Welcome to Helios Technologies Fourth Quarter 2019 Financial Results Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note that this conference is being recorded. I will now turn the conference over to your host, Karen Howard, Investor Relations for Helios. You may begin.

Thank you, Ariel, and good morning, everyone. Welcome to the Helios Technologies fourth quarter and full year 2019 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 review 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.hlio.com. You'll also find slides there that will accompany our discussions today. If you look through the slide deck on slide two, 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 measures in the tables that accompany today's earnings release as well as in the slides. Wolfgang will get started by summarizing our financial performance and strategic progress during 2019. Tricia will go through the details of our financial results for the fourth quarter and full year and then we'll turn it back to Wolfgang for his perspective on our outlook and 2020 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 three. For 2019, we reported a record-setting year at both the top and bottom lines. We realized sales of $555 million, a 9% increase over last year. Our 2018 acquisitions of Faster and Custom Fluidpower drove our 2019 growth, contributing $65.5 million of acquisition revenue in 2019. Organic sales on a consolidated basis, excluding currency, decreased 2% in 2019. Organic sales of our hydraulics segment grew 1%, while sales in our electronics segment declined by 11%, both excluding the effects of changes in foreign exchange rates. As expected, currency had an unfavorable impact during the year. Despite the challenging macroeconomic backdrop, our fourth quarter consolidated revenue and quality of earnings were better than we expected. We have been successfully improving operational efficiency and throughput at all of our operations. Tricia will provide more details on each segment's performance. Turning to the bottom line. For 2019, we reported $60.3 million of net income, a 29% increase over the prior year. On a non-GAAP cash basis, net income was $77.7 million or $2.43 per share, a 6% improvement over 2018. Adjusted EBITDA for the year was $131.1 million, or 23.6% of sales. As you may know, increasing cash flow and reducing debt have been important goals for us this year. We finished 2019 with very strong cash generation in the fourth quarter. This contributed to adjusted free cash flow for the year of nearly 14% of sales, significantly exceeding our 10% target level. During 2019, we reduced debt by over $52 million, closing the year with a 2.1 times net debt to adjusted EBITDA ratio. We are nearing our goal of less than 2 times which we anticipate achieving by the middle of this year. Please turn to slide four and…

Thank you Wolfgang and good morning everyone. Let's begin on slide 6 with a review of our fourth quarter consolidated results. Organic sales were down $11.1 million or 8% compared with last year's quarter, excluding a $1.7 million unfavorable currency impact. I will now touch on sales by region which are designated here in the sales bar charts on the left. During the 2019 fourth quarter, APAC realized year-over-year growth of 9%, while the Americas and EMEA markets declined by 18% and 10% respectively. Sales to the Americas, EMEA and APAC regions were 44%, 26% and 30% of the consolidated total respectively in the fourth quarter. Despite lower revenue in the quarter profitability remains relatively comparable with consolidated adjusted EBITDA margin at 23.2% compared with 23.4% in the prior year period. Turning to the bottom line, non-GAAP cash earnings per share were $0.54 down $0.02 compared with last year's fourth quarter. The adjustment to arrive at non-GAAP cash earnings consist of acquisition-related amortization of intangible assets in this year's quarter and also the impact of tax reform and some other nonrecurring items in last year's quarter. These are shown in the reconciliation tables in the back of the slide deck and release. Please turn to slide seven 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 our operating segment numbers. They are accumulated in our corporate and other segment reported in the tables in the back of our earnings release and slides. Sales for the Hydraulics segment declined 8% excluding currency which had a $1.7 million unfavorable impact. From a geographic perspective excluding the effects of currency, we saw 11% year-over-year growth for the quarter in the APAC region which…

Thanks, Tricia. Please turn to slide 14. The macroeconomic climate continues to be filled with uncertainty. In addition to the human toll that the coronavirus is having, it has caused significant economic disruption leading to future uncertainty. Helios Technologies generates approximately 9% of global revenue with Chinese customers. Like most Chinese companies, Helios Technologies is gradually resuming work within our facilities. We have no subsidiary in Hubei province, which remains in a lockdown state. Our factory and offices are in the expanded Shanghai metro area. After having received approval from the local authorities to reopen our businesses in mid-February, right now, we are operating at about 50% working capacity. The reduced staff level is driven mainly by the 14-day current period imposed on all travelers returning to the Shanghai area from other provinces. Tracking services across all cities remain limited, because of the closure of selected highways in shortages of drivers causing cargo deliveries to be under tight delivery constraints. We are monitoring the China situation closely and we are adjusting well to support our customers and channel partners on an ongoing basis. China remains a key market for Helios and the coronavirus will not change our localization plans, which involves sourcing activities and revenue growth on a mid and long-term basis. We expect a gradual improvement in China over the next few weeks. Most recently, several jurisdictions in Northern Italy near our Faster facility are under quarantine. Today, our operations are marginally impacted by the imposed Italian travel restrictions. We are observing ongoing developments. Given these disruptions we have seen delays in demand for Q1 and expect this to continue into Q2. Other factors such as the U.S. presidential election provide a lot of media hype, but are not expected to have a significant macroeconomic impact. It appears that…

Certainly. At this time we will be conducting a question-and-answer session [Operator Instructions] Our first question comes from Nathan Jones of Stifel. Please go ahead.

Good morning, everyone.

Hi, Nathan.

Let's start with the incremental R&D and engineering expenses in 2020 to support these projects in 2021 through 2023. Can you give us a little more information on what the incremental spend is in 2020 just so we can see how that's impacting 2020 results? And then can you talk a little bit more about the kind of revenue levels content products, et cetera that these projects are going into in 2021 through 2023?

Sure, Nathan. So with regard to the first question, if you look at the incremental spend, so as I explained earlier on, we obviously have quite a number of attractive projects in the pipeline that are slated for revenue generation than in the latter part of next year maybe 2021, 2022 and 2023. And we decided obviously, in order to support these projects professionally to invest into R&D and engineering expenses at this point in time already. So we are talking roughly about an increase of about 20 people, which is quite sizable. I mean, if you put that in relation to the entire workforce of innovation controls, that's an increase of 5%, basically right there. As you know about 40% of the entire workforce is working in R&D and engineering-related positions. We are talking roughly about 20 people. We are adding these people during the course of the year. Have pretty much started already at the beginning year – at the beginning of the year and are progressing according to plan. With regard to your second question from a revenue recognition perspective, I mean also as we indicated obviously, we are pretty confident based on the numbers of projects we have in the pipeline and based on the degrees of discussions and collaborations with our OEM partners that they will generate the double-digit growth in 2021 and 2022 and 2023. If you see from guidance for 2019, we are pretty much flat compared to 2018. But as of next year, we would expect double-digit growth in terms of sales revenue continuing in 2020 and 2023. Maybe the last statement I would like to add here to your first question because you were asking about the incremental spend is we are doing this in terms of step up function. So obviously they will – these 20 people will support projects for the next years and beyond, meaning that the investments in R&D expenses in 2021 and 2022 are expected to be significantly lower. These are kind of step up investments that you have to make upfront. You make it in one go over a certain period of time and then the following one or two years normally investments. That particular area will be at a lower pace.

Okay. So these 20 people become part of the base going forward and then we stay a little flatter after that going forward down flat?

Exactly. We'll stay flatter in 2021 and 2022. Obviously except – I mean, there is still some incremental costs that come in merit increases and so forth but it's a step-up function that we have basically built in guidance for 2020 and you won't see that then in 2021 and 2022.

Okay. My follow-up question then. I mean you guys had a lot of projects going there over the last few years. You've done two major acquisitions. So the company has seen a lot of disruption over the last few years. Can you describe the differences in the culture, the level of talent in the organization relative to three or four years ago? Where do you still need to add talent to support this ramp-up in revenue you see over the two years? What functions are you still upgrading? And what's your view of the culture within the company today? Thanks.

Yes. I mean, I wouldn't call it disruption I call it evolution. It's up an evolution as a classical hydraulic cartridge valve company. We entered into – into the electrical side of cost of business, obviously to enhance our capabilities. From a culture perspective, I would say there is not one culture in the Helios companies, because if you look at the acquisition strategy, obviously we are looking for very strong stand-alone companies that have already a very strong existing culture. So we don't want to destroy that DNA. And I think we have done a very good job if I look at innovation. If I look at Faster and even if I look at the most recent acquisition in Australia with Custom Fluidpower to protect the successful DNA that made these companies what we are made of and what we bring to the table for us. With regard to your -- to the talent pool, as you know and we highlight that on an ongoing basis. So covering the marketplace is, I think is key for us down the road. So occupying white spots and obviously expanding the business on a global basis, I think is one of the key challenges that we still have. And if we look at the talent pool or the pipeline from a talent pool perspective that is probably where we still have to focus on the development of people that we have onboard already today to develop the skill in them that they can help us to globalize the business even more in years ahead. I would say that's the area where I would say from a talent need perspective we have probably the most significant need.

Our next question comes from Jeff Hammond of KeyBanc Capital Markets.

Hey good morning.

Good morning, Jeff.

Hey, Wolfgang just to come back on the electronics investments, is there a way to quantify like the incremental spend in dollars? Just -- I'm just trying to get at the margin impact into 2020?

Well, it's 20 people as I said and we are hiring on these people during the course of 2020. It's more front-end loaded though, because we want to have these people on board and we have a number of them already hired over the last six or seven weeks. I think if you quantify it in dollars, it's somewhere in the range of about $2.5 million to $3 million fully loaded.

And clearly that's built into the guidance that we've given on the profitability side.

Right, okay. And then the margin resilience in hydraulics was pretty impressive as you just saw you're kind of for sales decline. What was really working there? And then how should we think about decrementals and hydraulics into 2020 on that? I guess is flat to down 6%.

Into the first part of the question, I’ll let Tricia answer the decremental margins. But for the first part of the question, what has been working? Well, I mean you have seen an improvement over the past couple of quarters already. And it's mainly driven obviously by productivity and efficiency improvements. So it's a much better oil to machine I would say than it was probably a year ago. And I'm actually pretty pleased with what the fund team is doing in that regard. And I'm pretty encouraged looking at some of the initiatives that are outlined for the balance of this year. Then besides productivity and efficiency improvement, I mean the other factor that comes into play is also pricing. We have done reasonably well from a pricing perspective. We were not always very lucky from a mix perspective as we explained on the last call. You might recall that we still have idle capacity in a certain area of manufacturing that is pretty attractive from a profitability perspective. That challenge has not been overcome yet, but there is additional potential I think there for margin improvement down the road. Mid and long-term, I would just like to repeat I mean the goal is that all of our businesses generate gross profit margins of 40% on sales revenue. And I am hopeful with everything I'm seeing there that we will get there over time.

On the decremental margin side, I think we're going to see more traditional decremental margins of 30% to 40% that we historically saw in these businesses. But I will say that I think over the last couple of quarters, we've done a good job of rightsizing the businesses from a perspective of being able to flex a little bit on the fixed cost side and the labor side. So I don't think we're going to see huge decrementals on the hydraulics side as we roll in through 2020 with a little bit lower revenue.

Okay. And then just on the 2025 targets, I think you fine-tune the absolute revenue number for hydraulics down, but I think the growth rate is actually higher just where we stand today. Is that a function of we get a snap back in the market or something around confidence for share gains and outgrowth?

Well, it's a mixture of both there. As you know we were always hovering around that 7% to 8% CAGR range for the hydraulics business going back all the way I think back to 2017. And it's obviously tied to all the investments that we are making from -- again from a global coverage perspective, I think we are covering the marketplace significantly better than we did three years ago, and obviously also from a product development perspective. I mean, there is still a lot lined up to broad and expand the product portfolio as I stated earlier on with electro-hydraulic products. So that in combination I think makes us pretty comfortable to look at an 8% CAGR rate in between now and 2025.

Okay. Thank you.

Our next question comes from Jim Sheehan of SunTrust Robinson Humphrey. Please go ahead.

Good morning. This is Pete Osterland on for Jim. On your fourth quarter gross margin commentary, you discussed a change in the margin profile of your products. Was this more of a negative mix shift? Or was it based on pricing versus raw materials? And what are your expectations for gross margins in 2020?

Yeah, it was a mix shift. It was the shift that we've been talking about the last couple of quarters specifically in the CVT business between auto sell products and used sell products. They have a little bit different margin profile. And we've seen a decline in the auto sell products over the last couple of quarters. So it's skewed more toward the used sell. And that's a function of the consolidation project as well that we've moved to this used sell manufacturing. With regard to gross margins, we aren't -- we don't guide to gross margin but I think that we can infer from one of the previous questions on what the decremental margins might be that we can roll forward the Q4 margins with some potential downside given the guidance that we provided in the hydraulics segment.

Thanks. And then with your net leverage closing in on your target of two times, how are you thinking about free cash flow deployment this year beyond debt reduction? Do you have an active M&A pipeline? Or would you consider share repurchases?

Yeah. I mean, we want to be consistent with the messaging of last year. So getting below a ratio of two as far as net debt to adjusted EBITDA is concerned is pivotal. So, we are -- we will continue and use the free cash flow generation to delever the company. Irrespective of that, I mean we have an ongoing M&A process in place where we continuously look at companies and evaluate businesses, but delevering at this point in time is still high up on the agenda here.

Thank you.

You're welcome.

Our next question comes from Mig Dobre of Robert W. Baird & Co. Please go ahead.

Thank you. Good morning everyone. Few questions on hydraulics first. Can you comment at all on when you -- on where you stand from a backlog standpoint? And I guess what I'm curious when we're looking at 2019 to call it $443 million of revenue, how much of that revenue would you say was associated with you being able to convert on the backlog build? Or put differently, how much of that revenue do you think is associated with the backlog decline through 2019? Just to kind of level set us into 2020.

Yes, I think from a backlog perspective, Mig, I think we're exactly in line with what we told you already two quarters ago. We had backlog based on what we could see and based on softening in the economy and expected order intake, we can foresee that backlog is still supporting revenue generation in Q1, maybe marginally into Q2 as well. And I think what we have seen over the last couple of weeks or last couple of months was exactly in line with that statement. So, backlog overall, obviously, is depleting because the ordering environment is soft. And coronavirus situation is not helping as I said. I mean we have 9% of revenue tied to Chinese customers. That was a specific geography where we have won quite some market share and they've done exceptionally well over the last three, four years. So, backlog is depleting, but I still expect it to support hydraulics revenue in Q1 and maybe even leading into Q2.

So, just to make sure I understand what you're saying here, you expect further backlog depletion into Q1 and Q2? Whatever -- the way I kind of read that is that the order intake that you're taking is not necessarily what's reflected in revenue. It's -- there's that plus the backlog burn, that's how I should be thinking about it right?

Yes exactly. I mean we are tapping into backlog and we are depleting the backlog. As I said, exactly as we said already during I think it was the Q2 earnings call last year. So, I think we're exactly in line with those projections at the time.

Understood. This is -- and the reason why I'm asking all of this is kind of a big picture question here. This is your first quarter -- or this was your first quarter of revenue decline in hydraulics. Can you maybe give us a framework for how you're thinking about the current environment versus prior downturns? I mean when I'm looking at my model here, I typically see four-plus quarters of revenue declines whenever market turn softer. But this time we had this backlog dynamic that I don't think we've seen in prior cycles. So, how do you think about the current environment? And how long revenue contraction might be lasting here?

Yes. Yes, maybe this will be helpful if we look at seasonality this year and comparing to previous years. So, last year in Hydraulics we generated 52% of revenue in the first half, 48% in the second half. We expect this to be evenly split in 2020. So, 50-50 and the 50% in the first half still supported by backlog as I mentioned just now. And then if we look at the 50% in the back half of 2020, that is in line with the second half of 2019. So, it's actually a little bit -- it's a little bit higher. So, obviously, we are expecting orders to increase as we enter into the third quarter this year. If you put the two statements together, backlog will be depleted no later than mid of this year and then actually early second quarter. We are then counting on order gains in the second half of this year in hydraulics compared to the second half of 2019.

Which in theory should be quite strong in order to offset your comparison on the backlog burn right because you're starting from a lower percent?

Yes. But nevertheless I mean it will be single-digit -- this will be a single-digit increase compared to the second half of 2019. But that's pretty much what our own forecast is based on.

Understood. And then this question on incrementals and decrementals was asked earlier but I want to make sure that first we're kind of talking about gross margin Tricia in terms of your comments on the 30 to 40 for incrementals decrementals, correct?

Yes.

Do you contemplate any adjustments to your SG&A in hydraulics given obviously the market volatility that we've got here?

No, we don't expect a lot of change on the hydraulics side. I mean we did have the restructuring that we did in Q3 of last year hit the SEA line for hydraulics. So, that will carry forward into the year but we clearly have some other expenses at the corporate level that may offset some of that. So, we don't expect to see the large increase in SEA that we're seeing in electronics, but we won't see a huge decline over the SEA that we had last year.

Okay. And then moving to electronics. These incremental costs, these incremental investments, you're saying that those are going to flow through the SG&A line, they're not going to flow through gross margin?

Correct.

Okay good. And then lastly here, I'm kind of scratching my head a little bit on how you structured the topline guidance, simply because unless I'm mistaken here your -- the first half of the year is going to be down maybe north of 13%. But then you've got pretty robust growth double-digit growth in the back half. So, I'd like a little more color on what gives you guys the confidence that we can have this level of swing and if that's sort of driven by your broader end market assumptions like it is in the case of hydraulics? Or if this is something that's specific to customers and products that you really have good visibility on? Thank you.

I think it's both Mig. It's obviously -- as you know in the meantime more than 50% is tied to OEM business. So, we have much better visibility I think what is expected for the balance of the year. And if we look at their forecasts and their schedules, I think it's pretty obvious that everybody is counting on a rebound in the second half of the year. I think if you look at the macroeconomic picture, obviously, and there we pretty much go by industrial production. If I look at the forecast for industrial production in the seven largest economies around the globe, you also see that there is an upswing expected in the second half of the year. So I think it's a combination of both what we've seen from a macroeconomic perspective and feedback that we are getting from our customer base in both segments.

Okay. Thank you.

Welcome.

Our next question comes from Brian Drab of William Blair. Please go ahead.

Hi. Good morning. [indiscernible] you mentioned in the prepared comments the back half of the year looks stronger from a macro perspective kind of across the board, across the regions. But then I think you just said that you're expecting your business to be flat in the second half of 2020 versus second half of 2019. I'm just wondering why that is? And is there some conservatism just given the uncertainty that is obviously out there?

Hey, I think Brian -- good morning first, I think Brian that you misunderstood. So the business will be slightly up in the second half, I said in the second half of 2020 compared to the second half of 2019. And that's applicable for both segments. When I discussed with Mig, we said in the Hydraulics segment it will be up in single-digit percentage ranges and it will also be up on the Electronics side in the second half of 2020 compared to 2019.

Okay. Okay. Yeah, I think I heard you at one point say, I don't know, I just it didn't sound like you had a ton of conviction in the back half growth. I thought at one point you did say flat to and actually then slightly up, but just given the rebound and given the challenges that we've had in the back half of 2019. That's so I was just wondering if there's some conservatism there. So…

I can help you a little bit more on the Electronics side. I mean in 2019, the ratio between the first and second half was 54 versus 46, and we expect that ratio to go to 49 versus 51. So it is back-end loaded in Electronics as well.

Okay. And in the back half of in 2020, if you do experience growth, let's say, a low single-digit rate, what would you -- actually, let's say this scenario, if let's say in a tougher scenario and growth doesn't come in the second half and you're flat in the second half, would you expect your gross margin to improve given the productivity improvements that have been in place even on flat revenue?

Yes. I think based on the initiatives that we launched last year in Q3 and Q4 if I look at the restructuring and everything associated with that, obviously, that benefit will carry forward. So we would expect margins to at least be stable or slightly improve.

Okay. Thanks. And then Wolfgang just finally. Can you put a final point on some of the activity that you're seeing in some of the end markets and maybe even a little color regionally just a little more on like ag, construction, mining, material handling since you've got such a good finger on the pulse of all of those end markets?

Yeah. So if I look at the four main clusters that we are supporting, so industrial, mobile, ag and recreational end markets, it's definitely a fair assessment to say, there is softness across all the four clusters. Now if you break it down into individual geographies and into individual sectors and the needs there, then we are seeing actually a few positive spots as well. I repeat again what I said last year I think renewable energy is still an attractive market. We grew a lot there in China over the last couple of years. I think that will continue despite the coronavirus situation that we consider being temporary. I think the other more positive note that we saw after the easing of the trade negotiations between U.S. and China this past December is in ag in North America is a little bit stronger than we anticipated. So that's a positive sign. But then I would say all the rest if you look at all the other sectors within construction, within material handling, energy, oil and gas, it is rather fast. And we expect that to continue during the first two quarters of 2020.

Okay. Thanks a lot. I'll save the rest of my questions for offline. Thank you.

Thank you.

Our next question comes from Joe Mondillo of Sidoti & Company. Please go ahead.

Hi everyone. Good morning.

Good morning, Joe.

I just wanted to follow-up on a couple of the questions regarding, I guess, at the end of the day we're talking about the revenue guidance. And it just seems like the high end of that revenue guidance in terms of sort of flattish sales, it seems a bit aggressive when you're talking about hydraulics backlog declining into the second quarter. You have Asia region, which was a really good growth factor for you in 2019. What's going on with coronavirus in China was already slowing before then. You know, back going on. And then on top of that we're hearing from -- you said over 50% of your OE customers are -- over 50% of your hydraulic sales are OE. We're hearing gear down 5% to 15% and Caterpillar similar. A lot of these OEs are talking about how their production is going to be down quite a bit. So I'm just wondering how you get to the high end of the guidance considering all that?

Well, I think, Joe as I mentioned early on I can just repeat what I already said. I mean based on the initiatives we have in place so -- so it's a split of 50-50 roughly OEM and channel. And I think the initiatives we have in place on a global basis on the channel side are there in order to cover geographies in a much better way than in the past. There we are dealing more with end users and small and medium-sized OEMs. So I would still expect business to trigger in there and grow particularly in geographies where we had nothing in the past. I'm still referring to places like Southeast Asia. We still have opportunities to do more even in countries like China and Japan and so forth. And on the OEM side we work with both partly with the large OEMs you are referring to that are obviously reasonably negative at this point in time but we are also working with a lot of small and medium-sized sinuses. And I think there probably the picture is a little bit more rosy or a little bit more optimistic. So all of that embedded into this forecast is pretty much what we reflected in the numbers here.

Okay. Could you talk about the decremental margin that the Electronics segment since you -- since we've already talked about hydraulics? Just wondering how that looks?

Yes. I mean, we will see some but there's a much smaller fixed cost-based on the Electronics business. So the decremental margins are not as significant as what we generally see on the Hydraulics side which has a very large capital investment. So I would expect that probably to be somewhere around 20%.

Okay. And regarding the -- the margin expectations that you're looking at Hydraulics is there anything baked in there in terms of more improvements or more costs restructuring or anything related to your cost structure going forward?

No. The only thing that we -- that's different from a cost structure perspective is what we've already touched on with regard to the addition of engineering resources for R&D in the Electronics segment. Nothing else is different from before.

Okay. All right. That’s all I had. Most of my questions were answered. Thank you.

Thank you.

We have reached the end of the question-and-answer session. I will now turn the call over to management for closing remarks.

Thank you for your interest in Helios Technologies and for your participation this morning. Also thank you to all of the hard-working Helios' employees who are driving these results. We look forward to updating all of you on our first quarter results in May. Thank you very much and have a great day.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.