Earnings Call Transcript - HLIO Q4 2020

Operator, Operator

Greetings. And welcome to Helios Technologies Fourth Quarter and Full Year 2020 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. 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.

Tania Almond, Vice President of Investor Relations and Corporate Communications

Thank you, Operator, and good morning, everyone. Welcome to the Helios Technologies fourth quarter and full year 2020 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.

Josef Matosevic, CEO

Thank you, Tania, and good morning, everyone. Please turn to slide three and I will summarize our highlights for Q4. 2020 was certainly a year that will not be forgotten. It was full of great accomplishments, even as we faced the challenges of the global pandemic head-on. The Helios team pulled together and drove results that exceeded the plans we put in place in the second half of the year. We protected our employees and communities. We supported our customers, kept all operations running, and executed on projects according to plan. We acquired a transformational health and wellness electronics company in November. Balboa is diversifying our offerings and our end markets. It also provides technologies that we can leverage to create new growth opportunities. Importantly, we ended the year on a strong note. We delivered solid financial results. All of our businesses exceeded our expectations in both revenue and profitability. There is strong demand across a number of our end markets, especially in agriculture, marine, and health and wellness.

Tricia Fulton, CFO

Thank you, Josef, and good morning, everyone. On slides seven and eight, I will review our fourth quarter consolidated results. As Josef noted, we delivered significant growth in the fourth quarter supported by our focus on delivery, our expanding sales channels, strong end markets, and of course, the addition of Balboa. Net sales grew 24% sequentially and 20% over the prior year period as we executed our growth plans. Fourth quarter gross profit of $52.7 million increased $5.8 million or 12% compared with the trailing quarter and $5.3 million or 11% over the prior year period from higher volume. Cost of goods sold in the quarter included $1.9 million of inventory step-up amortization related to the Balboa acquisition. While consolidated organic volume was higher than the third quarter, gross profit was also affected by the mix of products sold, Balboa’s gross margin profiles, and the impact on operations from increasing freight costs. We are working to offset the impact of these items with cost containment, adding shifts to reduce overtime, and working on our global supply chain efficiency programs. Gross margin was 34.8%, which reflects the 120-basis-point impact on gross margin of the inventory step-up. I should also point out that although Balboa’s business has lower gross margins, they have a lower selling, general and administrative expense structure. So that allows Balboa to still deliver performance within our target operating margins. In fact, Balboa well exceeded our greater than 20% target operating margins in its first two months given the high volume they have been producing to meet accelerated demand. Even with changes in mix, adjusted EBITDA margin held steady at 23.2% compared with the same period a year ago and was down just 20 basis points compared with the trailing quarter reflecting our cost management efforts, productivity improvements, and the contributions of Balboa. Non-GAAP cash EPS improved $0.07 to $0.60 for the fourth quarter compared with the trailing quarter and was up $0.06 compared with the prior year period reflecting better than expected performance of the Balboa acquisition.

Josef Matosevic, CEO

Thank you, Tricia. We are confident as we enter 2021 that we can drive growth and deliver strong margins. Our $1 billion revenue goal is not the end game but rather a milestone. We have our sights focused beyond that. As a management team, we have recently defined the Helios purpose statement and we are implementing four value streams to augment our strategy. We believe the value streams will deliver growth, diversification, and market-leading financial performance as we develop into a more sophisticated, globally oriented, customer-centric, and learning organization. The four value streams are as follows: one, protect the business and ensure the cash flywheel continues to spin. We plan to drive the cash flow engine through new product launches while we leverage existing products. We will cultivate customer centricity and are investing in expanding capacity, as well as productivity improvements. And we’ll continue to execute on our newly developed global manufacturing and operating strategy that will drive improved margins. Two, champion a global operating mindset to better leverage our assets, accelerate innovation, and diversify our end markets. Three, create great opportunities for growth while reducing risk and cyclicality by diversifying our markets and sources of revenue. We will add technology, capacity, and create differentiation that will make us hard to follow. And finally, four, develop our talent through a culture of customer centricity, continuous improvement, and embracing diversity, engaging the team, focusing on shared deeply rooted values and promoting our learning organization. These four value streams are interlaced with our flywheel acquisition strategy, as well as our Helios shared corporate values. We plan to provide more detail on all of this at our upcoming Investor Day that we will host later this year. All of this makes the year ahead very exciting and we are just getting started. We are excited about the many changes we are implementing to drive growth, profitability, and shareholder value at Helios. I have great confidence in the ability of the Helios team to continue to lead successfully and believe it will show in our results. With that, let’s open up the lines for Q&A.

Operator, Operator

Thank you. Our first question comes from the line of Nathan Jones with Stifel. Please proceed with your question.

Nathan Jones, Analyst

Good morning, everyone.

Tricia Fulton, CFO

Good morning.

Josef Matosevic, CEO

Good morning, Nathan.

Nathan Jones, Analyst

I’d like to start off talking a little bit about this John Deere Supplier Innovation Award and what that means to the company. I know when Helios acquired Faster, acquired Enovation Controls that a significant part of the thesis there was the revenue synergies you were going to be able to generate by coming up with products that resemble that supplier award you’ve got there. I know, Josef, that you mentioned that this is something that you think you could accelerate over the next few years. It is a big contributor to the 2025 goals. Can you talk about where you are in that process? What kind of revenue are you generating by consolidating those businesses, and what do you think it can add to growth over the next several years?

Josef Matosevic, CEO

Certainly, Nathan. I will start, and Tricia can chime in as appropriate. This John Deere Award, when you step back and look at the long-lasting relationship I’ve had with John Deere, you need to understand a little bit more about the John Deere strategy and what they are truly after. One of the key indicators is that many other OEMs are trying to simplify their supply chain, instead of having supplies coming in from numerous sources and having to manage that. We pitched an idea of integrating and combining certain products with our CVT and some other products, and we presented that which is a good system solution for them to reduce complexity, lower supply chain costs, and integration costs. It worked out pretty much as we planned it would. On a more strategic level, Nathan, when you reflect on the seeds we planted over the last couple of calls, we have three different strategic objectives in terms of growing revenue into diversified markets. For example, if we look at Balboa, they are traditionally sold into the wellness market, focusing on hot tubs, swim spas, and exercise spas. That product line fits well into other industrial niche sectors that create additional revenue streams, and that holds true for all segments. Enovation, for instance, serves a largely recreational supply chain-driven customer base. We will expand those product lines into other niche markets and protect our margins. As we combine the strengths of the entire company, we see great opportunities to establish ourselves as a system solution provider where appropriate and start increasing our penetration into new customers and markets that we traditionally have not participated in.

Tricia Fulton, CFO

I would just add that this is a great example of multiple aspects. Firstly, the synergies that we envisioned when we acquired Faster and how we could bring together CVT and QRC. Secondly, what we have been describing more recently as diversified end markets. This application is not a traditional application, so it has been quite enlightening for us to see the opportunities that lie ahead and how we can combine these two technologies for beneficial customer outcomes.

Nathan Jones, Analyst

When you think about the revenue synergy opportunity from putting all of these businesses together, including Balboa, is there a quantification you can provide on what you think that can drive in terms of growth over the next several years, assuming market growth is what it is? What do you anticipate you should be able to outgrow the markets by?

Josef Matosevic, CEO

Nathan, we hinted in our prepared remarks that we have our sights set on something much larger over the years than we originally outlined. However, I think it’s still a bit early to quantify that. We will certainly provide more detail during our Investor Day, including targeted customers by business segment and territory. As an example, looking at the Balboa acquisition in combination with our Enovation segment, that technology can be readily available for other industrial markets, such as the high-performance computing market or even the commercial foodservice market or exercise equipment for the home. With minor investments in integrating these two technologies, we will be able to penetrate the markets quickly. We have already identified our top three customers, one of whom is currently in a prototype testing phase as we speak. While it’s a little too early to outline the full opportunity, it’s clear that we have a strong path to introducing that technology into new diversified markets, which are truly new arenas for us.

Nathan Jones, Analyst

I’m sure we’ll hear a lot more about it at the Investor Day. I look forward to that now. I’ll pass it on. Thank you.

Josef Matosevic, CEO

We look forward to seeing you.

Operator, Operator

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

Mig Dobre, Analyst

Yes. Thank you for taking the question and good morning everyone. I’d like to stick with Nathan’s line of questioning here. I’m reflecting on the strategy that you laid out even before you joined Josef. As I understand it, it was this evolution from being a relatively narrow hydraulic components supplier to migrating more towards system sales. The idea was to have a more comprehensive hydraulic product that includes the electronics portion, essentially moving from within the vehicle to actually being in the cab in terms of displays and controls. It seems like the hydraulics side of the business has seen several years of investment in product development, which seems to be manifesting with Faster. But I’m curious about the Enovation aspect and how that ties in with the hydraulic products. It sounds like you’re finally starting to see breakthroughs with customers buying hydraulic products while also looking to migrate some of your electronics offerings onto a platform as well. Could you provide some context here? Also, related to this: Are you beginning to bump up against larger competitors employing this strategy? Are you equipped to handle those competitive dynamics? How is the market reacting to your evolution into a broader player?

Josef Matosevic, CEO

Good morning, Mig. Thanks for the question. You’ve actually outlined our strategy well. Clearly, we are integrating our electrification into the hydraulics sector as well. An interesting observation from our engagement with customers is that we are increasingly being seen as a pure play company, meaning we truly have both an electronics division and a hydraulics division, and we are focused on investing in both areas. Every competitor we encounter will, over time, only make us a stronger and better company, as we can learn from them. However, many of them have other priorities in their portfolios that may not allow them to be as agile and laser-focused in investing in these areas as we are. The integration of electrification components into our system sales is quite intriguing, and we are investing in this area. I forgot what your second question was, I apologize.

Mig Dobre, Analyst

I was trying to gather where you are in terms of progress. Can you confidently approach an OEM such as Astra AOG or John Deere and say, ‘Hi, look, I have a complete solution that is developed, and I’m ready to get on the next platform.’ Do you have that capability today?

Josef Matosevic, CEO

In many areas, we possess the system capability to support them over the next 12 to 24 months. What we lack is their innovation pipeline, which also calls for adjustments and electrification in certain areas. That’s what drove the acquisition of BJN and the augmented strategy of integrating our electronics segment with our hydraulics segment and preparing new products to deliver as our customers transition over the new models in 2023, 2024, and 2025. So, are we ready to meet current demands and needs? Yes. Will we be ready for the customer transitions over the next 12 to 24 months? Also yes.

Mig Dobre, Analyst

Okay. Shifting gears here a little, Tricia, I’m trying to better understand the moving pieces regarding your outlook. If I consider the topline, I think the midpoint indicates around 32% growth. Could you help us understand how much of this is driven by Balboa? My calculations indicate approximately 22% from this acquisition alone. How should we interpret core growth for Electronics and Hydraulics that’s reflected in this outlook?

Tricia Fulton, CFO

Mig, we suspended guidance back in March of 2020, and this is truly our first reintroduction of guidance as we emerge from COVID. We think it’s prudent to offer overall Helios guidance at this time and refrain from segment-level specifics. You can get a sense of the numbers based on the first couple months since we acquired Balboa, but we are not prepared to provide individual guidance at the segment level at this time. We feel very optimistic about 2021 across many of our businesses and end markets, but we need more time as we continue to emerge from COVID before offering specific forecasts in terms of growth at the segment or end market level.

Mig Dobre, Analyst

I guess my follow-up question pertains to the Electronics segment, excluding Balboa. You appear to be optimistic about the vehicle technologies, given marine is performing well. However, I’d like more insight on the supply chain disruptions you mentioned and how you foresee those being resolved. Additionally, I’m curious about the performance of the power control side of the business, considering that’s where you have many industrial stationary applications and off-highway vehicles. In theory, these end markets should rebound strongly in 2021. Do you see it differently?

Tricia Fulton, CFO

On the power control side, which encompasses the non-vehicle technologies of Enovation, the oil and gas industry continues to pose challenges from an end market perspective. However, we are definitely observing opportunities in the mobile equipment sector of this segment moving into 2021. As you know, we introduce new products on Enovation's recreational side, which subsequently flow into what we used to refer to as the power controls business or into end markets outside of recreation. We are beginning to see some of that occur. However, we still have several recreational rollouts planned for this year that will eventually benefit those other end markets as well. Regarding the supply chain, yes, like everyone else, we anticipate encountering challenges on the Electronics side for both Balboa and Enovation. We have already started addressing these issues by issuing blanket purchase orders for multiple years to cover our supply needs. We're buying ahead where possible for components that are experiencing shortages or are critical to specific products and rollouts. While it will be challenging—and has been challenging—we believe we have a solid grip on the situation and we are proactively working to stay ahead of the curve, ensuring we can meet customer demand in 2021, particularly on the Electronics side, which appears to be very strong.

Mig Dobre, Analyst

I appreciate the insights. Thank you.

Operator, Operator

Our next question comes from the line of Josh Pokrzywinski with Morgan Stanley. Please proceed with your question.

Josh Pokrzywinski, Analyst

Hi. Good morning, guys.

Josef Matosevic, CEO

Good morning, Josh.

Tricia Fulton, CFO

Hi, Josh.

Josh Pokrzywinski, Analyst

I have a couple of questions. To pick up on the last question, Josef, which markets do you identify as the big ones still underperforming that you expect to recover? Hydraulics versus Electronics likely does not appropriately slice the end markets to identify where the real opportunity lies. Also, anything that might potentially support those markets with a stimulus perspective, like an infrastructure bill? Given that you don’t focus heavily on larger equipment in either of those businesses, I’m trying to gauge where we might have the easiest comparisons and where capital from some sort of stimulus could drive incremental demand?

Josef Matosevic, CEO

Certainly, Josh. To your first question, I would say the construction sector is a key area. We are witnessing a recovery that is trending in a very positive direction. This would be one area to continue observing closely, and I feel optimistic about its trajectory. Regarding stimulus, across all of our companies, we have not incorporated anything into our plans that could offer additional upside. As Tricia mentioned earlier, we feel strongly about 2021 and have issued guidance we believe is robust. If infrastructure investments occur, such as in roads and bridges, this would certainly present an opportunity for us. Since we do not have it built into our plans, our ongoing strategy of system sales, where relevant, and protecting our margins, present the most significant prospects as infrastructure initiatives kick in.

Josh Pokrzywinski, Analyst

Understood. Related to supply shortages or any bottleneck. Could you share any anecdotes about customer inventory levels? I realize it's not directly related to your products going through distribution, but I’m interested in any observations about finished product or inventory levels among your customers and how they're catching up on backlogs.

Josef Matosevic, CEO

Certainly. I'll start, and Tricia will provide additional context. We anticipated supply chain shortages due to the ramp-up expected after COVID. In many instances, we implemented a pre-buy program and hedging strategies, particularly on the Hydraulics side in collaboration with our distribution partners. We’re seeing inventories decrease, which drives additional buying. While it’s a similar situation to what others are experiencing, we currently maintain a well-structured supply chain, especially on the Hydraulics side, where 90% of our supply chain is based in the Midwest and has been with us for over 30 years. This strong relationship has allowed us to solidify our manufacturing operations globally, placing us in a good position, and we will communicate any major changes if they arise. For now, we see a good trajectory for meeting the guidance we have issued this morning.

Tricia Fulton, CFO

I would add a note, Josh. We have recently appointed Rick Martich as Senior Vice President of Manufacturing and Operations. One of his primary focuses is optimizing supply chain, especially in the Electronics segment. Enovation and Balboa have already initiated significant coordination regarding their common suppliers, working to align their purchases wherever possible to reduce costs.

Josh Pokrzywinski, Analyst

That information is helpful. Thank you for your time, team.

Josef Matosevic, CEO

Thanks, Josh.

Operator, Operator

Our next question comes from line of Jeff Hammond with KeyBanc. Please proceed with your question.

Jeff Hammond, Analyst

Hey. Good morning, everyone.

Tricia Fulton, CFO

Hi, Jeff.

Josef Matosevic, CEO

Good morning, Jeff.

Jeff Hammond, Analyst

If we look at the organic growth embedded in the guidance, we’re targeting high single-digit growth organically while Balboa had a strong end to Q4 and is experiencing robust demand in their end markets. I’m uncertain if we are ready to extend that eight weeks into a full-year prediction, but they should see a strong first half outlook given their existing backlog.

Tricia Fulton, CFO

They were accretive to profitability and margins. At the EBITDA level, they are at or above our target. We’re focused on ensuring they maintain their capacity and are able to generate those margins over time as we progress through the first year of ownership.

Jeff Hammond, Analyst

It appears your EBITDA guidance indicates 23% to 24%. Given that you should see good incremental growth from high single-digit organic growth, and if Balboa is also additive, this suggests you should experience greater lift based on historical increments. Are there temporary costs, investments, or inflation factors that we should consider?

Josef Matosevic, CEO

To address this, the investment will be a crucial aspect, Jeff, as we continue enhancing our manufacturing plants. We will be incorporating another layer of low-cost manufacturing that extends beyond just our operations in Mexico. So one response to your question is there are investments planned throughout 2021 that will ultimately yield improved margins through equipment upgrades and automation on our Hydraulics side.

Tricia Fulton, CFO

Jeff, there are also cost add-backs. During COVID, we successfully compressed costs, some resulting from travel restrictions. However, most of those reductions were temporary and will rebound. The first half of the year may still see limited travel. We’re eager to engage with customers as soon as possible. Costs will inevitably come back, and aside from our investment comments, our first investment was in BJN. This includes investing in a group of talented engineers who will accelerate our entry into the diversified end markets, thereby increasing growth and profitability on the top line. However, such investments will impact our current outlook.

Jeff Hammond, Analyst

You mentioned Balboa's growth potential outside its established health and wellness markets. Is there anything factored into your guidance already regarding this growth, or should we anticipate that potential in 2022 and 2023?

Tricia Fulton, CFO

Some of the new product rollouts are already embedded in our forecasts. Still, we anticipate additional rollouts as we integrate our Electronics businesses to establish a good, better, best product strategy, which we will present to customers. We also have product rollouts in both QRC and CVT on the Hydraulics side.

Mig Dobre, Analyst

Thank you for the follow-up. I appreciate your time, and good luck moving forward.

Josef Matosevic, CEO

Thank you.

Operator, Operator

Mr. Matosevic, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Josef Matosevic, CEO

Thank you, Operator. Thank you all for joining us today. We really appreciate your interest in Helios and look forward to updating all of you on our first quarter in May. We have a great company and we are proud of the accomplishments we made as a team over the past year and look forward to our future growth. Thank you to the entire Helios family around the globe for your tireless efforts supporting our partners, communities, and each other. Have a great day and stay healthy.

Operator, Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.