Earnings Call Transcript - HLIO Q2 2021

Operator, Operator

Greetings. Welcome to Helios Technologies Second Quarter 2021 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I'll now turn the conference over to your host Tania Almond, Vice President of Investor Relations and Corporate Communications. You may begin.

Tania Almond, Vice President of Investor Relations and Corporate Communications

Thank you, operator, and good morning, everyone. Welcome to the Helios Technologies second quarter 2021 financial results conference call. We issued a press release 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, our Chief Financial Officer. They will spend the next several minutes reviewing our second quarter results, discussing our progress with our accelerating growth goals, reviewing our recent NEM acquisition, updating our outlook for the rest of 2021 and then we will open the call to your questions. If turn to Slide two, you will 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 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 will be provided in our 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. And with that, it’s now my pleasure to turn the call over to Josef.

Josef Matosevic, President and Chief Executive Officer

Tania, thank you and good morning, everyone. Please turn to Slide three and I'll summarize our highlights for Q2. Our team delivered another excellent quarter with strong sales and earnings surpassing our expectations at every level. I want to thank the entire Helios family for their hard work and tireless dedication to our customers. We have excellent operating momentum as we execute our augmented strategy and are on the right path to achieve our accelerated goal of $1 billion in revenue while delivering top tier adjusted EBITDA margins by the end of 2023, which is two years earlier than our previous plans. We have very strong double-digit organic growth driven by serving our customers well and diversifying our market. In fact, we believe we are gaining market share as we provide industry-best lead times. We have been winning over the hearts and minds of our customers; we are focused on remaining flexible to meet their needs in this very volatile macro environment. In addition, we are bringing new products to the market at an accelerated pace to help make them more competitive as well. In total, we had 87% growth in the quarter with 37% organic growth. In addition to driving the top line, we are gaining traction with our manufacturing strategy as well. This helps drive solid operating and EBITDA margin expansion. In fact, we posted the best margin results we have had in three years. The targeted pricing strategies have helped offset the continuing supply chain headwinds that the industry is facing, including higher freight costs, raw material price increases, and shortages of components. We're focused on cash generation with approximately $35 million of cash from operations in the quarter and 137% trailing 12 months free cash flow conversion, and through our growth strategy, we can deliver the balance sheet while self-funding our bolt-on acquisitions. We're making excellent progress with our acquisition strategy too. Our most recent success is NEM, which we closed in less than 30 days. NEM is an innovative hydraulic solutions company providing customers with material handling, construction, industrial vehicle, and ag applications to its global OEM customer base. NEM is ideally located in Northern Italy, in a region that is among the world's most innovative and technology-friendly areas in the hydraulic industry. NEM enhances our electrohydraulic product offering and provides us geographic expansion with greater global reach. The addition of manufacturing and engineering capacity also provides us scale to address markets. Finally, NEM has very strong brand recognition in hydraulic valve technology and deep application expertise that will enable us to grow our OEM business. We could not be more pleased to have welcomed the NEM team into the Helios family. Given our outperformance, we are raising our full-year outlook again, which we will review in more detail later in our remarks. On Slide four and five, I will touch on some financial highlights for the quarter. Then Tricia will go into more detail during her prepared remarks. Our second quarter NEM sales grew to over $223 million, of which $60 million was from acquisitions. Our adjusted EBITDA margin grew to 25.7% compared with last year, reflecting an increase of 310 basis points. Non-GAAP cash EPS was $1.20, an increase of 118% over last year, reflecting the better-than-expected performance of both segments. All in all, the second quarter demonstrated strong execution by the entire company. I'm incredibly proud of the Helios team and the excellent momentum we are building as we execute our augmented strategy to drive growth, generate cash, and deliver top-tier adjusted EBITDA margins. I will now turn the call over to Tricia to review the financial results and outlook in a little bit more detail.

Tricia Fulton, Chief Financial Officer

Thank you, Josef. And good morning, everyone. On Slide six and seven, I will review our second quarter consolidated results. Let me start by saying that we heard your request for greater transparency on acquired revenue and are pleased to give you what you need to better understand our strong performance. You will find in our press release a table that shows organic revenue by quarter and the contributions of acquisitions. As Josef noted, we outperformed and delivered outstanding growth in the second quarter, supported by our focus on delivery lead times, our expanding sales channels, strong end markets, managing our operations efficiently, and our most recent transformative acquisition of Balboa, which exceeded our expectations again. Net sales grew 9% sequentially and 87% over the prior year period, as we executed our growth plans and continued to take market share. Second quarter gross profit of $82.2 million increased $6.8 million or 9% compared with the trailing quarter and $37.5 million or 84% for the prior year period from higher volumes. Gross margin of 36.8% was flat sequentially and year-over-year was impacted by improved fixed cost leverage on higher volume, the difference from Balboa's margin profile, as well as supply chain challenges and increased material and freight costs. We're implementing multiple pricing strategies while also carefully managing the business to overcome the higher input costs. Manufacturing is performing well given the juggling act required to get products out the door. Our manufacturing operations are extremely flexible and agile in balancing available materials and staffing to ship products to our customers. Adjusted EBITDA margin grew to 25.7%, up 310 basis points from the same period a year ago and up 60 basis points compared with the trailing quarter, reflecting our disciplined cost management efforts, productivity improvements, and the contributions of Balboa. Non-GAAP cash EPS improved $0.21 to $1.20 for the second quarter over the trailing quarter and was up $0.65 compared with the prior year period, reflecting strong demand across all industries and better-than-expected performance in the Balboa acquisition. Our effective tax rate in the second quarter was 17.6%, which was lower than expected due to the settlement of a transfer pricing dispute. Please turn to Slide eight for a review of our hydraulics segment second quarter operating results. Second quarter hydraulic sales of $133 million were up 30% over the prior year periods and benefited from broad-based improved demand in most of our end markets, showing growth in all geographic regions. Sales also included a positive $6.7 million impact from foreign currency exchange rates. Due to hydraulics, gross profits benefited from higher volume while margin increased 160 basis points to 38.3%, primarily driven by fixed cost leverage on higher sales and production labor efficiencies. These drivers were partially offset by rapidly increasing freight costs and efforts to provide deliveries on time to customers. The 280 basis point operating margin expansion to 24.3% compared with the prior year period reflects operating leverage on higher volume, as well as our disciplined execution on our manufacturing strategy. Please turn to Slide nine for a review of our electronics segment second quarter operating results. Electronic sales were $90.4 million, up from $17.2 million in the year-ago period, reflecting an increase of 426%. Notably, we have very strong organic growth in this segment year-over-year. We are seeing the positive impact of the new product rollouts in the recreational market that we've been discussing for some time. By comparison, last year's second quarter was the most heavily impacted by the pandemic for this segment. Acquisitions contributed $60.2 million in revenue to our electronics segment sales for the second quarter. In addition, Balboa continues to exceed our expectation. The capacity expansion investments we made have enabled Balboa to meet the ongoing growth in demand. We are very excited by the potential this acquisition has brought to our business. Electronics segment gross profit of $31.2 million in Q2 increased with the acquisition and higher volumes. Electronics gross margin was 34.5% and reflects the impact of mix primarily related to the different margin profile of the Balboa acquisition, as well as increased costs resulting from supply chain challenges to meet strong customer demand. Operating income for the electronics segment of $19.6 million increased $1.3 million or 7.1% from the trailing first quarter and was up from $900,000 in the prior year period. Operating margin improved 30 basis points sequentially to 21.7% and was up from 5.5% in the prior year period. The 2021 second quarter margin reflects the strong operating leverage inherent in this segment. Please turn to Slide 10 for a review of our cash flow. Cash from operations was $34.5 million in the second quarter, up from $25.3 million in the prior year period. We are carefully balancing our working capital requirements with our efforts to provide timely deliveries to our customers on that significant demand. For the quarter, CapEx was $5.3 million, representing about 2% of sales. We are tightening our expected CapEx range to $30 million to $32 million for 2021, which remains approximately 4% of sales for the full year based on our updated outlook. Free cash flow was a strong $29.1 million at the end of the second quarter, equating to a trailing 12-month free cash flow conversion rate of 137%, as Josef mentioned. We are confident we have significant financial flexibility to further pursue our flywheel acquisition strategy. Regarding our capital structure on Slide 11, we continue to rapidly strengthen our balance sheet with a pro-forma net debt to adjusted EBITDA leverage ratio of 2.16 times. This continues to improve from three times at the end of 2020. Total debt was $437 million at quarter-end, reflecting total repayment of more than $15 million during the quarter. At quarter-end, we had $161 million available on our revolving lines of credit with total liquidity of $196 million. As a reminder, our financial strategy is to increase leverage for disciplined acquisitions, and then to quickly pay that down. Our capital priorities remain debt reduction, organic growth through new products and technologies, acquisitive growth, and distributions to shareholders. We have done a consistent dividend pay over the last 24 years. We recently paid our 99th sequential quarterly cash dividend on July 20th of this year. Now let’s turn to Slide 12, and I will discuss our outlook for the rest of 2021. Our guidance for 2021 assumes constant currency using quarter-end rates, as well as the assumption that our markets are not further impacted by the global pandemic. We are raising our revenue outlook for 2021 to the range of $800 million to $830 million, which implies an annual growth rate of approximately 56% at the midpoint of the range. Adjusted EBITDA margin outlook is increasing by 50 basis points to 23.5% to 24.5%. We continue to leverage our manufacturing efficiencies to offset stronger headwinds in the second half due to rising material costs. This implies we're raising our expectation for adjusted EBITDA dollars to the range of $188 million to $203 million, or a 61% annual growth rate at the midpoint of the range. Additionally, we continue to invest through non-tax-related items into our manufacturing strategy to reap the rewards of margin improvement over the long-term. We are being cautious as we look at the second half of 2021, while demand across all of our served markets continues to be robust; we recognize that the supply chain challenges could disrupt our ability to continue to deliver at the pace that we have been. As a result, we are increasing the size of our guidance range from what was a $10 million range to now a $30 million range. I'd like to draw your attention to our margin guidance; we are reflecting the impact of inflated material and freight costs continuing through the second half of the year. The challenges of obtaining parts and supplies, even as we build inventories, as well as the difficulties in staffing and balancing production lines. Interest expense outlook at current borrowing levels and rates remains unchanged and should be between $16 million to $18 million. Due to a favorable shift in the mix of earnings into geographies with advantageous economic incentives, along with the favorable resolution of uncertain tax positions, the effective tax rate for 2021 is now expected to be in the range of 22% to 24%, down from 24% to 26%. Depreciation is now expected to be between $22 million to $23 million and amortization is now expected to be approximately $32 million to $33 million. We are raising our non-GAAP cash EPS outlook to between $3.60 to $3.80 per share or a 65% increase over the prior year at the midpoint of the range. The increase in our guidance for 2021 is driven by the strong kind of market demand we had in the first half of the year and expect to continue throughout the remainder of 2021. We are able to leverage our fixed cost base and maintain our strong margins, even given the headwinds on the supply chain, material costs, and logistics. With that, I will turn the call back to Josef for some final comments.

Josef Matosevic, President and Chief Executive Officer

Thank you, Tricia. Again, we're driving excellent performance and I am extremely proud of our team. We are stepping up to the many challenges we are facing while driving amazing execution of our plans. We are uniting efforts across the organization to deliver outsized growth and are confident in our ability to meet our long-term accelerated financial goal. With that, let's open up the line for Q&A, please.

Operator, Operator

Our first question is from Mig Dobre with Robert W. Baird and Company. Please proceed with your question.

Mig Dobre, Analyst

Good morning, everyone. Thanks for taking the question. I figured maybe I would start with your updated guidance, your topline guidance. So, your initial guidance had about a $10 million range. The range has actually widened to $30 million in your updated guidance. And for me, it's a little bit counterintuitive. We're only dealing with six months left in the year. So I'm curious as to what's embedded in here in terms of the high end versus the low end? And I'm also curious when I'm thinking of the midpoint, the $70 million increase at the midpoint; maybe you could bucket it by the various segments or business lines?

Tricia Fulton, Chief Financial Officer

Hi Mig. Thanks for the question. So in the guidance, we did expand the range quite a bit, which we agree with you is a little counterintuitive at this point, but given what we're seeing in the market, we thought that we needed to give ourselves a little bit of room. Certainly, on the high end, it shows the strong demand that we have in all of our end markets and all of our businesses. And we're very pleased with where we are on order intake and the demand levels and where the market seems to be going. However, because of the supply chain challenges that we're seeing across the businesses—probably a little bit more on the electronic side—we felt that we needed to give ourselves a little bit of room in any events that we might be able to get the parts we need to turn around the shipments in the third and fourth quarter. And I think it is important to remember that the demand is there. It really just is a supply chain constraint problem that we're dealing with. Our pricing teams are doing an excellent job of getting products in the door, but it is also largely dependent on the parts we need to make in any given day. We're happy with where we are, but we don't see those clearing up before the end of the year. There have been some reports that we might still see some of them in 2022. I think we have a pretty good handle on it, but there are still logistics issues and a few supply chain challenges that are holding us back from being able to state that our top line is going to be at the high end of that range, for sure.

Mig Dobre, Analyst

Yeah. That's helpful. And that makes a lot of sense. Are there any areas of your business where you're seeing more of a constraint? I'm thinking electronics in particular. I'm wondering if you can also help us out with any of the buckets as to the $70 million of revenue increase? Was that mostly electronics or was that hydraulics as well? That'd be helpful. Thanks.

Tricia Fulton, Chief Financial Officer

It really was across the board: hydraulics and electronics. The split between the two segments for the first half is at the higher end of the range, what we anticipate that will be for the second half as well. Where we're seeing supply chain constraints is across all the businesses, but specifically in electronics, so I think we've had probably more challenges on the electronic side than on the hydraulic side. Some of the components have been getting tied up in ports; we had shipments get lost in transit that were then found, but we weren't able to get those products in time to meet our customers' delivery schedules. So while we're seeing all of those things occur on the electronic side, I don't think we're any different than anyone else in that regard. We are really pushing our supply chain teams to come up with creative ways to supply us with the parts we need. We're going out to the broker market when we need to. On the hydraulic side, I think the constraint is more about material costs, and steel prices are going up, which has some effect. However, the constraints are really that our suppliers are very busy because all markets right now, whether it's ours or in other industries, are very strong. So the suppliers are very busy as well.

Mig Dobre, Analyst

I see. Okay. And the last question from me is on Balboa, where just the revenue traction that this business has had this year has been considerably higher than what we expected or modeled. I'm curious about what's driving the growth and how sustainable do you see this? Is there any seasonality here to be aware of in the back half of the year? Thank you.

Josef Matosevic, President and Chief Executive Officer

Good morning, Mig. Look, during our investor meeting a few weeks ago, we laid out exactly what the path would look like for each of our businesses. In particular, avoiding the large piece that comes from pent-up demand, you also heard of our desire to diversify into other markets. With the acquisition of Balboa joining our family, we are working collaboratively with innovation to develop the next generation products and really have a good, better, best strategy in other markets to gain traction slowly but surely. To summarize your question, clearly backlog and pent-up demand combined with some diversification in our offerings and new customers are contributing to our revenue growth.

Mig Dobre, Analyst

And on the seasonality question, Josef.

Josef Matosevic, President and Chief Executive Officer

Look, as far as we can see right now, we have everything factored into our guidance for the remainder of the year. We continue to see a very strong pattern, and as we get better educated on that business, we'll communicate accordingly, but we don't see any seasonality, quite honestly, at all right now.

Operator, Operator

Our next question is from Nathan Jones with Stifel. Please proceed with your question.

Unidentified Analyst, Analyst

Good morning. This is following on for Nathan. As we mentioned a few times, you’re gaining market share by providing excellent lead times. Can you explain how you maintain that advantage and what your outlook is?

Josef Matosevic, President and Chief Executive Officer

Look, great question! Actually on the hydraulic side, about a year ago, we undertook an effort to clearly understand our investment strategy in manufacturing, and what were the bottlenecks in the operation for supply chain or material flow. We heavily invested, not only in improving processes but also in bringing in additional talent in some areas that allow us to separate ourselves from the competition. So the investment part followed by training and education and lining up the supply base with our core competencies helped us to reach a point where we keep our suppliers updated regularly. We invested in this area, knowing we needed to get better here, and it's resulted in us holding extremely strong lead times. Additionally, we are well aware of where our customers are heading and what is required for us to maintain and gain market share. The essence of the strategy is the investment in manufacturing operations that has driven that result.

Unidentified Analyst, Analyst

Okay. And then switching over to product costs. I know some contracts on the price, especially in electronics. How is Helios able to negotiate any pickup in pricing from share inflation and price increase plans for the second half? Thanks.

Tricia Fulton, Chief Financial Officer

We do have pricing for the back half in all of the businesses to some degree. Like you said, these end up being negotiations, especially on the fixed-price contracts. However, we've been with many of our customers for so long that we have been able to approach them and get pricing adjustments even on fixed-price contracts related specifically to the material cost increases we are observing. Some of those adjustments go through as straight price increases, while others will be materials surcharges. Some are temporary, others are permanent, but we have been able to have those tough discussions successfully and implement the pricing or surcharges as needed to help cover some of these increased material costs in the back half of the year, which I think is essential to maintaining our strong margins.

Operator, Operator

And our next question is from John. Please proceed with your question.

Unidentified Analyst, Analyst

Tricia, in your commentary, you talked a little bit about the new platforms driving in revenues in the electronics segment. We discussed this for the last six to nine months. How do you see that unfolding over the next nine months? Are we just sort of seeing the tip of the iceberg in terms of the new platform contributions?

Tricia Fulton, Chief Financial Officer

Yes. At this point, we are just seeing the beginning of those rollouts. In the first year of any rollout, we clearly haven't reached the maturity level for those products. We rolled them out slowly to ensure we are meeting commitments to our customers. Over time, those become very significant. Especially in the electronics side, we've seen that with specific products because they have model year rollouts related to their recreational vehicles. Some have started rolling out this year, but we have more to come in the back half of the year. We are making sure that we have the parts in place to be able to produce those products; that has been a key focus for the supply chain team. We believe we are ready to go on these rollouts, but for the year, the total percentage of revenue they add is currently low single digit. However, certainly, as these mature, they will contribute more significantly to revenue.

Unidentified Analyst, Analyst

How many different platforms do you anticipate launching over the next couple of quarters?

Tricia Fulton, Chief Financial Officer

Over the next couple of quarters, we have, what we would consider significant rollouts, probably three to four for the rest of this year. We do have others that are smaller and they're important as well, and crucial for us to execute correctly. However, from a revenue perspective, those smaller initiatives will have a relatively lower impact.

Unidentified Analyst, Analyst

Okay. Josef, on the improved lead times. I would think that the improved lead times would allow you to take share from others; are you confident you'll be able to retain that business, that new market share?

Josef Matosevic, President and Chief Executive Officer

We know, on the hydraulic side, most of our products ship for distribution. We know our customers extremely well. Currently, we believe that with lead times of anywhere between six to seven weeks, we clearly have the upper hand, and we feel comfortable that we will maintain those lead times and, in some cases, improve them. On the OEM side, we also have very strong lead times, whether it's the path of business or our electronics business. The differentiation is crucial. Once you get into that process, you’re locked in for the next three to five years; it becomes very challenging to get out. So we have invested wisely as a company into knowing that we could create differentiation there and how to safeguard our margins. So, does that answer your question? We're comfortable that we will maintain those lead times, but we also have other areas we're working on that will further separate us from the competition.

Operator, Operator

Our next question is from Jeff Hammond with KeyBanc Capital Markets. Please proceed with your question.

Unidentified Analyst, Analyst

Good morning. This is [indiscernible] on for Jeff. To start, you had a healthy incremental growth of about 40% this quarter despite facing various challenges. However, you noted a slight decrease expected in the second half. Can you explain the factors affecting your outlook and how these challenges and seasonal trends in the business will influence your guidance?

Tricia Fulton, Chief Financial Officer

Yeah, I think it's difficult to assert that there's seasonality this year, to be quite honest. With all the demand in the markets we are seeing across different sectors, I'm not sure that it's a normal seasonal behavior. Certainly, you've noticed strong incremental improvement, specifically with what we observed on the supply chain side. In the back half of the year, there are a few factors to consider. We have fewer workdays, and we’re seeing some supply chain challenges likely to hinder our performance from matching the level of Q2. However, the positive side is really the demand we're seeing in end markets and our anticipated growth in those markets. Still, it is primarily driven by supply chain issues that are influencing our expectations for margins and revenue.

Unidentified Analyst, Analyst

And then you mentioned it a little, but could you quantify the pricing you expect for Q2 and your outlook for pricing cost for the rest of the year?

Tricia Fulton, Chief Financial Officer

The pricing adjustments we put through in the first half were selective, focused on specific products, and really helped counter some of the costs we were incurring. However, the overall impact was low single digits in millions for the year-to-date pricing effects. So, it isn't a substantial contributor to the first half of the year. It will likely become a larger factor in the back half because we have a few price increases that will not take effect until August, September, and October. Thus, there will be some influence there, but these price increases are primarily designed to help cover increased material costs and address supply chain constraints we're currently facing.

Operator, Operator

Thank you. And we have reached the question-and-answer session. I'll now turn the call over to Josef Matosevic for closing remarks.

Josef Matosevic, President and Chief Executive Officer

Thank you, operator. Thank you very much for joining us today. We appreciate all of your interest in Helios and really look forward to updating all of you on our third quarter in November. We remain super confident in our ability to continue to grow and deliver value for all of our stakeholders. Have a great day and stay healthy.

Operator, Operator

This concludes today's conference, and you may disconnect your line at this time.