Helios Technologies, Inc. (HLIO) Q4 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to the Helios Technologies Fourth Quarter and Full Year 2018 Financial Results. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Karen Howard, Investor Relations for Helios Technologies. Thank you. Ms. Howard, you may begin.

Thank you, Jerry, and good morning, everyone. Welcome to the Helios Technologies, formally known as Sun Hydraulics, Fourth Quarter and Full Year 2018 Financial Results Conference Call. On the line with me 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 do not have that release, it's available on our website at www.heliostechnologies.com. You'll also find slides there that will accompany our discussions today. If you look through 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 in other documents filed by the company with the Securities and Exchange Commission. These documents can be found at our website or at www.sec.gov. I also want to 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 to non-GAAP measure in the tables that accompany today's earnings release as well as in the slides. Wolfgang will get started with summarizing key highlights for 2018, Tricia will go through the details of our financial results for the quarter and the year, and then we'll turn it back to Wolfgang for his perspective on our outlook and 2019 guidance before we open up the line for questions and answers. And with that, it's now my pleasure to introduce Wolfgang.

Thank you, Karen. Good morning, everyone. I will start on slide 3. 2018 has certainly been a very busy and exciting year for our Helios associates around the globe. Over the past two years, we have meet considerable progress as we are executing division 2025 strategic plan that we laid out to you at the end of 2016. I will start with summarizing our financial results. We achieved 2018 sales of $508 million that reflects almost a 50% increase over 2017 and is about 2.5 times more than 2016. In addition to acquisition growth during this period, we have also been experiencing significant organic growth. 11% was realized in 2018 after an amazing 21% organic growth rate in 2017. Turning to the bottom line on a non-GAAP basis. We realized $1.74 per share in 2018 up 9% from 2017 and almost double the $0.93 per share we reported for 2016. That excludes acquisition related and other onetime type items but it does include amortization expense consistent with how we have been reporting non-cash EPS for year. As a heads up, beginning in 2019, we plan to start reporting our non-GAAP net income in EPS on a normalized cash basis excluding our acquisition related amortization expense. We'll talk more about that shortly. We are generally pleased with our operating margins for the year, but to recognize that we have room for improvement which I will touch on later in this presentation. Our 2018 adjusted operating margin was 21.4% and adjusted EBITDA margin was 24.5%. These reflect modest erosion compared with our 2017 results at 110 basis points and net 90 basis points respectively. However, those metrics reflect improvement over our 2016 results. Finally, I want to point out that as we expected we generated strong cash flow in the fourth quarter. This allowed us to reduce our net debt by nearly $20 million and finish the year at our target levels of 15% operating cashflow to sales and 10% free cashflow to sales. Additionally, we made significant progress toward our leverage goal of less than two times EBITDA. We finished the year at 2.4 times. Please turn to Slide 4 and I'll summarize the key milestones we achieved in 2018 from a business perspective. We reflect back on the year as one in which we diversified significantly from expanding our end markets to product growth to global footprint to customer base. Allow me to summarize 2018. About a year ago, we raise capital in the equity markets and then we amended our bank credit facility. This additional capital financed our acquisition of faster and provides for further growth. Faster was a strategic and transformational acquisition providing us with a solid manufacturing footprint in Europe from which to expand our European presence in accordance with our in-the-region for-the-region philosophy. Along with a very innovative culture, it brought us a global and market leading family of quick release couplings. Strong relationships with new OEMs and solid penetration in the agricultural market, which is very important to us. Since that time, our teams have been diligently working on the synergies we identified targeting at least $7.5 million of incremental EBITDA by 2022 mostly driven by sales opportunities. Also in April of 2018, we began our CVT manufacturing consolidation project in Sarasota. In applying our lean enterprise principles, we have been diligently moving production lines amongst our three facilities in Sarasota to consolidate our manufacturing into our two adjacent plants. We expect to complete this part of the project by the end of next month. Over the course of the year, as we fine tune our newly organized production line, we expect our productivity to improve and free up about 15% of additional capacity. In the next phase of this project which we expect to complete by the end of 2019. We are establishing a center of excellence in our third Sarasota facility which is about two miles from the other two. It will house our hydraulic research and testing activities for the Americas region as well as certain administrative and operating activities. During the second half of 2018, we announced our new business name as Helios Technology. This was strategically important to us. As we maintained Sun Hydraulics as the operating name for one of our businesses complemented by our other operating businesses innovation controls and faster. At nearly the same time, we announced our acquisition of Custom Fluidpower or CFP. This was not significant in terms of size relative to Helios, but it is very significant in terms of its strategic importance to us. CFP is an innovative hydraulic integrator with eight locations based in Australia. Prior to closing on the acquisition, we referred to this project as stepping stone seems to be viewed as exactly that. A stepping stone for us in the South East Asia region, the base from which to build our other businesses. Since its acquisition, we have been diligently working on the synergies we identified targeting at least $2 million of incremental EBITDA by 2022, mostly driven by sales opportunities. At about the same time, in August 2018, we started production at our new state-of-the-art facility in South Korea serving our CVT business. From purchasing the land to getting it up and running, we completed this project in just 11 months. We previously leased space nearby. But this new own facility provides us with about 4.5 times more square footage from which to service the fast-growing Asia-Pacific region. In addition to the achievements of these specific milestones, our associates were very busy with many other projects during 2018. A key one which is very broad and encompasses several teams of different people is focusing on realizing the synergies from the acquisition. In addition to Faster and CFP which I already mentioned, we have been working hard on synergies from our Enovation Controls acquisition which we have targeted to achieve at least $5 million of incremental EBITDA by 2020. On a day-to-day basis, we have also been focused on productivity improvement and our progress is evident particularly in the second half of the year. At the same time, we have continued to work on our organic growth initiative including penetrating geographic light spots, identifying new sales opportunities in the field and introducing new products to be responsive to market trend. All of these actions are in alignment with our vision 2025 plan which we announced back in late 2016 to achieve global technology leadership in the industrial goods sector with critical mass exceeding $1 billion in sales while maintaining superior profitability and financial strength. With that overview, I will now turn the call over to Tricia to review the financial results for the quarter and full year in a bit more detail.

Thank you, Wolfgang and good morning, everyone. Let's begin on Slide 6 with the review of our fourth quarter consolidated results. Sales were up 65% compared with last year's quarter. Faster contributed 36 million, CFP contributed 11.9 million and our organic business sales grew 8%. Foreign currency had a 400,000 unfavorable impact on consolidated sales for organic businesses. Faster and CFP sales were also unfavorably impacted by the decline in the Euro and Australian Dollar resulting in 2.6 million of lower sales compared with their pre-acquisition exchange rate. I'll now touch on sales by region, which are designated here in the sales bar chart on the left. There is a table in the back of the press release as well as the supplemental slides summarizing this information. As you can see all geographic markets realize considerable year-over-year growth. With the addition of Faster and CFP, the EMEA and APAC regions are now larger contributors to our sales base. Sales to the Americas, EMEA and APAC region were 49%, 27% and 24% of the consolidated total respectively. Last year, this was 56%, 22% and 22% to the Americas, EMEA and APAC respectively. Regarding profitability, our consolidated adjusted EBITDA of 32.4 million was almost double last year's fourth quarter. Turning to the bottom-line, adjusted earnings per share were $0.41 more than 50% higher than last year's fourth quarter. That comparison is impacted by a few factors I'd like to point out. First, the average number of shares outstanding in the 2018 fourth quarter was 4.9 million higher than last year primarily due to our equity offering in the first quarter. Second, we have more expense from amortization of intangibles as well as interest on new debt resulting from our acquired businesses. This year’s quarter includes $0.14 and $0.11 per share for amortization and interest expense respectively compared with $0.05 and $0.03 per share for amortization and interest expense respectively in last year's fourth quarter. Together, these two acquisition related items have a $0.17 impact on the fourth quarter comparison on both a GAAP and non-GAAP basis. As Wolfgang mentioned, I want to reiterate that beginning of 2019, we plan to report our non-GAAP EPS on a normalized cash basis so we will be adding the amortization back for that purpose. I now like to bring to your attention the items that impacted our consolidated results and that we added back for purposes of reporting adjusted EBITDA adjusted EPS as shown here. Please refer to the tables in the back of the press release or slides for reconciliations of GAAP and non-GAAP numbers. During the fourth quarter of 2018, we incurred the following. First, 776,000 reduction in amortization of the inventory step-up costs resulting from a revision to the purchase accounting for Faster as we finalized the valuations of intangible assets. This was in cost of goods sold. Next, we incurred about 90,000 of acquisition related costs and selling engineering & administrative or SEA expenses. Next, we recorded a charge of about 554,000 for contingent consideration associated with the innovation controls acquisition reported on its own line and the income statement. Finally, we had some favorable tax items specifically 1.4 million related to the impact of tax reform and 1.9 million for other discrete items. For consistency, we added those back for purposes of calculating our adjusted net income and EPS. Please turn to Slide 7 for a review of our Hydraulics Segment fourth quarter operating results. Consistent with prior periods, I want to point out that acquisition related costs including amortization are not included in these segment numbers. They are accumulated in our corporate and other segment reporting on the tables in the back of the earnings release in slide. Sales for the hydraulic segment grew 89%. We saw 73%, 113% and 89% year-over-year growth for the quarter in the Americas region, EMEA and APAC. Those growth numbers benefited from the addition of Faster and CFP. On an organic basis, we realized 8% growth which was driven by increased market demand in most geographies and end markets and was also positively impacted by global sales and marketing initiative. Orders continue to outpace revenue and our growth could have been even higher except that it was dampened by disruption from our CVT manufacturing consolidation project. While gross profit increased by 87% on the higher sales including the addition of Faster and CFP, the quarter was unfavorably impacted by higher outbound freight satisfied customer demand Faster shutdown over the December holidays and the impact of CFP’s integrator business model. Performance by our legacy CVT business was strong Hydraulics Segment operating income nearly doubled. Our selling engineering and administrative expenses or SEA included 7.1 million for the Faster and CFP businesses and we effectively managed the SEA expenses for our Sun business. Please turn to Slide 8 for review of our electronics segment fourth quarter operating results. Revenue was up 8% compared to fourth quarter of last year. This was impacted by the timing of project revenue some of which shifted into the fourth quarter from the third. Gross profit for the segment increased significantly to 45.7% of sales. Favorable productivity, project mix and operational efficiency drove the growth rate as we recovered from cost pressures realized earlier in the year. Operating income in the fourth quarter grew from a loss in last year's fourth quarter to 18.7% of sales this year. In addition to the gross margin improvement, SEA expenses decreased by about 1 million. This was primarily due to the restructuring costs included in last year's quarter. Please turn to Slide 9 for a review of full year consolidated results. Sales of 508 million were up 48% over 2017. Acquisitions contributed 126.8 million and our organic businesses grew 11%. Regarding profitability, our consolidated adjusted EBITDA grew 43% while the margin declined slightly. The erosion results primarily from higher outbound freight costs to meet customer demand, inefficiencies during the CVT manufacturing consolidation project and the impact of the CFP integrator business model. Turning to the bottom-line, adjusted earnings per share were a $1.74 but like the quarter are impacted by a few factors when comparing to the prior year given our acquisition strategy. First, the average number of shares outstanding in 2018 was 4.3 million higher than last year primarily due to our equity offering in the first quarter of 2018. Back in 2018 includes $0.56 and $0.33 per share for amortization and interest expense respectively compared with $0.21 and $0.09 per share for Americanization and interest expense respectively in last year's period. Together, these two acquisition related items had a $0.59 impact on the full year EPS comparison on both a GAAP and non-GAAP basis. Please turn to Slide 10 for a full year review of the Hydraulics Segment. Sales of 381.8 million were up 66% over last year. Gross profit increased by 55% and operating income increased 53%. Now please turn to Slide 11 for a full year review of the electronic segment. Sales were up 13% over 2017. Gross profit increased by 19% and operating income increased 40%. Please turn to Slide 12 for review of our cash flow and capitalization. In 2018, we generated 77.5 million of cash from operating activities, 57% more than 2017 with the increase driven by higher earning. Our CapEx was 28.4 million including the cost to complete our new production facility in South Korea, the addition of the Faster business and costs associated with our CVT consolidation project as well as other productivity investments. In 2018, we are pleased to meet our ongoing cash flow targets of 15% operating cash flow-to-sales and 10% free cash flow-to-sales. Regarding capitalization, we finished the year with about 23 million of cash, 353 million of debt and 531 million of equity. Strong cash flow in our fourth quarter allowed us to reduce our net debt by nearly 20 million in the quarter. We finished the year with our net debt to pro forma adjusted EBITDA of 2.4 times. With our strong cash flow profile, we are focused on getting that down to below 2 times. Wolfgang, I'd like to turn it back to you for your perspective on outlook and our 2019 guidance before we open the lines for Q&A.

Thanks Tricia. Please turn to Slide 14. As we have been expecting the leading U.S. indicators that are important to Helios signals slowing growth in 2019 with accelerating growth to resume in 2020. Around the world, nearly all major global economies are already in the slowing growth phase of the business cycle. Economic forecasts that we follow point to a mild recession in Western Europe in 2019 returning to growth in 2020. Important to note, as we have said before in accordance with our vision 2025 plan, we expect to outpace macroeconomic growth. This is being driven by the investments we have been making to expand our coverage in the field increasing and broadening relationships with OEMs, penetrating regions where we have wide space and continuing to introduce new and innovative products and solution. Further, we are much more diversified by any market than the legacy business was and we expect these factors to help us successfully weather economic cycles. Please turn to Slide 15 for our thoughts regarding our outlook for Helios in 2019. Referring to our Hydraulics Segment, keep in mind that the timing of our 2018 acquisitions will impact our expectations for 2019. Specifically, our first quarter will include acquisition growth for both Faster and CFP. Recall that Faster will anniversary on April 5th then our second quarter and part of our third quarter will include acquisition growth for CFP which will anniversary on August 1st. Most of the end markets for all of our businesses are continuing to grow although at a slower pace but we have started to see some softening in the end market as we indicated last quarter and the oil and gas sector. Regarding operating profitability, we are very encouraged about the results we are seeing from action taken to improve production flow with our facilities as well as manage our fixed cost. As previously indicated, we expect to complete our Sarasota manufacturing consolidation project over the next month. We are already seeing better workflow in those operations and expect that will continue to improve as we progress. Turning to our electronics segment, we are cautious about expected demand given the timing of customers new model launches affecting that sector. But we are focused on opportunities and synergies as well as continuously improving production flow. On a consolidated basis, regarding quarterly cadence, we are currently expecting performance to be evenly spread throughout the year. However, we expect the Hydraulics Segment to have a stronger start to the year and the electronic segment to be a bit stronger in the second and third quarters based on timing of product launches. I am pleased to report that we are accelerating our new China manufacturing facility project. This will provide us with needed capacity to service that region by all of our businesses. We expect to begin production later this year. Lastly, I want to highlight that we are continuing to aggressively invest in innovative manufacturing technologies and market leading new products. These projects are driving our growth that is outpacing the market as well as ongoing productivity improvements that are allowing us to service our growing customer base around the globe. Please proceed to Slide 16 where we provided our guidance for 2019 compared with our actual results for 2018 you will notice that we have simplified the items that we are guiding on for 2019. We are focusing on absorbing the business that think we acquired over the past couple of years that have transformed Helios as we advance along this strategic journey. We are expecting consolidated revenue of $590 million to $600 million, growth of 16% to 18% driven by both of our segments. On a consolidated basis, this includes organic growth of 2% to 4%. We're expecting 21% to 23% revenue growth in our Hydraulics Segment in the flat to 4% revenue growth in our electronic segment. We're expecting GAAP EPS of between $2.10 and $2.20, reflecting about a 41% to 48% growth over 2018. As Tricia and I mentioned earlier, we are introducing a new non-GAAP metric cash EPS for 2019. Without visibility of onetime items, the only predictable difference between GAAP and non-GAAP cash EPS will be amortization expense on the tax effective basis. We're currently expecting between $2.55 cents and $2.65 of cash EPS in 2019, up about 11% to 15% over 2018. We provided a calculation of 2018 cash EPS for your convenience in the supplemental sections of our release and slide. We are currently expecting an adjusted EBITDA margin of 24.5% to 25.5%. At the midpoint, that represent a 50-basis point expansion over 2018. Now let's open the lines for Q&A.

Thank you. We’ll now begin the question and answer session. [Operator Instructions] The first question is from Nathan Jones, Stifel. Please go ahead.

Good morning everyone.

Good morning.

Good morning, Nathan.

Just a housekeeping one on the GAAP and non-GAAP EPS. I think you said this Wolfgang is the only difference in there currently, your expectations of amortization and of intangibles. Any restructuring expense that you're anticipating in 2019?

Now it's just the amortization of intangibles at this point. We aren’t anticipating anything else in the numbers that we're provided I think.

Okay. Thanks. And I guess then probably the first question is going to be on price cost. I know you guys had a lot of inflation you had to deal with in 2018 and some places where you could pass it through some places where you couldn't pass it through particularly in Enovation Controls I think. Maybe you could talk about where you stand at the moment. How you think you can improve that that price cost dynamic through 2019?

Yeah, sure. Nathan. As you know from previous calls and the conversation, we basically secured the majority of the purchases through LTA at least on two long-term agreements on the hydraulic side of the business after seeing obviously significant cost increases there particularly in the first half of last year. As you also know, we have had price increases in all of our businesses that were introduced at different points in time in in 2018. I think it's fair to say on the legacy business. So on the Sun business, we have made very good progress with regard of getting the price increases through. With regard to the Enovation business, the majority of the business there is in the meantime obviously OEM driven. And as we pointed out also on numerous occasions obviously it's very difficult to impose price increases if there is not basically a snapshot in time where we have new product launches. Overall, I think I have to say everything we have seen in the fourth quarter is pretty much in line with what we projected mid-year when we had the LTE’s in place and when we launched the price increases across the different businesses.

Maybe you could talk a little bit about on the innovation side. How successful you've being been on shifting customers to new products as you've gone through 2018 maybe the anticipation of doing that in 2019 because I know I understand that's where you can get those pricing increases through on the OEM side.

Absolutely. I mean as you know we have about I would say 10 major product launches every single year on the innovation side, major project product launches and that obviously provides the opportunity also to re-discuss the pricing levels. The team has been -- to your question has been very successful in shifting customers over to new products and new solutions. You know with that very strong engineering approach we have they are pretty much coming in and suggesting modifications and upgrades to the OEM customers on an ongoing basis. That is one of the true strengths I think of Enovation Controls. So we have been pretty successful there and I'm very hopeful that we will continue as we move forward from here.

Is it possible to quantify that at all like you moved 25% of customers or 75% customers or anything like that?

It's relatively difficult to quantify because you have to distinguish between modification you do on existing products and then you have new product launches as you know the product sides are very short on the electronics sides. So I would hesitate to put the percentage on that. That's an ongoing process happening in the in the daily business but new launches as I said are about 10 that are of significant size during the course of the year. The rest I would I would classify more as modifications upgrades and so forth.

Okay. Thanks very much for the call. I'll pass it on.

Welcome

The next question is from Brian Drab, William Blair & Company. Please go ahead, sir.

Good morning. Thanks for taking my questions. I wanted to first ask on organic revenue growth expectations. I may have missed it if you gave that number but you didn't provide organic forecasts for 2019 for the segments, or did you?

Yeah, we did not provide organic guidance there. We're focused on the consolidated business and looking at that in the 2% to 4% guidance that we provided there. And we did give overall guidance for each segment as well but we were not guiding to organic.

So is it 2 to 4, Tricia?

2% to 4% is consolidated sales growth in 2019, but the 290 to 600 represent 2% to 4%.

Okay. And that's our organic you're saying. Is that right?

Yes.

That is organic growth. Yes.

Okay. I got it. Okay I was just doing some math but I guess I don’t needed to do here. So as I was saying about a one to two point headwind from CapEx?

Yeah, that's probably fair and you know we're seeing most of that from the euro for the Faster business.

Right. Okay great. And then you mentioned I was getting a stronger start in the hydraulics business in the first half of 2019. There's something we do with some pent-up demand maybe as these orders were stacking up during the facility movement. Or can you talk a little bit more about why we get out of that stronger start?

Yeah. We are seeing obviously I mean I wouldn't say just because of the facility moved but obviously coming out of -- having a lot of good tailwind actually all through 2018. We are seeing of course higher backlog numbers that we can work off. And now obviously with facility consolidation here progressing well and as expected we are in a good position to increase output relatively quick in the first half of the year. The reason why I emphasize the first half of the year Brian is we have good visibility for the first half of the year I think across all businesses. It's fair to say that visibility for the second half of the year is not is not truly representative. I think we would give forecasts and projections that we cannot underline with very fundamental data there is too many moving pieces I think in the macroeconomic environment right now.

Okay. Thanks. And then maybe just one more for now the Faster business if you look at that on a standalone basis and just kind of the half of that business given I know you have some challenging end market in Ag you know with that business be in your forecast so expecting it to be up in 2019 versus 2018?

Oh, yeah, absolutely. And don't forget Brian I mean only 65% of that business is exposed to the Ag market. We are still seeing strong development in construction equipment and the industrial sectors last but not least also maybe generating synergies here in collaboration with Sun and Enovation.

Okay. Thank you. I’ll follow up more later.

Thank you.

Now I have a question from Mr. Jeff Hammond, KeyBanc. Please go ahead Mr. Hammond.

Hey, good morning, this is Brad on for Jeff. Just on the CVT project could you give us some color to the extent to which that was a drag on the fourth quarter it sounds like that continued to progressed from levels in 3Q but how much of a drag was on the fourth quarter then you know how much of that you know lingering kind of headwind it stays with us until 1Q or then you know once the project completes in the back half of the year.

Sure Brad. So first of all things have progressed exactly as we told you already in the queue into Q2 and Q3 earnings release last year. So if I had to quantify that rank to come to your specific question in Q4 I would probably say it's between 5 and 10% of output that was impacted in Q4. Now as we are progressing and pretty much to the move is completed at the end of this week already as far as the maneuvering of machinery and equipment is concerned. We then have to do streamlining during the month of March and then basically can finalize that project at the end of March. So as we move through the first quarter obviously we are reducing that 5 to 10% deficit that I referred to for Q4 gradually. So I am hopeful then that by Q2 we are still on a level playing field where we can reap the benefit of a more streamlined manufacturing and the increase of capacity.

Okay. That's helpful. And then just along the same lines you know if I look at the margin guide it seems like there's quite a few headwinds in 2018 primarily on the hydraulic side and you know a majority of those left there or go away altogether in 2019. So I guess then you know if you layer on some productivity upside you know once the project completes I guess can you talk about the upside to margins that might exist in hydraulics and maybe some of the new gaining factors that are out there as well.

Yeah I mean I would caution you a little bit on the upside potential because I want to make sure that the expectations are not too high. As I pointed out earlier that we actually price increases last year. We are obviously monitoring the situation right now but we are not planning an imminent price increase at this point in time. So from a pricing level we'll probably not to do anything for that for the next few months. As far as productivity and efficiency is concerned. As I said the side consolidation project is completed. We’ll ramp up the capacity, will streamline everything and should see a positive impact there. We are doing pretty much the same on the Faster side as well. So I want to make sure that we are not talking only about some hydraulic here and streamlining of manufacturing here in Sarasota I mean we have a number of ongoing projects in place on the Faster side of the business to further streamline manufacturing and become more efficient there.

Okay. And thanks for the color. I’ll pass it on.

Thanks.

Next question is from Nick [Indiscernible], Robert W. Blair & Company. Please go ahead, sir.

It’s Robert W. Baird. Good morning everyone. How are you?

Good morning.

Good morning.

I want to clarify something, perhaps I missed this. But in terms of DNA should we expect any changes in 2019 versus 2018. Where I'm going with this? I'm looking at confirmed that the margin expansion here is on EBITDA is kind of a core operating guide.

Yes, so on the amortization side, amortization for 2019 will be lower than it was in 2018. Some of the items that come through on the intangibles for amortization are short lived like backlog. So we ended the year 23.3 million we're looking at the amortization of probably 17 to 19 for 2019. And on the depreciation side, with the addition of Faster and CFP for more of the year as well as the assets that are put in place what we do expect an increase in depreciation over 2018 as well we ended the year at 16.5 and we're looking somewhere between 22 to 24 million.

Okay. That's helpful. Thank you for that. And then also speaking with minutia here, do you have a view on the tax rate for 2019 and also kind of looking to confirm how you're thinking about the cash flow?

Yes. So we ended the year with an effective tax rate of 17 as we noted in our prepared remarks or some onetime impacts in there. But we also do get the benefit of the new U.S. tax laws. So our rate going forward we expect to be somewhere between 20 and 22% for 2019 and beyond and you had a question on how we view free cash flow. So we still are looking at our targets of free cash flow of 10% of sales and that's even given the significant CapEx that we're expecting in 2019.

Okay. That's helpful. And then maybe going back to margin and I think previous the person and I try to get at this. So when you're looking at your 50 basis point midpoint guidance for expansion that is how do you think this flows at segment level do you essentially bake in similar expansion for both electronic and hydraulics or is one essentially benefiting more than the other.

No I mean we don't necessarily look at it like that make. First of all the margin levels as you know from a gross margin perspective are higher on the electronic side to be to begin with.

Yes. But I’m talking about the year-over-year change here. Right. I mean you're talking about margin improvement and I'm trying to figure out where you see more of an impact if at all want that number.

It will be in both segments. So there will be a positive contribution from both segments.

But you cannot call out one versus the other based on either pricing dynamics or what you know you have in terms of efficient based on itself what I mean it you know it strikes me for instance that you've had a lot of headwinds in hydraulics some of which are you know getting resolved in 2019. So I would I would imagine for instance that you'd have relatively good margin traction there.

That's a fair assessment, probably a little bit more contributed by the hydraulic segments. My opening statement was referring to electronics where we have already absolutely superior gross margins. There is not a lot of room to improve there. The benefit on the hydraulic side is that goes back to the five consolidations project in Sarasota as you know I mean our business model is still fixed costs driven. So the higher the utilization is the better it is. We’re creating more capacity through the lean manufacturing principles that we are applying that helps us actually to invest less in machinery and equipment. We are just squeezing more out of the existing export machine based. And that’s coming back to your question will definitely contribute then to margin improvement.

With the significant fixed costs in the hydraulic segment primarily related to capital I think we can leverage those costs a little bit more quickly than we can on the electronic side. So as we start to see revenue increases I think the Hydraulics Segment does generate more margin more quickly.

And then going back to growth and hydraulics so you know if I heard you correctly you said that your book to bill has remained above one and a quarter. That essentially implies that you build some backlog of orders. Then I know that you've built a backlog of orders throughout 2018. I guess I'm trying to get a sense from you as to how this dynamic is playing out in terms of supporting growth maybe in 2019. Can you maybe size the backlog or give us the sense or how it is now versus prior years? And I'm also looking to understand what role your disruption played in building this backlog and whether or not you know eventually this backlog conversion now that your facility consolidations have had been you know essentially complete that that drives this outgrowth in the front half that you mentioned early.

I mean the backlog is elevated but it is not exceptionally high. If I look at the actual numbers as such and as I answered already I think it was Brad earlier on. So the backlog is definitely elevated also to a certain degree because of the site consolidation project its started in April last year. If you know we had very strong order intake in Q2, Q3 and Q4 and I've been quantifying the impact in Q4 between 5 and 10%. So that had an impact on backlog. This is also the reason why we feel we feel pretty comfortable for the first two quarters in 2019 what we’re seeing. So basically eating into that backlog and still continue to see solid orders and order intake at the same time. That's why we are more comfortable about the first half of the year on the hydraulic side compared to the second half of the year.

Okay. I only have two questions left. One on hydraulics again if you quantified the effects earlier we kind of know what the acquisition are contributing in terms of faster and CFP running the math here it seems to me like you're implying organic growth and hydraulics of roughly call it 4%. Correct me if I'm wrong but as I'm looking at this 4% figure I'm trying to understand how much of that is essentially volume driven versus the left over from price increases. It seems like about half of that would be would be related to price increases on a year-over-year basis.

I think you're probably in the ballpark with the numbers that you've stated. The only thing with regard to the price impact there it's higher on the legacy business as you know and that is simply something to do because we work more through the channel compared to faster where we sell more through OEMs and price increases are more difficult to impose on customers. But in general, I think your numbers are in the ballpark.

Okay. And then lastly your comment on quarterly cadence I'm looking to make sure that I understand that in as part of your slide 15 that quarterly cadence is essentially an EPS comment right. I mean that's how I took it rather than.

It's both. I don't know that you can have one without the other necessarily. So I it was intended to cover revenue as.

Okay. Alright. Thank you so much.

Yes.

The next question is from Charley Brady, SunTrust. Please go ahead.

Good morning. This is actually Patrick Wu standing in for Charley. Thanks for taking my question.

Hi, Patrick

Good morning, Patrick.

Can you provide a little bit more detail on the establishment of the China facility for electronics? It sounds like you guys are expecting production to begin later this year. When do you expect sort of for full ramp production capabilities at that facility? That's one. And then what are the associated costs for the incremental costs related to the project in 2019 and I guess John just generally what is your overall outlook in view of China at the moment.

Sure Patrick. So let me start with the with the last question. First the overall outlook on China remains positive for us. We have we have built a very strong team particularly on the legacy business over the last five to eight years. We are seeing the benefit of that in the marketplace. We have excellent channel partners in China that have tremendously helped us to grow the business despite all the geopolitical and turmoil. We are very optimistic on China because we deal with lots of Chinese companies that export their machinery and equipment and they will continue to do so. And in order to be competitive on the global scale they need sophisticated and best in class components and solutions. And that's why I'm very positive about that. Now let me come to your question with regard to the facility, we have planned to put this facility in place about two years ago. At this point in time, we were looking at 2021 probably 2022. I pointed out earlier on that we are accelerating the plant then it pretty much one of the products coming out of the facility already in Q4 of 2019 this current year. Reason being that we obviously want a what a move out from the exposure that we have right now of just importing into China. We don't want to be get exposed by the outcome of that of the tariff discussions at the end of the day and in the context of our philosophy of building products and building up engineering competence in the region for the region we have to we have decided to accelerate the project. In stage one, this is not a full-scale manufacturing. So in stage one, we will do assembly and test. So there will be still a lot of parts coming from outside of Greater China, then in phase 2 we obviously localized there was parts and in phase 3 we want to go into full scale manufacturing. The first point I wanted to make Patrick that you were referring to this being an electronics manufacturing that's not the case this is first and foremost manufacturing for the hydraulics business and here in particular for the legacy business. Nevertheless, this is at the end of the day Helios compound. And we might pull in other businesses as well and embark on the value-add activities in China does. Does that answer all your questions?

Yeah, thanks for clearing that up. I'm so I guess it sounds like stage two and three. That's obviously going to be a post 2019 event. Does that accurate to declare that I say that.

Yes. That's correct. You still have a question I think on CapEx for this year. So the CapEx exposure this year will be minimal because we are talking about. We are leasing that facility. So we are not basically building the facility on our own as we did in Korea. It's a leased facility and 40 assemble and test the CapEx exposure is relatively minimal this year there will be a higher CapEx being applied than in 2020 but this year it's in material looking at the overall CapEx number that we have for the Helios group.

Got it. And then, can you provide a little bit more color on the oil and gas and I guess the Ag softness that you're beginning to see in particular in ag. Just wanted to see how that sort of implies for the Faster margins which I think carries higher margins to begin with fully appreciating your earlier comments that you guys are diversifying more the construction and market. But it sounds like because of the OEM relationship with that business pricing is a little bit harder to get through as like this Sun business. But I just want to get more color on oil and gas ag and AG softness and how that might imply faster margins both in 19 and 20.

Let me start with the oil and gas first. So oil and gas exposure we have only in two of the business. So that Sun and that is Enovation that's the legacy business of Enovation that came through for the Murphy brand actually. And then on the Sun business we have already reduced over the last three four years our exposure to oil and gas and mining at the time by diversifying into other segments. But just on the outside I want to clarify that that our exposure to oil and gas is significantly less than it was about three or four years ago to begin with but we are seeing softening in oil and gas for both for sun and innovation probably already since mid of last year and in the forecast and the assumptions we are making for the balance of this year we are not expecting a significant change there. So we are you see a moderate business level and that that's what we expected to seek for the balance of the year. In ag, ag has been softening probably since the beginning of the fourth quarter already and that started to soften in Europe at that point in time. In the meantime, I think the softening has expanded also a little bit to some of the some of the other regions as well. It's faster if you were referring to the margin levels. I also pointed out early on we have a lot of initiatives in place from the product from a manufacturing perspective to streamline things that drive more cost out of the system. I am pretty confident that we have enough room there to protect to protect the high margin level the high margin levels that we have seen historically also during the course of the year.

Okay. Thank you. Appreciated.

Welcome.

We have a question for Mr. Josh Parker's Windskey, Morgan Stanley. Please go ahead, sir.

Hi, this is [Indiscernible], gentlemen for Josh. I wanted to ask you about cash EPS. The move is understandable given the deal amortization but if I'm looking back at the past few years the conversion has been on cash has been relatively low. So how should we think about that cash conversion going forward changing from here?

Yeah. So you know I think that -- we've had pretty significant CapEx investments 2017 2018 and expected in 2019 we historically have said that we think CapEx would be 4 to 5% of sales and we're above that for the last two years and we're projecting to be above that for 2019. Obviously, those investments that we need to make before we get back to the lower historical expected and expected level. So you know I think that we are right now happy with the cash EPS that we're able to generate in the free cash flow that we're able to generate at 10% of sales. We think is a good target for us to be able to pay down the cash or pay down the debt as quickly as possible to get below two times net debt to EBITDA.

Okay, thank you. And then just looking at electronics you mentioned that project timing was a big driver there. So can you provide any more color on that was any of that whole forward. And then I guess just more broadly if you saw any inventory movement from customers ahead of tariff.

Let's start with the second question first. We saw a little bit of inventory movement but I think it was it was at the end of the day pretty insignificant. We actually see more inventory movement on the channel partner side because once you have extended lead times that it's probably more influential than the tariff side if such. With regard to your first question to the product launches I mean this is just a pure timing situation. So if I pointed out we have we have the same amount of major launches pretty much every single year. But this year these launches are pushed back a little bit. So that's the only difference compared to last year. I think the second factor that is coming into play here is we have been innovation has been highly successful as you know this business grew organically 50% in two years since we acquired and I think they were also highly successful because in in the last two years they really generated a lot of additional pull through on equipment with their electronics solutions. We're in the beginning not even not even requested. Now we are continuing doing that but we cannot see the scene growth rates every single year that we saw in 2017 and 2018.

Okay, got it. That’s helpful. And then just looking at your 2025 Vision, you have pretty healthy growth rates all through 2025. So we're starting off this year at 2 to 4% growth which would require a lot of catch up afterwards. Are the AG and oil and gas markets slower than you expected where you were to cry or more catch up after that or is this already baked into the 2025 vision that you would see this growth rate the first year.

This is an integral part of the 2025 vision. If you look at the diversification of the end markets as I pointed out earlier on our dependency on oil and gas a couple of years ago was significant. Today it is this kind of material it's still having an impact but it's in material because at the end of the day we have spread our four major clusters here industrial, mobile, agriculture and recreational market. And we think those clusters we have diversified a lot into individual sectors. And I mean the business at the end of the day is cyclical. But this is the diversification is the best way of dampening the impact if one of those sectors or any market is sluggish or even declining over a longer period of time.

Okay. Thank you.

You’re welcome.

We have a final question from Joe Mondillo, Sidoti & Company. Please go ahead, sir.

Hi, good morning, Wolfgang and Tricia.

Good morning, Joe.

Good morning, Joe.

So I want to -- I'm still having a little difficulty. I’m little unclear on the gross margins especially at the Hydraulics Segment. Just because there's been so many moving pieces price cost and productivity was a big issue early in the year and I think that's improved throughout 2018. But then you acquired a CFP and you still got what you're doing in Sarasota. So looking at sort of the fourth quarter sort of gross margin that hydraulics. How can we sort of think about things going forward? I'm assuming that you're expecting some productivity improvements given once you complete the Sarasota consolidation. And then remind us how the seasonality sort of plays the role in the thing amongst the quarters.

Yes. So looking at the fourth quarter hydraulics gross margin there's a little bit of step-up included in that that's bringing it down a little bit. So we should see higher gross margins than that for the hydraulic segment in 2019 then what we just saw in Q4. You're right that there were some challenges to the gross margins some of which the CVT price increase helped in the back half of the year in that we will actualize that throughout 2019. The addition of the CFP with their different business models is playing in a little bit to some margin changes in that segment but we do expect to have modest improvement in 2019 in actually in both segments at the gross profit level.

And in terms of seasonality, could you remind us if there's any I think at hydraulics the fourth quarter tends to fall off. Correct me if I'm wrong about the seasonality there and then in terms of seasonality electronic just wondering how to look at sort of that fourth quarter gross margin that you posted electronic you know taking into account seasonality.

Yeah, I mean we're trying to take out the segment seasonality discussion by guiding to even consolidated quarters throughout the year. There are some different things at play here we talked in our prepared remarks specifically about electronics having to ramp up of model year rollout in Q2 and Q3 this year that sort of changes the dynamic little from last year. So I think we'd like to stay with the way we've talked about it from a quarterly perspective of expecting consolidated results that are pretty evenly spread across the four quarters of 2019.

Okay. And then just last question in terms of the geographical region looking at sort of the construction market particularly if you look at Caterpillar's most recent January retail sale they're continuing to see the pressure. I think their declines are accelerating in Asia market. Europe sort of following in North America seems to be holding off. Could you just sort of give us your take on sort of the geographic markets and how they're trending through February or up until whatever data you have.

Yeah sure. So I think in general I think we can see that moderate growth is expected here to continue on a global basis. If you break it down into the trade I would say probably the most concerning pieces is Europe right now. And as you quite correctly said Joe is probably the strongest situation we are seeing here still in North America. I think Asia in particular East Asia we have to see how this will shake out. We are still seeing quite solid tailwind at this stage particularly in recent weeks and months. So no reason for a concern at this stage in Asia.

Okay. So just to follow up on Europe

Europe is the weakest piece and I think that what I mean that is applicable not just for construction machinery. I think that's for industrial production. I was just looking in preparation for today's call. Looking at some of the numbers again I mean if you look at total machinery production in Europe it's pretty much expected to be flat. And it could even be moved into negative territory towards the second half of the year.

Okay. Alright. Thanks for taking my questions.

Sure.

There are no further questions at this time. I'd like to turn the conference back over to management for closing remarks.

Thanks for your interest in Helios and for your participation this morning. Also I want to thank to all of the hardworking Helios employees who are driving these results. So we look forward to updating all of you on the first quarter 2019 results in May. Thank you very much and have a great day.

This concludes today's teleconference, you may disconnect your lines at this time. Thank you for your participation.