Helios Technologies, Inc. (Sun Hydraulics Corporation) — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 29, 2018. The filing is by Sun Hydraulics Corporation, doing business as Helios Technologies; shares traded as SNHY. Amounts below are in U.S. dollars unless noted.
Business context and reporting period
Helios develops and manufactures products for hydraulics and electronics markets. Hydraulics includes Sun Hydraulics, Faster and Custom Fluidpower; Electronics consists of Enovation Controls. Helios adopted its new business name in August 2018. Faster was acquired in April and Custom Fluidpower in August, so their results are included only from their respective acquisition dates. The company’s stated Vision 2025 targets $1 billion in sales by 2025.
Financial results and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $135.8m | $88.0m | $369.3m | $258.7m |
| Gross profit / margin | $51.7m / 38.1% | $36.3m / 41.3% | $139.8m / 37.9% | $107.7m / 41.6% |
| Operating income / margin | $19.2m / 14.1% | $17.4m / 19.8% | $53.5m / 14.5% | $53.9m / 20.8% |
| Net income | $11.6m | $11.3m | $30.3m | $28.8m |
| Diluted EPS | $0.36 | $0.42 | $0.97 | $1.07 |
| Net interest expense | $4.6m | $1.1m | $9.3m | $2.7m |
For the first nine months, operating cash flow was $44.2m, versus $38.4m. Investing cash outflow was $555.9m, principally reflecting $534.7m of net cash paid for acquisitions and $18.7m of capital expenditures. Financing provided $463.2m, including debt borrowings and $241.0m of stock-offering proceeds. Cash fell $48.0m to $15.9m.
At September 29, cash was $15.9m and total current assets were $196.3m against current liabilities of $91.9m. Debt comprised $267.0m drawn on the revolving facility and $98.9m of non-revolving debt before issuance costs and current classification. The PNC revolver had $133.0m available; the filing also reports $2.2m available under the NAB facility. The company said operating cash generation and borrowing availability should cover foreseeable operating and capital needs.
Receivables were $77.9m and inventory $88.4m. Days sales outstanding rose to 52 from 42 a year earlier; days inventory on hand increased to 92 from 72. The company attributed the increases to acquisitions and, for Sun, supply and capacity constraints.
Material changes versus the prior comparable period
- Q3 revenue increased 54.3%; management attributed $31.8m of the increase to Faster, $8.4m to Custom Fluidpower and $7.6m to organic growth. Nine-month revenue increased 42.8%.
- Q3 net income grew 2.7%, but EPS declined 14.3% to $0.36, reflecting higher weighted-average shares after the public offering and acquisition-related financing. Nine-month net income rose 5.2%, while EPS fell 9.3%.
- Gross and operating margins contracted. Management cited acquired-business mix, inventory step-up amortization, increased acquisition-related intangible amortization, inflationary material costs, supply-chain constraints and disruption from a Sarasota manufacturing consolidation.
- Debt and interest costs rose substantially following the Faster and Custom Fluidpower acquisitions. Nine-month interest expense increased to $9.3m from $2.7m.
- Foreign-currency translation contributed to a $29.3m nine-month other comprehensive loss; accumulated other comprehensive loss was $35.8m at quarter-end.
By segment, Q3 Hydraulics sales were $104.1m, up 83.9%, with a 37.6% gross margin; Electronics sales were $31.8m, up 1.3%, with a 46.5% gross margin. Hydraulics benefited from acquired sales and organic demand, while Electronics growth was modest in the quarter.
Guidance, management commentary, risks and unusual items
- 2018 outlook: Revenue of $500m–$507m, including Hydraulics of $375m–$380m and Electronics of $125m–$127m. Adjusted operating margin, before acquisition-related amortization and one-time costs, is projected at 20.5%–21.5%. Net interest expense is forecast at $13.7m–$14.2m; effective tax rate at 19%–21%; capital expenditures at $25m–$30m.
- Management described demand as strong across regions but said supply-chain and capacity limitations constrained Sun shipments and increased backlog. The Sarasota consolidation is intended to expand production capacity. Management also noted signs that North American electronics growth may have plateaued or retreated from cycle peaks.
- Acquisition accounting remains preliminary. Faster’s purchase price allocation may change during the measurement period, and Custom Fluidpower’s allocation is also pending final valuation and tax adjustments. Faster generated $70.5m of sales and a $1.9m pretax loss from acquisition through quarter-end; its reported loss included purchase-accounting and intangible-amortization charges.
- Acquisition-related costs were significant: nine-month transaction costs of $5.4m, inventory step-up charges of $5.2m and acquisition-related intangible amortization of $17.0m were included in corporate and other costs. Faster’s acquisition was funded with cash, equity proceeds and borrowings; the company also issued shares as partial consideration for Custom Fluidpower.
- Other items to monitor include $18.4m of contingent consideration, $37.9m of supplier purchase commitments expected to be fulfilled in 2018–2020, and $5.2m of unrecognized tax benefits. Federal tax returns for 2007–2012 and some state returns were under examination; management reported no significant proposed adjustments not already accounted for. The company was still evaluating certain effects of the Tax Cuts and Jobs Act.
- The company reported no material legal proceedings, no material change in market-risk disclosures, and effective disclosure controls. It identified economic cyclicality, foreign exchange, integration, capacity and supply constraints, and tax and purchase-accounting estimates as relevant uncertainties.
Important facts for investors to verify
- Whether the $500m–$507m full-year revenue and 20.5%–21.5% adjusted operating-margin outlook was achieved, and how reported margins compare after acquisition-related costs.
- Organic growth, backlog conversion and capacity improvements, especially at Sun, alongside the effect of supplier constraints, inflation and the Sarasota consolidation.
- Integration and profitability of Faster and Custom Fluidpower, including final purchase-price allocations, amortization, inventory step-up effects and realized synergies.
- Debt repayment, interest burden, covenant headroom and available revolver capacity; cash was $15.9m against approximately $365.9m of gross debt at quarter-end.
- Working-capital quality, including rising receivable and inventory days, and the outcome of tax examinations and remaining tax-law accounting estimates.