions and expand our capacity to meet growing customer demand. This translated to our bottom line increasing 21%. Thank you once again to our global team for their great performance. We have methodically invested over the last 3 years to develop or acquire new technologies, close product gaps, filling geographic white spaces and drive opportunities for growth by expanding our addressable end markets. All this work is on the verge of bearing fruit. Currently, we are in our next phase preparing for another growth cycle, and we are accelerating this transition. Our customers' appetite for our new offerings is rapidly building. We want to be ready to address the indicated interest. As such, we are pulling forward investments and project timelines to enable this new capacity to take on step change growth starting in 2024. Our innovation and engineering excellence is the lifeblood of this organization. In the quarter, we closed our acquisition of i3, and we are already far along with the integration of i3 remote field service platform into the Helios solution. As a result, recurring revenue could start to show up in our P&L as early as next year. Helios continues driving technological breakthroughs, and we are well-positioned to capitalize on many megatrends with our solution. This includes electrification, reducing emissions and creating more energy-efficient solutions while continuously improving our user interface. Our long-term outlook at Helios is very bright. In the short-term, we are faced with some near-term challenges for the second half of '23. We are seeing a slower-than-expected recovery in APAC. About 40% of our CVT hydraulics volume goes through APAC, with 2 of our largest distributors located there. In North America, the distributor inventory levels have been trending in the right direction since the end of last year, but also a bit lower than expected. Additionally, our hydraulics colleagues in Europe dealt with a plant fire in the second quarter. Then in July, they had to endure a tornado, hail storm and flooding. I am grateful to report all of our teammates are safe, which is most important. These macro issues combined with the natural disasters is pressurizing our top line for the second half. As a result, our near-term visibility is, in fact, less clear than our long-term outlook. We are adjusting to current conditions while continuing to prepare for what we believe will be a very healthy 2024. Before I turn the call over to Tricia to review the financials, I would like to wish her well on her retirement. Tricia has been a cornerstone of our company during her 26 years of service, 17 of which she served as the CFO. On behalf of the Board of Directors and the entire company, I would like to express our gratitude for her significant contributions. We wish you the best in your next chapter of life. Starting tomorrow, Tricia passes the baton off to our new CFO, Sean Bagan. Sean joins us most recently from a 23-year career with Polaris. He has a proven track record of building, growing and transforming global businesses into highly productive and profitable operations. We are excited to welcome Sean to the Helios family. I will now turn the call over to Tricia to review our financial results for a final time. She will then hand it back to me for some closing color. Tricia, please?

Thank you, Josef, and hello, everyone. On Slides 6 through 10, I will review our second quarter 2023 consolidated results. We continued to deliver solid sequential improvement, with revenue up 7%. Profitability also improved sequentially, with operating income and net income up 19% and 21%, respectively. Adjusted EBITDA expanded 170 basis points, and free cash flow was up $15 million, or 475%. We were able to deliver these results even as we drive investments in our future. By market, Australian mining began a recovery and grew significantly in the quarter both sequentially and year-over-year. Encouragingly, health and wellness increased more than 20% over the first quarter, continuing to build off the floor we hit in the fourth quarter last year. Agriculture, a large end market for Helios, saw robust growth in the quarter over the year-ago period and modestly improved sequentially. Recreational sales had a solid quarter, with high single-digit annual growth and double-digit sequential growth. There were mixed results within the mobile market, with specialty vehicles and construction being the top performer sequentially. As you might imagine, we can have variability from quarter-to-quarter within our markets. Our strong revenue growth over Q1 '23 was driven by the electronics segment, which was up 15%, while the hydraulics segment was up 3%. Year-over-year, hydraulics was up 7%. And if you exclude health and wellness, electronics increased 5% over last year's second quarter. Geographically, we saw growth across all regions sequentially led by the Americas at 10%, EMEA was 4% growth, and APAC at 3%. Compared with last year, revenue decreased both in EMEA and in the Americas by 5% each and by 10% in APAC, reflecting macroeconomic conditions. Overall, we had nominal unfavorable FX impact on revenue of $0.3 million in the quarter. Sequentially, gross profit grew 7% and gross margin was unchanged over the first quarter. As we would expect, on a year-over-year basis, the lower volumes impacted our gross profit. The benefits of pricing net of material cost increases, acquisitions and improved direct labor efficiency on gross profit were offset primarily by lower volume. Our SEA expenses sequentially were down slightly but up $5.5 million, or 17% compared with the second quarter of 2022. As we have discussed, we are investing heavily in our growth plans and incremental SEA related to acquisitions, integration, growth and new product development, which are driving the year-over-year increases. As I mentioned, adjusted EBITDA increased 16% sequentially, and adjusted EBITDA margin of 22% was up 170 basis points over the first quarter level. Even as we make growth investments, we delivered top-tier EBITDA margins as an industrial technology company. Our effective tax rate in the second quarter was 22.9%, up slightly from the prior year based on the mix of earnings in various jurisdictions. Diluted non-GAAP cash EPS of $0.81 in the quarter reflects the impacts I've discussed as well as a $0.09 impact from higher interest expenses compared to last year. Slides 9 and 10 provide visual trends on overall key metrics for the past several quarters. We estimate that supply chain constraints delayed $14.2 million in sales at quarter-end, up sequentially from $12.4 million and down from $15.1 million in the year ago period. On Slide 11, you will find the highlights for our second quarter hydraulics segment. Sales grew 7% over the prior year period. Acquisitions added $15.2 million. Sequentially, the segment grew 3% over Q1 '23. Gross profit increased modestly, driven by price, efficiency and acquisitions, partially offset by rising material costs. Gross margin this quarter decreased 210 basis points compared with Q2 '22 primarily due to rising material costs in the margin profile of acquisitions. SEA expenses increased by $4.3 million or 23% year-over-year. The increases were driven by acquisitions as well as growth investments. Please turn to Slide 12 for a review of our electronics segment. This segment is more concentrated in the U.S., so foreign currency usually does not have much of an impact. Sequentially, as mentioned, we had 15% growth in this segment. Annually, electronics sales decreased by 24% to $75.2 million as demand across all regions declined primarily related to the softness in the health and wellness market. Excluding health and wellness, electronics grew 5% over last year, driven by recreational mobile and agriculture market. The electronics gross profit of $26 million grew 24% sequentially and gross margin expanded 260 basis points. Year-over-year, lower gross profit reflects the slowdown in the health and wellness market. Gross margin increased 150 basis points over Q2 '22 due to favorable sales mix and material costs. SEA expenses increased sequentially 4% over the Q1 '23 level. Please turn to Slide 13 for a review of our cash flow. We had strong cash generation in the quarter with $28.8 million in adjusted cash from operations. Cash and cash equivalents were $37.5 million, providing us sufficient liquidity. CapEx of $10.5 million was 5% of sales for the quarter, at the upper end of our expected range to support our growth and expansion plans. Adjusted free cash flow was $58.8 million on a trailing 12-month basis with a conversion rate of 100% compared with 79% for the full year 2022. You can see on Slide 14 that we have a solid balance sheet and financial flexibility to execute our strategy for growth. Total liquidity at the end of the quarter was $221 million. Our net debt to adjusted EBITDA leverage ratio was 2.7x ending the quarter. As you know, we have a well-established track record of managing our leverage ratio as we execute on our acquisition strategy. As we increased above our target level for recent acquisitions, we have been able to quickly de-lever back to or below our target leverage ratio of 2x based on our cash generation. Before I hand it back over to Josef for a review of the outlook and closing comments, I would like to express my gratitude to each and every member of Helios, past and present, for their role in what has been a rewarding career for me. I have had the honor and privilege to work with so many exceptionally talented and brilliant people throughout the years. I also want to thank all of you on this call as well for being with me on this great journey. Importantly, I have great confidence in the future of Helios, the power of our strategy and the capabilities of the team to execute on them. Please reference Slides 15 to 17 as I hand it back to Josef.

Thank you much, Tricia. Again, we truly appreciate your dedicated service first to Sun hydraulics and then Helios over so many years. We are moderating our outlook for the second half of the year, given the factors I mentioned that have reduced near-term visibility. We now expect revenue in the range of $880 million to $900 million, implying the second half will be similar to the first half. We expect more weighting in the fourth quarter versus the third. As a result of the accelerated capacity expansion, we are investing over $10 million. With these revenues and investment expectations, we are moderating our adjusted EBITDA target for this year to $187 million to $196 million, still a healthy 21% to 22%. We intend to get to the mid-20s and beyond and adjusted EBITDA margin over time, but we are down-shifting our gears in the short term to absorb the one-time macro factors and build momentum to climb our next growth slope. There are clearly a lot of great things coming together at Helios. We are executing against the pillars of our business system. The second quarter demonstrates our ability to protect our business and margins while investing for the future. As we think and act globally, we efficiently leverage our expanding footprint through our new regional centers of excellence. We are diversifying our end markets and revenue through our new innovations and solutions to grow wallet share. While our team continuously demonstrate the dedication and tenacity to our shared purpose, we develop our talent by fostering a diverse and customer-centric learning organization. We have our sights set on driving shareholder value far into the future. As I said earlier, our future is very bright. With that, let's open up the lines for Q&A, please.

[Operator Instructions] Our first question comes from the line of Chris Moore with CJS Securities.

Maybe I'll start with Josef. Josef, just hoping you could talk a little bit more about what's transpiring this year, what have you seen so far, kind of what you expect for the rest of the year into '24 and beyond with the investments that you're making.

Chris, certainly. Let me break this down into maybe 2 parts. So the first part of it, just addressing the current state and the headwinds we are seeing and have been seeing going into 2023, and then switching over to the more exciting part, 2024 and beyond. So when we entered this year, on the OEM side we usually have pretty good visibility, and that is panning out to be exactly what we expected. On the distributor side, which is very heavily weighted on our Sun Hydraulics CVT business, in North America we saw elevated inventory levels, but has started to come down pretty nicely. So the trend clearly showed month-over-month that the inventories are coming down into what will be a reorder pattern back to somewhat of a normal. And then we had substantial conversations with our distributors in Asia, specifically in China. And there was a pretty good sentiment that the recovery will start taking shape in Q1, ramping up into Q2 and continuing into Q3. So we obviously bake this in the forecast. And clearly, we have eye on this. So having gotten that customer feedback, we anticipated strong orders coming out of Asia since 40% of our hydraulic CVT revenue goes into Asia, specifically into China. That didn't pan out. That's on us beyond that, following by our marine demand has been very stable, but tempering off slightly. Not falling off the cliff, but tempering off. And the Balboa business in the health and wellness showed very strong sense of recovery in Q1 going into Q2 and now kind of plateauing off at levels we saw in Q1 and Q2. So, all in, that's what drove us to kind of be a little bit more conservative on the forecast, just by not having enough visibility in the second half and not knowing if China will really recover this year or not recover this year. So naturally, when you add those 3 factors, between 40% of volume going into China, distributor inventories still slightly higher than expected, we lose leverage on the top line. And then to add a little bit more flavor to that story to our current state, we had a very unfortunate situation in Europe where we literally lost 10 production days of manufacturing, following by Mother Nature kicking in and adding a few more days of loss. So, all in, that's what drove our pullback in terms of top line, so to kind of summarize, Chris, I hope your first question of the current state. Now going into 2024 and beyond, we have been saying now for 1.5 years or a couple of years, we have methodically worked with some customers. One is a current customer, 2 are new customer to us, but, more importantly, they're also very new markets to us. And we went through the initial RFQ stage to an RFP stage, and the appetite got much stronger as the customer needs to make certain strategic decisions before year-end, and that accelerated, obviously, our investment portfolio. And as part of the process is, they want to see and review our operations and the lines and the equipment in place before we can hit the ground running. So that was the main reason why we are adding over 200,000 square feet of capacity to be able to absorb that new incoming business. That has been in play for the last 1.5 years. It's finally around the corner, and we're gearing up for that journey. And we have invested year-to-date over $10 million additional dollars into that because we truly feel that is the right thing for Helios and that is the right thing for our shareholders. So that's kind of the 2 answers to your question, Chris.

And what's the timing on the additional capacity? Is that first half of '24? Or what do you see at this stage?

Yes. Our revised plans indicate that we will be completed by around Q1 of 2024. It's broken down into different geographic territories, Chris. Obviously, a lot of them is in North America between Daman and CVT. There is significant expansion going on in Europe at the Faster location. There's 2 different phases. Phase 1, we're adding an additional 35,000 to 40,000 square feet, and then there is another phase coming in 2024, where we will add another 100,000 square feet. So Faster will go from 300,000 square feet to 600,000 square feet over time. And then we are standing up a brand-new facility next door to our current one in Mexico, adding another 75,000 square feet. So if you extrapolate this into potential future orders, we would never add capacity if we wouldn't feel comfortable the demand is coming. So the answer to your question is we should be complete with Phase 1 in Q1 2024.

Our next question comes from the line of Jeffrey Hammond with KeyBanc.

Best of luck to you, Tricia.

Thank you.

So I wanted to make sure I understand these accelerated costs. So it looks like you had $2 million in 1Q. I want to know what the accelerated costs were in 2Q, and I think you said $10 million in the second half. And just want to verify these. One, what do they entail in terms of pulling forward expansion? And just to be clear that these are all kind of one-time and go away next year?

Yes, Jeff, certainly. So year-to-date, we accelerated cost around $10 million and those OpEx costs, meaning certain equipment expediting costs, freight, extra contract, those extra people, setting up the manufacturing sales based on the agreement we have with our customers, where we have visual work aids where we have work instructions, ergonomic addressable items. Those type of cost is what drives a lot of dollars. And in many cases, when we order the material, the lead times in terms of equipment was much, much longer than we could have waited, so we had to pay premium to get the equipment in. But once that is fully paid, Jeff, the answer to your question is, yes, those will be one-time costs, and we certainly expect that to pay back with accelerated and better margins, going forward.

So it's $10 million in first half, $10 million in second half?

$10 million in first half that's in the books. I'm not sure the $10 million will be exactly in the second half because we're going to watch it very closely here, Jeff. We had a couple of forecasting boo-boos here when we anticipated strong orders from the international markets, and we obviously own that. So we want to be a little bit careful how much do we spend and still protect the margins. But there clearly will be additional one-time dollars in the second half in the area of $4 million to $6 million, $4 million to $8 million. Tricia, does this sound right?

Yes. And we still have a pretty big range on the top line of our guidance that reflects some of the uncertainty that we have in the top line. So at the lower revenue levels, we understand that we can lose a little bit of leverage, so we baked that into the assumptions, as well.

And then you've been talking about this. Obviously, you're pulling forward $15 million of costs. So I think you mentioned in the prepared remarks kind of step-change opportunity. So I just want you to better frame the opportunity around the '24 and kind of the pull-forward and all the capacity expansions.

Yes, Jeff. So what we'll be talking about here is an integrated systems package that 2 of our customers have been working with us for north of 1.5 years now. And one customer had that product, or many different elements of the product in-sourced, and now they have decided to outsource this as an integrated package. And we are due to submit final prototypes next Thursday, and the feedback has been very strong and very complimentary. The other customer is more on the commercial food service side, where we have worked very closely together and feel comfortable now that we are far along that the step change will start to occur in 2024. From a monetary standpoint, or dollars, so to say, look, when you add 200,000 square feet globally, you're talking about a pretty nice size business starting in 2024 through 2027, and we feel pretty good that this is going to happen.

Our next question comes from the line of Mig Dobre with Baird.

Tricia, all the best to you, working with you for the last 13, 14 years. I've always really appreciated your help and insight. So good luck.

Thank you, Mig, I appreciate that. It's been a pleasure.

I guess where I would like to start, I'm a little bit confused about on what's going on with capacity. There are a lot of numbers that are flying around there, Faster going from 300,000 square feet to 600,000, Balboa, or the facility in Mexico, adding 75,000 square feet. Maybe we can sort of take a 30,000-foot view here. And have you outlined for us what percentage increase in your square footage or capacity are you currently undergoing versus maybe where we were a year ago? And what exactly does that mean for the company's ability to support revenue? Or, essentially, what are you scaling your business up to?

I heard the first part of your question. I don't know if we had a technical issue here, but I apologize, I didn't hear the second part.

I'm trying to understand the changes in capacity here because there's been a lot of numbers that were kind of like floating around between Faster and Balboa so on. So can you maybe talk about what percentage of your existing capacity, relative to your existing capacity, are you adding? And what are you scaling this business up to? What sort of annual revenue run rate will this capacity be able to support?

So for an example, In Indiana, we are going in Mishawaka here in terms of now becoming a center of excellence for our manifolds. We are going from 40% to pretty much 70% of capacity. Everywhere we're adding capacity, Mig, is based on percentage of volume increase and also our strategy of center of excellence, regional structure coming to play and in the region, for the region. So as we look at the new incoming business with the step change we are talking about in the integrated package, when we extrapolated our overall opportunity for the next 3 years to come and the volume associated with that and how much we need per square foot, that's what drove the investments globally. So in so many words, with the one particular customer we are working on, they will be absorbing or purchasing an integrated package that has different sizes of manifolds, some cartridge valves, Faster couplings, wire harnesses and Enovation controls. So every business has a piece of the square footage assigned to that volume, and that's how we came up with the capacity and the hours needed to manufacture that product.

So capacity is going up, what, 20%, 30%?

It's around 25% globally.

From a pure square footage perspective, but I think the opportunity really is how we can better utilize all of the square footage that we have with this additional space and the way we're laying out the plants with the additional space, hopefully getting more out of the 25% than 25% for top line.

And what exactly is your guess here in terms of, or your goals in terms of what the business will be able to support as far as total revenues are concerned? Are we talking $1.2 billion, $1.3 billion or more?

I knew this question will come, so I'm going to learn a little bit here from the previous forecasting assumptions we have made in particular to my opening comments in Asia. But I would say it's around $300 million in addition to our current guidance.