Earnings Call: Q3 2022

Nov 7, 2022

Greetings, and welcome to the Helios Technologies Third Quarter Fiscal Year 2022 Financial Results Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. Would now like to turn the call over to Tanya Almond, Vice President of Investor Relations and Corporate Communication. Thank you. You may begin. Thank you, operator, and good day, everyone. Welcome to the Helios Technologies Q3 2022 financial results conference call. We issued a press release announcing our results this morning. If you do not have that release, it is available on our website athli0.com. You will also find slides there that will accompany our conversation today. On the line with me are Joseph Matosevic, our President and Chief Executive Officer And Tricia Fulton, our Executive Vice President and Chief Financial Officer. They will spend the next several minutes reviewing our Q3 results, discussing our progress with our strategy, providing our updated outlook for 2022, 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 and 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 were provided in our 10 ks filed with the Securities and Exchange Commission. You can find these documents on our website or atsec.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 slides 34 now. With that, it's my pleasure to turn the call over to Joseph. Tanya, thank you, and good day, everyone. This quarter, again, our team has kept the heads down to deliver to our customers, execute our plan and drive results Against the backdrop of a major hurricane, rapid and measurable change in FX rates, Ongoing supply chain challenges, effects on Europe from a prolonged war and a weak and restricted economy in China. We continue to innovate with new technology, capture market share, integrate our flywheel acquisitions and diversify in applications and markets. In a nutshell, we are executing on our augmented strategy to continue to deliver on our long term growth plans with top tier margins. Our steadfast dedication to our customers, Our technology innovation leadership and our ability to leverage our unique vantage point as pure play In the Hydraulics and Electronics space provides us confidence that we will continue to outperform against our competition. Protecting the business, our margins and cash flow are top priority in this environment. As I mentioned on our last earnings call, we have been making great progress executing on our manufacturing and operating strategy. We provided some excellent examples of our strategy at work at our recent sell side Analyst Day. For example, this includes leveraging the manufacturing expertise and operational footprint we gained with the acquisition of Balboa. We are moving the production of several product categories to our state of the art low cost operations in Mexico. Our strategy addresses our in the region, for the region approach that has enabled us to outperform and lead times to our customers and gain market share. In addition, we are seeing our operating companies working closer together across R and D, Manufacturing as well as system sales, our transformation to an integrated operating company is happening. This strategy provides the framework for a long runway of operational efficiencies that we are still in early innings of executing. As we fold in more flywheel acquisitions over time and add new markets and products, there will always be something to optimize. We outlined examples of several current projects we have in process. I encourage you to review the analyst on our website to learn more about the many actions we are taking to drive efficiencies, productivity and optimize our cost structure. This quarter, we further demonstrated our focused Flywheel acquisition strategy closing untayment products. They are an excellent complement to our Hydraulics platform. Damian brings established long term relationship with a diversified customer base serving multiple end markets. Additionally, they have a differentiated value proposition With a strong engineering team that serves a breadth of applications across both custom and standard manifold design packages. With the Helios business system, we expect to leverage Daemon from a very successful small business to closer to a $100,000,000 business over the next few years. We are so pleased to add them to the Helius corporate family. We continue to prove our innovation leadership. Capitalizing on our expertise in the hydraulics and electronics, We created a breakthrough one of a kind solution that we expect to drive change throughout the markets we serve. Our recently announced Energen solution creates electrical power by capturing wasted energy from our hydraulic fluid, which can be used to support the growing number of electrical applications required on any type of equipment. This changes the paradigm and we are serving the megatrend of electrification of Hydraulics by creating power where it's needed. This is just one of many technology innovations that we have recently announced. We held a science fair To led by our engineers during our Analyst Day to highlight the large number of new innovative Energy efficient products we are bringing to the marketplace over the coming months as we execute on our innovation roadmap. All we do remains centered and our intent to protect our business, think and act globally, Diversify our markets and revenue sources and attract and retain talent, which is the backbone of our success. Thank you once again to all the Helios colleagues this quarter for their tireless work and dedication to our company. Let me now turn the call over to Tricia to review the financial results and discuss our updated outlook in more detail before I come back for some closing remarks. Tricia? Thank you, Joseph, and hello, everyone. On Slides 5 through 9, I will review our Q3 2020 to consolidated results. As Joseph noted, we are executing to drive growth through innovation and acquisitions, Protect earnings in tough market conditions and support our future through the talent of our team. First, I want to address the most recent in Sarasota with regard to Hurricane Ian. With our Sun Hydraulics operations in Sarasota Close to where many of the predictive models were forecasting a potential direct hit, we proactively shut down our operations for the safety of our team. As the majority of our cartridge valve manufacturing is located here, ultimately over 14 shifts were impacted. Thankfully, I'm happy to report that our colleagues are all safe and our facilities unscathed from the event. With an estimated $5,300,000 impact of revenue unable to shift due to the hurricane and when we Exclude the $8,200,000 impact of foreign currency exchange rates, revenue in the quarter was basically unchanged over last year. It's important to note that the sales impact from the hurricane is not lost business. It just shifts the timing given the number of labor hours that were impacted. Geographically, the Americas were solid, while EMEA and APAC, specifically China, clearly reflected the economic conditions in those regions. In terms of end markets, our recreational market growth was significant with strong double digit increases primarily driven by our new product wins that were several years in the making. We also had nice growth in the industrial market driven by machinery and energy and the mobile markets grew as well. The diversification we now have in our end markets is much better than in the past, but the tough year over year comparison to the amazing performance our health and wellness market had last year is still having a drag on results. I will discuss this more in a moment. Current conditions prevented optimal operations in the quarter. Gross profit and margins declined on lower volume, The impact the hurricane had on operations, FX rates and continued challenges with supply chain and logistics. We are realizing benefits from our manufacturing and operating strategy that partially offset the other items. We are focused on cost containment and FDA expenses were down 3% over the prior year. Adjusted EBITDA was $48,000,000 and adjusted EBITDA margin was 23.2%. When normalizing for the hurricane, Adjusted EBITDA margin would have been 23.6%. We continue to demonstrate we can provide top tier margins even through a very challenging operating environment. Our effective tax rate in the 2nd quarter was 23.6%, Up sequentially as expected and above the high end of our original guidance range, but down compared with the year ago level, primarily reflecting the impact of varying tax jurisdictions. Diluted non GAAP cash EPS of $0.90 included a $0.03 impact for FX and an estimated $0.05 impact for the hurricane. On Slide 10, you will find highlights of our Hydraulics segment results. Sales grew 8% on a constant currency basis and normalizing for the estimated hurricane impacts. The effects to sales related to foreign currency exchange rates was $7,900,000 in the quarter. In addition to the approximate 5.3 And shipment delays from the hurricane. We estimate there were $6,600,000 of sales delays in this segment due to supply chain shortages. This amount is up from $6,000,000 last quarter. Hydraulics segment gross profit was impacted by unfavorable FX of 1,900,000 and an estimated $2,300,000 from hurricane impacts. Cost discipline resulted in a 7% reduction in SEA expenses over the prior year. Please turn to Slide 11 for a review of our Electronics segment results. Our Electronics segment is more traded in the U. S, so foreign currency has less of an impact on revenue. We saw strong double digit growth in recreational, Industrial machinery as well as the construction markets. Our new product rollouts could not fully offset the decline we are seeing in the health and wellness market. Therefore, our net sales declined 15% over the prior year quarter. We are not expecting improved conditions from the health and wellness market over the next year given the global economic environment. Delays in electronics segment shipments because of Supply shortages was an estimated $8,200,000 which improved from $9,100,000 last quarter. We expect to continue to see this come down. Electronics segment gross profit of $22,800,000 and gross margin of 30% is a direct reflection of the slowdown in the health and wellness market. SBA expenses were managed well, down 9% in light of the weakness in sales. Please turn to Slide 12 for a review of our cash flow. Cash flow was strong in the quarter as we generated $30,000,000 in cash from operations. CapEx came in at 4% of sales for the quarter and 3% year to date. We continue to expect CapEx for the year to be in the range of 3% to 4% of sales. Free cash flow was again nearly $22,000,000 in the quarter. We have generated over $52,000,000 of free cash flow year to date. As we have noted before, we are intentionally investing in working capital to meet customer demand, outpace the competition and deliver on our commitments. In the quarter, our cash conversion rate was 105%, back above 100%. You can see on Slide 13 that we have a strong balance sheet and significant financial flexibility to execute our strategy for growth. Total liquidity at the end of the quarter was $168,000,000 Our net debt to adjusted EBITDA leverage ratio was 1.9 times. We believe this puts us in a solid position to capitalize on current market conditions to make selective bolt on acquisitions. Now let's turn to Slide 14. I want to take a moment to review our longer term growth plans we set at our Investor Day in June 2021 and put some perspective around the health and wellness market. When we acquired Balboa Water Group in November 2020, Their annual revenues were north of $100,000,000 In 2021, they nearly doubled their revenues significantly outperforming our M and A model and accelerating our return on investment timing on the acquisition. They capitalized on the pandemic trend of Consumer investment, while people were not traveling as much. The deal was perfectly timed for Healios shareholders to benefit from the market trends. In addition to adding a new end market to our business, they brought complementary technology as well as the state of the art low cost manufacturing Facility in Tijuana, Mexico. As Joseph described, we are leveraging that facility in our manufacturing and operating strategy and expect several benefits from it over time. As you know, that industry is currently going through a normal market correction coming off such a boom cycle, which is impacting our 2022 performance and comparisons. We continue to remain on our trajectory path to achieve our original destination of at least $1,000,000,000 in revenues by the end of 2023, which we had accelerated by 2 years. We have executed on several high quality flywheel acquisitions along the way to help us reach our goal. We to continue to advance toward our long term financial goals. Please turn to Slide 15. We are adjusting our 2022 outlook down to accommodate for known factors. We are cautious given inflation, The decline in consumer spending, China restrictions, the war in Ukraine and FX. High inflation may continue to slow the global economy and is also causing a pullback in consumer spending, which is directly impacting the health and wellness market. Weakness in the economy in China driven by continued restrictions is negatively influencing demand in that region. Significantly rising energy costs in Europe driven by the prolonged war has slowed the economy in EMEA for our end markets and driven up fixed Cost of our manufacturing facilities. The strength of the U. S. Dollar negatively impacts results generated in currencies other than USD. These issues, of course, are all driving the widely discussed global recession. As noted, We are reducing revenue and adjusted EBITDA and while expecting a slightly lower adjusted EBITDA margin, it should remain in top tier performance. Higher interest expense and a higher effective tax rate will also impact the bottom line. Despite all of this, we believe we can protect the business, cash flow and earnings and that the Helios business system provides the structure and discipline to execute our long term plans. Against these headwinds, we remain confident in our ability to achieve our accelerated longer term growth targets. This will be accomplished through a combination of the diversification of our business, continuing to bring innovative products to market and the progress on our manufacturing and operating strategy. We are focused on our continued evolution into system sales as become an integrated operating company as well as our active acquisition pipeline to drive growth. We believe we are in a unique position Dean, as I turn the call back to Joseph for some final comments. Thank you much, Tricia. Clearly, We are all in this challenging global times together. This is when companies will remain critically focused on their purpose and mission, Stay incredibly close to their customers and partners and keep investing in their people and technology will be the long term winners. I believe the Helios team is up to the challenge and the value proposition of our augmented strategy provides the framework for us to win. We are driving market share, protecting our margins, creating innovative sticky solutions, Leveraging our earnings power and delivering on our long term goals. Where there are challenges, there are always opportunities. Because of this, I strongly believe we have line of sight to continue to drive scale and achieve our accelerated milestone of reaching at least $1,000,000,000 in revenue by 2023 with top tier margins. With that, let's open up the lines for Q and A, please. Thank you. We will now be conducting a question and answer Our first questions come from the line of Jeffrey Hammonds with KeyBanc Capital Markets. Please proceed with your questions. Hey, good morning, everyone. This is David on for Jeff. Hey, David. Hey, David. Hi, David. Can you just walk us through the electronic weakness, specifically regarding the health and wellness declines A little bit more. Like are you seeing a more aggressive destock in North America similar to other residential end markets? Are there more moving parts? And I guess on this, just how do you expect this to progress near term? Yes. As we talked about on the last few calls, we started to levels rising in Europe, primarily from goods that were being shipped out of China and into Europe and that market slowed First, we throughout the quarter started to see the slowing also in the Americas, but Certainly not to the degree that we saw it in Europe or in APAC. There's probably some destocking going on in the Americas, But the majority of that destocking needs to happen in EMEA as we go forward. We're still getting some good news For 2023 from our North American customers, it really seems to be focused more on Europe. But with the economy the way it is, interest rates the way they are, I think that's going to be probably a few more quarters than we had anticipated before we start to see that market turn back up, but we know that it will turn back up. This is A short term problem that we're having right now with it, but certainly I think there's a lot of opportunity Going forward and we saw that we are coming off of a record year last year in that market and we were able to take advantage of that very well, I think. So this is just a normal market correction we believe. Okay, great. And then I guess kind of staying on that topic, just Can we parse out the headwinds in electronics between kind of the health and wellness and supply chain? And then relative to these headwinds, how should we be thinking about new products as an offset to some of the About new products is an offset to some of the weakness in supply headwinds? Yes. We had an Analyst Day here, David, just a few weeks ago, and I think the folks got a very good sense for what products they'll be introducing to the market in 2023 beyond. And there was well invested and well planned over the last 2 years. We knew we would be in a correction stage, especially in the health and wellness. But working with our customers very closely and ran our customer perception study a couple of years back And continue to follow-up. We knew pretty much we are to hunt. And over the last couple of years heavily Invested in products that are not just going to be complementary to what we are doing, but you will clearly help us diversify Into other application, other markets and most importantly, get us the system sales capability that we are Really after making it very sticky. So a few specific examples in the health and wellness area with Having our Helios sense of engineering excellence working together with innovation and Balboa teams, We are bringing products in out to the market over the next few quarters that will clearly Diversify above and beyond the health and wellness industry, more into the specialty vehicles area and other applications that we clearly laid out in our Analyst Day. So Look, we feel pretty confident. Yes, this is a pullback. We do believe that we're nearing in many areas The bottom in the health and wellness and we should start seeing slight recovery. Asia obviously is a Still a wild card as we have substantial growth opportunity there as well. But the new products over the next couple of years in the electronics segment in the health and wellness and on the innovation side We're more than offset with what we currently see. Great. Thanks, everyone. Thank you. Thank you. Thank you. Our next question has come from the line of Mig Dobrehn with Baird. Please proceed with your questions. Thank you. Good morning, everyone. So, Trish, I appreciate The context on Balboa, dollars 200,000,000 of revenue were close to it in 2021. If we're looking at Q3 and your Q4 guidance, what Sort of revenue level or revenue run rate for Balboa is implied in our Q4 guide? Yes. On the electronics side, certainly, Balboa is affecting The Q4 numbers, we're still seeing a lot of strength of innovation and we talked about the new product rollouts that Recreational markets are still going very well for us both in marine and vehicle. So the impact that you're seeing on Q4 is pretty much all being driven by the Balboa demand cycle. Right. But just look, I'm not clear as to what the revenue run rate is here. Is this business now reverted back to Kind of a $100,000,000 base that you had when you initially acquired it. Is that the sort of revenue run rate here or is it different? We don't really like to give out specific business Unit targets, we're looking at the Electronics and Hydraulics segments as segments, especially as we're rolling acquisitions And so that's certainly the run rate is significantly lower than what we saw in 2021. Because I think this is the thing that we're all grappling with here. And David was asking about this earlier As we're trying to sort of right size our estimates for 2023, We're really trying to understand the magnitude of the headwind that is coming from this health and wellness market. What's kind of baked into the pie for the second half of this year? And what might still be on the comp in the early part of 2023. So I don't know if you can help at all with that dynamic. I think a fair way of answering your question here actually is when we acquired Balboa in particular, we're just north of 100,000,000 Ted revenue obviously jumped up, as you know, almost double sized and now it pulls back More into the $150,000,000 $160,000,000 type of range. And we think that in some cases we are seeing the bottom and seeing some slight recoveries in Particularly North America, still waiting for data points from Asia and we will be in Europe Actually next week or week long and getting a good feel for where the markets are trending In Europe, will you see Galboa falling back to the levels that we have Acquired the company, we don't see that. We are right now somewhere in between those two numbers When we acquired them versus when we peaked, I think that It's factual where we can answer your question at this point. Okay. That's helpful. Yes. Maybe just at the same time, as you saw in our Analyst Day, we have developed New products, in particular, on the valvora side, considering the energy cost in Europe On the heat pump for an example as you saw that will help us mitigate some of the headwinds and certainly Help us with the sales in Europe. But you should have a very good feel for where these products are going And what's our opportunity? So we're really not too worried, not too concerned. We got plenty of feedback from our customers, Direct feedback. There was a few days here in a couple of weeks where the orders We peaked quite nicely. We just need the Asian market to open up and Europe to stabilize a little bit more and We should be well in our way. Understood. My final question, Shouldn't we think of this as being really probably the baseline run rate for 2023? Any variances relative to Q4 that you would call out for us, Trish, into next year? Thank you. I think that the run rate going I don't know that we want to look at it necessarily as the run rate For 2023, but possibly heading into it in the Q1, I do think that with all of these new products coming out That we have both in electronics and hydraulics, we're going to be able to drive additional top line revenue in 2023 that will get us above that Run rate, as we go forward certainly could hold true for 20 or for Q1, but Not for the full year of 2023, given new product plus the new product rollouts that we have coming out at Enovation, which have been Really, you're incoming with the relationships we have with those OEMs. Great. Thank you. Thank you. Our next question has come from the line of Nathan Jones with Stifel. Please proceed with your question. Good morning, everyone. Good morning, Nathan. Good morning. I guess I'll follow on for Mig. Maybe we can talk about the Parts of the electronics business that aren't Balboa. You talk about strength in marine and recreation, obviously exposed to consumer Spending trends there. I think generally speaking, in the U. S. At least, there's a lot of complaining about inflation, It hasn't really stopped the consumer spending at all yet. So what are you guys thinking about the risk of Those markets slow down as the Fed continues to raise interest rates and inflation is generally going to bite into consumer sentiment. What's the risk that you see a drop off in those businesses going into 2023, year over year? Yes. Nathan, on the innovation side, knowing what we know now, folks are having a really strong Yes. And again, what Tricia said earlier, our investments over the last 2 years In that product line and into the diversification gives us a very strong confidence level that this journey We'll continue. The products that have been rolled out in 2023, As you know, that business becomes very sticky for a minimum of 2 to 3 years. And then there's a refresh and then it continues. So We really feel very confident that innovation will continue to grow With strong margins and have a very solid year as it stands right now. So your view is that the market share gains from new product rollouts in 20 You can offset any end market weakness that you see for innovation. Yes. The key comment is here, Nathan, for folks to understand is, As I mentioned during our Analyst Day, traditionally innovation has been In marine and recreational customers supply and now we are really diversifying this into many other applications With that product line and that is the strength of innovation going forward. It's no longer just the 2 key markets. It's an expanded Throughout the market offering with much stickier solution leveraging the entire technology play of Balboa, HCE and innovation and on top of that you have the hydraulics coupled in on the system sales side. It's really a good deal here. So I don't I see the headwinds, But I think we are very, very comfortable saying that innovation will continue to succeed with very strong margins. Just to add on to that a little bit, Nathan. We're already starting to see some really good and interesting opportunities with the OpenView Displays that we have had a couple of press releases about through innovation and those are brand new opportunities and One that we couldn't have gotten with our existing product line under the good, better, best strategy. So we're very encouraged by what we're seeing From the marketplace related to that specific new product. And in particular Nathan, The two areas that you will see probably you folks will see probably sooner than later is the diversification into the energy market And general industrial, what we call it, that's where our applications We'll go here next. Clearly gaining market share in markets that you weren't in before is all incremental. Maybe we could just go on and talk a little bit about Damon. I know you guys were very excited when we were down there in September. Can you talk about the revenue and financial profile of the business now, what it adds to the Q4, what the financial targets are For Damon over the next 3 to 5 years, I know you talked about getting it to $100,000,000 of business and how you get from point A to point B on that. Yes, certainly. So as you stated, we're really very excited about Fit product offering, but more importantly, The people and the technology and the engineering capability, it's a very sound business, very profitable, Diversified markets that we were not in before, sound relationships, financial Performance for this year is really not material as we just closed this. What we expect over the next year as we continue to develop a very Focused or execute our very focused augmented strategy in terms of having center of excellence, diversifying and really closing in on the system Sales application, we feel we can leverage that Hydraulics segment With electrification and get to the $100,000,000 number as we outlined in our press release. So next year, you will see A baseline run rate of anywhere between $35,000,000 to $45,000,000 $50,000,000 type of range and then it continues from there. And the strategy to get to that $100,000,000 how you're leveraging the footprint with Legacy business, etcetera, in order to get to that $100,000,000 what drives the growth to get there? Yes. It's twofold. One is the organic application that we are Just continuing to execute our manufacturing strategy with center of excellence And in the region, for the region, leveraging our Festa brand From Europe into North America and then coupling our system sales application where we can To a system within the Daemen footprint and leveraging their engineering capabilities To do more into the diversified markets and coupled in other products in the Hydraulics And electronics within the Damon 4 walls to get into the applications and markets they are currently serving. It's a combination, Nathan, between organic, new products and there could be another Flywheel acquisition that we add for electrification to speed the process up. Great. I'll pass it on. Thanks for taking my questions. Thank you. Thank you. There are no further questions at this time. I would now like to turn the call back over to Tanya Almond for any closing comments. Great. Thank you, operator, and thank you, everyone, for joining us today. We appreciate your interest in Healios and look forward to updating all of you on our Q4 results next year. Please feel free to reach out to me throughout the day with any follow-up questions. Have a great day and We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your