Helios Technologies, Inc. (HLIO) Q4 2016 Earnings Report, Transcript and Summary

Greetings, and welcome to the Sun Hydraulics Corporation Fourth Quarter and Full Year 2016 Financial Results Conference Call. [Operator Instructions] As a reminder this conference is being recorded. It is now my pleasure to introduce your host Ms. Pawlowski, Investor Relations for Sun Hydraulics. Thank you. You may begin.

Thank you, Donna, and good morning everyone. We certainly appreciate your time today for our fourth quarter and full year 2016 financial results conference call. On the line with me today are Wolfgang Dangel, our President and Chief Executive Officer and Tricia Fulton, our Chief Financial Officer. Wolfgang and Tricia will be reviewing the results that were published in the press release distributed after yesterday's market close. If you don’t have that release it is available on our website at www.sunhydraulics.com. You will also find there the slides that will accompany our discussion today. If you would look to the slide deck on Slide 2 you’ll 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. 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 are provided in the earnings release, as well as other documents filed by the Company with Securities and Exchange Commission. These documents can be found at our website or at sec.gov. I 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 as comparable GAAP to non-GAAP measure in the tables that accompany today's earnings release, as well as in the slide. Wolfgang will get started with some highlights for the year and discuss our strategic focus and Tricia will go through the detail of the financial results. I will then turn it back to Wolfgang for his perspective on our outlook before we open up the line for questions and answers. So with that, it is now my pleasure to introduce Wolfgang.

Thank you Debi, and good morning everyone. Please turn to Slide 3. 2016 was a very exciting year for Sun, one of transformational evolution. We strategically reassessed our future culminating in our 2025 vision that we announced to you in November 2016. This vision will give us to build scale to reach $1 billion in revenue while preparing some history of superior profitability and financial strength. It was the development of this vision that guided us to the acquisition of Enovation Controls which we closed on December 5. As we discussed in November, Enovation Controls is a leading provider of electronic control, display and instrumentation solution. The business has a solid reputation for providing innovative, recognized, integrated turnkey solution that combine proprietary software platforms and customized hardware. It is very complimentary to Sun's hydraulics valve solution in a number of end markets and application. Enovation Controls carries two primary product lines, power controls and vehicle technology. Power controls provides panels for off-highway vehicles, stationary equipment and power generation. These products are used in factors such as construction, agricultural and material handling equipment, as well as utility vehicles, defense vehicles, generators and irrigation. Vehicle technology provides solutions for recreational vehicle which are used in sectors such as watercraft, snowmobiles, motorcycles and altering vehicles. With solid profitability in cash flow, the business is also strategically important as it diversifies some into new highly specialized market and customers seeking complete machine control. In addition to the acquisition, we invested in our organic business throughout 2016. We expanded our global leadership team complementing fresh new talent with bright and energetic knowledge that exist within us. We organized ourselves to establish key critical roles to support our growth initiatives. We host our product development process emphasizing the distinction between innovative and sustaining engineering. The Enovation Controls business also added almost 100 degreed engineers representing approximately one-third of their workforce bringing a proven track record of new product development and technical innovation. We've been investing in field application specialist, increasing our channel partner and direct customer interaction globally. We initiated a formal lean enterprise program which dedicatedly forces for engaging all of our personnel, building a culture of continuous improvement. We are already seeing the benefits of those efforts in terms of further reducing times and improving productivity. Please turn to Slide 4, and I'll provide more detail on our strategic growth plan. As you know we strive to have US$1 billion in revenue by 2025. As I just described, we have been investing in our foundation to drive that growth. We plan to build on our existing core business and achieve the US$1 billion revenue with approximately half coming from organic growth and the other half resulting out of acquisition. With our acquisition strategy including an electronics focus, we've already acquired part of that with the addition of Enovation Controls. We intend to broaden our business profile into areas that leverage our unique expertise with higher growth opportunities since growth in our traditional industries over recent years has been very modest. In addition to electronics, we see natural complementary opportunities in hydraulics and other adjacent technology such as electromechanical activation, factory automation, software or products relevant to the Internet-of-Things. In addition to this product and solution diversification, we are mindful of the need to consider broad geographic opportunities to manage the impact of currency fluctuations given that our customer base is global. Ultimately our goal is to achieve global technology leadership in the industrial goods sector by 2025. We have a lot of work to do but we have a clear roadmap and a strong foundation to get us there. And with that strategic perspective, I will now turn the call over to Tricia to review the financial results for the quarter and year.

Thank you, Wolfgang. I'm starting on Slide 6. Fourth quarter sales were $49.9 million up 13% compared to last year's quarter. This includes $4.1 million for the recently acquired Enovation Controls business indicating that the organic business grew approximately $1.5 million or 3%. We didn't have any price increases in 2015 or 2016, so pricing did not affect the comparability. Additionally, the foreign currency translation impact was negligible. Turning to the bottom line, earnings per share were $0.12 down from $0.19 last year. The current quarter results included several acquisition related items as follows; $1.5 million of transaction costs which amount to approximately $0.04 per share, $2 million of the amortization expense related to acquisition items which amount to approximately $0.05 per share. Of that $2 million, $1 million of it is in cost of goods sold and $1 million is in selling, engineering and administrative or SEA expense, and $500,000 of incremental net interest expense primarily due to the cash and debt used to fund the acquisition. That amounts to approximately $0.01 per share. I will now touch on sales by region which are designated here on the sales bar chart. We will also notice that we considered a chart in the back of the press release summarizing this information. We're experiencing improvement in all of our geographic markets since about September we realized year-over-year fourth quarter growth in each. In the Americas, sales grew 14% to $25.3 million driven by the Enovation Controls business, EMEA realized 4% growth to $13.3 million and the Asia-Pacific region was up 23% to $11.3 million. We are especially pleased to see that the investments we're making in China, Korea and India are proving fruitful. Please turn to Slide 7 for review of our fourth quarter operating results. Gross profit grew by $1.5 million on the higher sales partially offset by the $1 million of acquisition related amortization I mentioned previously. This drove a reduction in the gross margins by one percentage point to 34.7%. SEA expenses increased by $4.3 million to $12.4 million including several new items some of which are non-recurring and non-cash. The increase consists of primarily the following. We have a couple of items that were included in our fourth quarter forecast and those were $1.5 million of transaction cost for the Enovation Controls acquisition and $1 million of higher professional fees, CEO transition cost and compensation and employee benefit expense. We also have a couple of items that were not included in our Q4 forecast that was $1 million of the amortization expense on acquired intangible assets and $1.5 million of SEA expense for the Enovation Controls business. Our adjusted EBITDA for the quarter grew by $1.6 million resulting in an adjusted EBITDA margin of 22.3% compared with 21.4% in last year's quarter. As summarized in the chart at the back of the slide in the press release, this excludes the $1.5 million of Enovation Controls transaction cost, as well as the amortization which I mentioned a moment ago. Please turn to Slide 8 which summarizes the results for the year. 2016 sales were $196.9 million down 2% compared to 2015. This includes $4.1 million for the recently acquired Enovation Controls business indicating that the organic business decreased approximately $7.9 million or 4%. That decrease includes $2.7 million of unfavorable foreign currency translation. Turning to the bottom-line earnings per share were $0.87 down from $1.24 last year. These results included the acquisition related items previously described. Sales for the year vary by region, in the Americas sales decreased 3% to $94.8 million, EMEA decreased 4% to $58.7 million and APAC sales were up 4% to $43.4 million. Please turn to Slide 9 for a review of our 2016 operating results. Gross profit decreased $5.8 million primarily due to lower sales in production volumes, as well as the $1 million of acquisition related amortization I mentioned previously. This drove reduction in the gross profit margin by 2.2 percentage point to 36.2%. SEA expenses increased by $6.7 million to $36.9 million including the acquisition related items previously described, I’ll repeat here for convenient. $1.5 million of transaction cost, $1 million of incremental amortization expense, $1.5 million of SEA expense for the Enovation Controls business and $3 million for higher professional fees, CEO transition cost and compensation and employee benefits expense. The CEO transition cost will be completed in the first quarter of 2017. Our adjusted EBITDA for the quarter decreased $9.5 million resulting in an adjusted EBITDA margin of 24.3% compared to 28.6% last year. Please turn to Slide 10 for a review of our capital structure. At the end of 2015 we had a total of $126.1 million in cash and short term investment and no debt. We used $60 million of cash and incurred $140 million of debt for the innovation controls acquisition. Accordingly we finished 2016 with $81 million in cash and short term investments, and $140 million of debt. This puts our net debt and net capitalization at 20% at the end of 2016, a very manageable level especially given our very strong cash flow profile. Given that strong cash flow profile, we generated $38.5 million of operating cash flow during 2016. I'm pleased to report that the Board authorized a share distribution once again this year a total of $1.3 million will be paid out to employees and shareholders. The dividend amounts to $0.02 per share in addition to our regular quarterly dividend of $0.09 per share. Wolfgang, I'd like to turn it back to you for your perspective and outlook before we open the line for Q&A.

Thanks Tricia. Please turn to Slide 12. As Tricia indicated we've seen improvement in all of our global regions since about September. That continues to the present time and is very encouraging. As I noted here, the rise in [USPMI] [ph] reported 2016 is expected to give rise to increase the U.S. Industrial production in 2017 which should bode well for Sun. In addition to the U.S., most economic regions of forecasting accelerating growth in industrial production in 2017. This includes market important to us Eastern and Western Europe, as well as India. While growth is forecasted for China it is not expected to be as a robust at some of the other regions. However in China we do believe that we can take market share given a strong positioning of our quality brand in combination with marketing and training investments we have made in recent years. We have seen growth across the variety of end markets including energy, mining, material handling and construction. The U.S. single unit housing market has been showing strength finishing 2016 with a solid year-over-year growth in excess of 12% in the fourth quarter. These factors, as well as the attraction we are gaining from our market penetration initiative give us confidence as we think about our expected financial performance in 2017. Please turn to Slide 13 for additional thoughts regarding our outlook. The growth trends sided on the prior slide of course do not take into consideration changes in economic policy that may be implemented by the new U.S. Administration so we will monitor those changes going forward. Additionally, we are cautious about geopolitical risk, major upcoming election in the Netherlands, France, Germany, and most likely in Italy may have a significant impact on the future viability of the European Union, especially given what appears to be a recent rise in global populism. Please proceed to Slide 14 where we summarized our guidance for 2017. You will notice that we are providing guidance for the entire year as opposed to only the next quarter which we have historically done. We believe this approach provides better clarity on our expected financial performance, especially as it will include our Enovation Controls business for the entire year. We are forecasting revenue between US$295 million and US$310 million representing 7% to 13% growth over pro forma 2016 combined revenue. We will be reporting in two segments. With the Enovation Controls business comprising the significant majority of our electronics segment, and most of the historical Sun business comprising our hydraulic segment. We currently estimate our hydraulic segment revenue to be between $205 million and $215 million and our electronic segment revenue to be between $90 million and $95 million. We estimate that our consolidated operating margin will be between 20% and 22% before acquisition related amortization expense. Our consolidated interest expense will be between $4.2 million and $4.7 million and our effective tax rate will be between 32% and 34%. Finally, we anticipate capital expenditures between US$8 million and US$10 million, depreciation between $12 million and $13 million, and amortization between $8 million and $9 million. So with that, let's open up the line for Q&A.

[Operator Instructions] Our first question is coming from Mig Dobre of Robert W. Baird. Please proceed with your question.

Good morning, Wolfgang and Tricia. This is Joe Grabowski on for Mig this morning. Just a quick clarification on the guidance that you just ran through. The electronic segment, it's not all Enovation. It could maybe of that 90 million to 95 million, maybe how much is Enovation and how much is legacy fund businesses?

Yes, you're right. Joe there is a legacy electronics business of Sun's High Country Tek HCT which amounts to about US$4 million.

I see. Okay, that's helpful. And then just kind of walking through the math on Enovation. So Enovation sales are going to be - I guess at the mid-point of the guidance range, a little below 90 million. And then the margin on Enovation, I remember when you made the acquisition, you said Enovation's operating margin were similar to your legacy business. Is that going to be true for 2017? Will Enovation's margin be kind in that 20% to 22% range?

Yes. It's quite similar to ours. It's not quite on the same level, Joe. As you might recall, they have actually a higher gross profit than Sun has, but then obviously, there is more engineering and selling expenses. But pretty much the statement that we made in November is true and is embedded in these numbers.

Okay. So if I assume maybe like a 20% operating margin for innovation, and then I subtract the 8 million to 9 million of amortization, I subtract about maybe 6 million of incremental interest expense, I tax affect it, I get to Enovation accretion in 2017 all in of maybe $0.10 and I'm just wondering how that compares to the $0.25 to $0.35 of GAAP EPS accretion that you guys talked about at the time of the acquisition?

We did not run through those numbers at the EPS level in particular when we were doing the guidance. We are focused more on the operating margin numbers then looking at the EBITDA. I have to run through those specifically. There is some noise in those numbers obviously from the amortization that's going to come from the intangibles and when we have to roll these up in total, there is significant amortization related to the identified intangible assets that came with the acquisition.

Sure. I mean where you expecting that level of amortization when you gave the $0.25 to $0.35 guidance or is that higher than you had anticipated?

It's a little higher than what we had anticipated. We didn’t have that analysis fully completed at that time. Actually we've left the measurement period open so that we do have some flexibility if we recognize that those efforts should be re-valued over the next year as well. So you will see that in the K as well.

Okay, that's helpful. And then maybe switching to the kind of the legacy, I don’t know basically what to call at the Legacy Sun business, so that businesses operating margin I guess is going to be maybe slightly higher than 20% to 22%. If I look back to 2015, when you had around $201 million of sales, operating margin was about 23.5%. And so there was a lot of noise in the numbers in 2016 with the CEO transition costs and deal related cost and so forth. But if I just kind of compare 2017 to 2015 your sales guidance is higher and your operating margin guidance is lower, so are there kind of some unusual costs over and above the one quarter CEO transition cost that might be impacting again the legacy margins in 2017?

No there is - Joe there is no additional expenses embedded into that and once we get to an apple-to-apple comparison situation here, you will see pretty much the same profitability levels that you are referring to back in 2015, specifically that's indication of the calculations we are seeing here. We have a little bit higher expenses right now in - because we invest heavily in engineering but obviously for that we get the return in additional profitable sales and I think that is reflected here in the guidance as well for 2017.

Sure, that makes sense. Couple of more questions. The full year guidance is very helpful especially with all the changes to the business what I was just wondering if you could give any color on quarterly phasing of sales and maybe specifically Q1 what your outlook is for sales or anything, anything as far as the quarterly phasing goes?

Of course, Joe. So as I mentioned before so we have seen an uptick in business in September of last year, we are very encouraged what we are seeing now - right now during the first quarter of 2017 and I think the good news is we are seeing it across the spectrum, it's coming from various end markets, as well as from all the regions around the world. The U.S. is rebounding particularly strong. We have to see - this can be sustained but everything we are seeing is reasonably positive right now.

Great, okay. Two more questions from me. When you made the Enovation deal or announced it, you talked about a $35 million favorable tax benefit over time it doesn't seem to be hitting this year because your tax rate guidance is 33% to 35%. So any updated thoughts on the tax benefit from the deal?

Yes, we still believe that we are going to get that level of tax benefit in there - is benefit but being recognized in the 2017 estimates that we gave. The part that we are still working through are these state effect of having additional states brought in that are driving up the tax rate a little bit, so the tax benefit is offset somewhat by the additional state tax that we've recognized as we’re going through and bringing in all the additional state under the innovation umbrella.

I see, okay. Final question, you've owned innovation for a few months now. Any early learnings, or any surprises from the last time you kind of talked about the company in the transaction?

No negative surprises at all. I have to say things are actually going smoother than we had anticipated for Phase 1, and we are just getting a daily reconfirmation for what we believe and saw during the feasibility phase about a year ago. So things are looking rather positive.

Great, okay. Thanks for taking my questions. Good luck in 2017.

[Operator Instructions] Our next question is coming from Jon Braatz of Kansas City Capital. Please proceed with your question.

Good morning, Wolfgang and Tricia. Wolfgang, just want to touch base on your sales guidance of about 205 million to 215 million for basically the legacy business. That sort of suggest bar growth of 10% for the year, something of that magnitude. And I guess, at least some of the other industrial companies that I talked to - that 10% growth is maybe an excess of what some of the other companies are guiding. I guess my question is, does that estimate assume that there's going to be some increase sales momentum as we go through the year? And then secondly, what does that suggest about market share gains? What part of that growth rate that you are expecting comes from market share?

That's a good question, Jon. So to the first part of your question, we have a bit of seasonality in the business as you know historically, the second quarter is stronger than the first one. So obviously having these encouraging finds during the first quarter makes us pretty confident for the second quarter as well. With regard to market share gain, when you refer to the legacy business, we will talk about [cartridge] [ph] growth technology, so we expect cartridge growth technology to grow probably somewhere in the range between 5% and 10% this year. So that assumes that we are taking some market share, and I'd say predominantly in Asia, that maybe also little bit here in North America. So that's the assumption based on the guidance that we are giving you on cartridge growth.

Okay. And no price increases. Is that correct?

No price increases at least at this stage. There is very little pressure from the supply side on commodity price increases. So there is no need for us to pass anything on to the marketplace. As I mentioned earlier, Jon we started the lean enterprise program and obviously we are looking for efficiency and productivity gains internally here. So we don't feel this is the environment to impose any price increases on our customers. I think this is the right opportunity here to rather focus on market share gain in the individual end markets.

Okay. Tricia, on the balance sheet, some short term and long term contingent considerations coming from the Enovation acquisition. What are the metrics associated with that, are they sales oriented, profitability oriented, return on investment oriented? What can you tell us about that consideration?

The consideration is what we call the earn-out on Enovation acquisition. And the metrics for those are 75% related to revenue target being hit, and 25% related to EBITDA targets being hit for each of the three measurement periods and earn-out periods.

Okay. And is that - the longer term consideration, is that over, let's say, a 2, 3 year period, or 5 year period, or how longer period is that?

The total earn-out period is 27 months. So it's broken down into three 9 months segment with the first payment and earn-out measurement period ending on August 31.

Okay. And then lastly Tricia the amortization that you estimate between $8 million and $9 million for 2017, is that incremental and associated with only - incrementally new for the Enovation acquisition?

The vast majority of it is - there is a very small portion that's related to identified intangibles or HBT and wide-out that were identified at the time of those acquisitions but the vast majority is related to the intangibles related to acquisition of Enovation. Most of them have useful life of around 15 years but they range anywhere from 5 to 20 years.

Okay. Was any of the amortization that we saw in the fourth quarter one time in nature or is that - just the right off of the intangibles for the first month.

The portion that we saw hit in the cost of goods sold section was what I would consider one time in nature. There might be a little bit closed into Q1 as well but it's related to the step-up on inventory that we acquired though as soon as they turn that goes away.

Yes, okay. Tricia, thank you very much.

Thank you. At this time I’d like to turn the floor back over to management for any additional or closing comments.

Thank you again for your participation this morning. I'm proud to have the opportunity to lead this outstanding team and appreciate your interest in Sun Hydraulics. We look forward to update you on the first quarter progress then in early May. Thanks again and have a great day.

Ladies and gentlemen thank you for your participation. This concludes today's teleconference. You may disconnect your lines at this time. And have a wonderful day.