Greetings and welcome to the Helios Technologies First Quarter 2019 Financial Results. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Karen Howard, Investor Relations, Helios Technologies. Thank you. Ms. Howard, you may begin..

Thank you, Gary and good morning everyone. Welcome to the Helios Technologies formerly known as Sun Hydraulics first quarter 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 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 will also find slides there that will accompany our discussions today.

If you look through the slide deck, on Slide 2, you will find our Safe Harbor statement. As you maybe 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 on 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 with summarizing key highlights for the first quarter of 2019.

Tricia will go through the details of our financial results for the quarter 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. Business wise, we are off to a solid start for 2019 and let me first summarize our financial results. We reported sales of $147 million, a 51% increase over last year’s first quarter.

Our Faster and Custom Fluidpower or CFP acquisitions contributed most of that growth, if changes inorganic sales of our two segments were virtually offsetting. Organic sales of our Hydraulic segment grew a very strong 8%, while our Electronic segment contracted by 12%.

Our first quarter in 2019 forecast for Electronics was unfavorably impacted by some changes we made to our customer base, including the release of certain contractual obligations to customers, that allows us to leverage all products to a broader customer base.

While, this is temporarily dampening sales for 2019, it gives us the ability to secure new important customer commitments for 2020 and 2021 and allows us to further penetrate our sweet spot, which is mid-markets OEMs.

Turning to the bottom line, we reported $16.4 million of net income on a non-GAAP cash net income basis that represents $20.3 million or $0.63 per share, up 34% and 24% respectively over last year on a comparable basis. Adjusted EBITDA was $34.7 million or 23.7% of sales.

We do anticipate margin expansion as we progress in 2019 and I will touch on that in a moment. Referring to the balance sheet and our leverage, we reduced our net debt this quarter closing at 2.3x net debt to adjusted EBITDA as we progress toward our goal of less than 2x. Please turn to Slide 4.

And I will summarize the business highlights we achieved in the first quarter of 2019. As anticipated, we completed our CVT manufacturing consolidation project in Sarasota. As most of you know, we began this 12 months project in April of 2018.

This project involved consolidated manufacturing into our two adjacent Sarasota facilities by applying our lean enterprise principles and reorganizing our production lines.

As we progress in 2019 and fine-tune our processes, we expect our productivity to improve and free up about 15% of additional capacity, leading to margin expansion, which we have built into our guidance for the year.

Now that the CVT manufacturing consolidation project is complete, we are proceeding with establishing a center of excellence in our third Sarasota facility, which is about 2 miles from the other two.

It will house our global CVT research and development activities as well as certain administrative and operating functions and is expected to be complete by the end of this year. One of the synergies we identified as part of the faster acquisition was to begin machining CVT components at our faster facility near Milan, Italy.

I am pleased to report that we are ahead of schedule and began making components this month. Faster will produce six critical parts for high volume cartridge valves initially representing a near-term vertical integration cost synergy, we expect the cost savings will ramp up to full realization in mid 2020.

This represents the first phase of CVT manufacturing in Europe in accordance with our in the region, for the region initiatives. The next phase of this project will involve full cartridge valve production capability for the European market.

Turning to the Asia-Pacific region, development of our new facility in China is also progressing ahead of schedule, which is strategically important, given the strong growth and market share gains we continue to see in that region. We purchased equipment and customized the newly built facility during the first quarter as we prepare for production.

By the beginning of the third quarter of 2019, we expect to be performing test and assembly to support CVT demand in the region. The mid-term plan for this facility is very similar to what I described for Italy and Europe. We will bring full cartridge valves production capability to APAC to support our in the region, for the region initiative.

Finally, I want to mention that our new product development investments remain very active in both of our segments. One very significant CVT product launch, which took place last week was the addition of 16 new FLeX series valves. We first launched this line of electro-hydraulic valves near the end of 2017.

We have now added to the product offering in that series, expanding our opportunities for many new applications. The FLeX product line provides robust electro-hydraulic control for mobile and industrial applications and creates a critical path to expanding systems business.

To reiterate our product development initiatives and an important component of our Vision 2025 strategic plan, 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 in a bit more detail..

Thank you, Wolfgang and good morning everyone. Let’s begin on Slide 6 with a review of our first quarter consolidated results. Sales were up 51% compared with last year’s quarter. Faster and CFP contributed $49 million and our organic business sales grew 2% excluding the impact of changes in currency rate.

Foreign currency had a $1.3 million unfavorable impact on consolidated sales of our organic businesses. Faster and CFP sales were also unfavorably impacted by the decline in the euro and australian dollar, resulting in $2.4 million of lower sales compared with their pre-acquisition exchange rate.

I will now touch on sales by region, which are designated here in the sales bar charts 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 pace. Sales to the Americas, EMEA and APAC regions were 46%, 30% and 24% of the consolidated total respectively. In the prior year quarter, this was 58%, 23% and 19% to the Americas, EMEA and APAC, respectively.

Regarding profitability, our consolidated adjusted EBITDA of $34.7 million grew 49% over last year’s first quarter. Turning to the bottom line, non-GAAP cash earnings per share were $0.63, about 24% higher than last year’s first quarter.

You may recall that last quarter we indicated that we would be reporting non-GAAP cash EPS this year, which adds back our acquisition related amortization and other no-recurring type item. In the first quarter of 2019 we had $4.5 million of acquisition-related amortization of intangible assets.

We also recorded a charge of about $719,000 for contingent consideration associated with the Faster acquisition. Both of these items have been added back in arriving at adjusted EBITDA and non-GAAP cash net income. Please refer to the tables in the back of the press release or slides for reconciliation of GAAP and to non-GAAP numbers.

Please turn to Slide 7 for a review of our Hydraulic segment first 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 reported in the tables in the back of our earnings release and slides. Sales for the Hydraulic segment grew 86%. We saw a 58%, 113% and 98% year-over-year growth for the quarter in the Americas region, EMEA and APAC respectively. Those 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 all geographies as well as price increases. Orders continue to outpace revenue.

The CVT manufacturing consolidation project was completed at the end of the first quarter and is expected to expand capacity as we progressed through 2019 in an effort to see the strong demand. Foreign currency translation for the Sun Hydraulics business had a $1 million unfavorable impact compared with the 2018 first quarter.

Gross profit increased by 82% on the higher sales, including the addition of Faster and CFP. While the Faster business demonstrated strong gross margin achievement in the quarter, the CVT business was down slightly compared to the first quarter last year due to a slow start in January.

CVT margins improved throughout the quarter and are expected to improve further as we progress through 2019. Another factor impacting the gross margin comparison to last year is that CFP’s integrator business model carries a modestly lower gross margin than a manufacturing business.

While CFP retracted from margins by about 100 basis points in Q1, the strategic plan of CFP remains very important to Vision 2025. CFP is our stepping stone into the Southeast Asian markets where we believe there is significant opportunity to gain market share.

Hydraulics segment operating income grew 78% to $23.8 million, higher selling, engineering and administrative expenses or SEA included $8.2 million for the Faster and CFP businesses. Please turn to Slide 8.

For a review of our Electronics segment first quarter operating results, revenue was down 12% compared with the first quarter of last year, impacted by timing of OEM customer model year rollout and softening end market.

First quarter gross margin increased substantially to 45.7% up from 40.9% in the prior year’s quarter driven by cost management efforts. We also implemented price increases and realize material cost reductions, both of which drove significant margin improvement.

Operating margin in the first quarter improved to 21.4% of sales despite the lower revenue level. Please turn to Slide 9 for a review of our cash flow and capitalization.

In the first quarter, we generated $19.8 million of cash from operating activities, 35% more than the prior year first quarter with the increase driven by higher cash earnings, partially offset by a net increase in working capital. Our CapEx was $8.8 million, up from $4.2 million in the first quarter of 2018.

The increase was primarily for manufacturing technology enhancements, including equipment for completion of our CVT manufacturing consolidation project, our new China facility and the addition of the Faster business. Capital expenditures are still estimated to be between 30 and $35 million for 2019.

Regarding capitalization, cash flow drove an $8 million reduction in net debt in the first quarter of 2019. We finished the quarter with our net debt to pro forma adjusted EBITDA of 2.3x. With our strong cash flow profile, we are focused on getting that down to below 2x.

I do want to mention the early in the quarter, we made the final $17.8 million earn out payment associated with the Enovation Controls acquisition. Given the strong performance of that business the maximum earn out was achieved demonstrating a win-win for all parties.

Wolfgang, I would 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 11. There are several macroeconomic factors impacting our current outlook. First, recent tariff negotiations over the weekend point to a higher degree of unpredictability for the remainder of the year. Also, as we have been expecting, the leading U.S.

indicators that are important to Helios indicate that we are currently experiencing a slowing growth phase, with accelerating growth expected to resume in 2020. Around the world nearly all major global economies are already in the slowing growth phase of the business cycle.

Economic forecast that we follow point to a mild recession in Western Europe in 2019. Similar to the U.S., all global economies are expected to return to accelerating growth in 2020. Geopolitical factors including the impact of Brexit present uncertainty for our global business and the end markets we serve.

It is important to note as we have said before in accordance with our Vision 2025 plan, we expect to outpace the 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 white space and continuing to introduce new and innovative products and solutions.

Further, our intentional shift from the traditional business into more diversified end market expands our ability to successfully weather economic cycles. Please turn to Slide 12 for our thoughts regarding our outlook for Helios for the remainder of 2019.

On a consolidated basis regarding quarterly cadence, we expect revenue to be evenly spread throughout the remainder of the year. Also, as I mentioned earlier, I want to emphasize that we are continuing to aggressively invest in innovative manufacturing technologies and market leading new products.

These investments are critical to achieve our revenue and profitability goals. In the overall macroeconomic environment, oil and gas, agriculture, recreational and most recently construction and material handling end markets are softening.

There has been a shift in the outlook of these markets over the last few months that has caused us to take a closer look at our expectations. Referring to our Hydraulic segment, keep in mind that our second quarter and part of our third quarter will include acquisition growth for CFP, which will anniversary on August 1.

Regarding operating profitability, we are very encouraged about the results we’re seeing from actions taken to improve production flow at our facilities as well as managing our fixed costs. As previously indicated, we have been seeing better workflow in our Sarasota Operations on a month-by-month basis throughout the first quarter.

We expect that will continue to further improve as we progress through the balance of the year.

Turning to Electronics, this segment is highly driven by OEM engagement and therefore product launches are not consistent on a year-over-year basis affecting the quarterly comparison, but we remain confident in our proven go-to-market strategy with OEMs as well as our ability to optimize operational efficiencies in an effort to maintain the superior growth margin levels Tricia referred to.

Please proceed to Slide 13 where we provided our updated guidance for 2019, which demonstrates growth over 2018. As I noted a moment ago, in the overall macroeconomic environment many of our end markets are softening. Nevertheless, we reiterate our hydraulic segment revenue guidance.

Our strong backlog and the completion of our CVT manufacturing consolidation project give us confidence to maintain hydraulics revenue guidance for the year. In Electronics, we initiated a deliberate shift in our customer base which materialized in the first quarter.

We believe this change is in the long-term best interest of our business and puts us in a better position to take market share as we work towards achieving Vision 2025. This initiative includes the release of certain contractual obligations to customers that allows us to leverage all products to a broader customer base.

Electronics has experienced growth of over 50% in the last 2 years due to significant new product introductions in recreational end markets and overall growth in mobile and industrial end markets. Compared to prior periods this year’s rollouts are at lower volumes.

This is partially due to the production schedule of specific vehicles as well as softening in end market demand. We have a strong OEM sales pipeline of opportunities with new and existing customers. We are currently in the development phase for these new products and anticipate the start of productions for most in 2020 and 2021.

Our change in top line guidance translates to a revision in adjusted EBITDA margin. However, lower depreciation estimates for the year allow us to maintain our GAAP EPS and non-GAAP cap EPS guidance.

We remain committed to investing for long-term profitable growth throughout the business cycle to outpace the market as we work diligently towards our Vision 2025 goal. Now, let’s open the lines for Q&A..

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] The first question is from Brian Drab, William Blair. Please go ahead sir..

Hi, this is Joe Aiken getting on for Brian Drab [ph].

I was wondering if you could talk about what you expect in terms of gross margin progression throughout the rest of the year?.

Yes. So we talked about gross margins for the Hydraulic segment showing some expansion, especially related to the CVT, completion of the CVT consolidation projects. So we are looking somewhere 50 basis point to 100 basis point increases there for gross margin as we progress through the year.

And on the electronics side, we expect those gross margins to stay elevated. It’s going to depend on what the top line sales are by quarter, but we expect them to be somewhere between 43% and 45% for the remainder of the year..

Thank you.

And you mentioned in the outlook, but the risk of additional tariffs, are you able to quantify what that risk, potentially be at all?.

It’s very difficult Joe at this stage to quantify. So far we have been able to pass everything onto the marketplace in a pretty successful manner.

And as you know with being in the region, for the region initiative, we are obviously also ramping up value add in those places, particularly referring now to Korea and to China where the new facilities is coming online shortly.

So at this stage, I think it’s too – still too early to quantify the exact impact and as we all know these discussions I think are still in balance. And I think we first have to wait for the exact outcome before we quantify any specific numbers here..

Okay. Thank you for taking my questions..

Sure..

The next question is from Mig Dobre, Robert W. Baird & Company. Please go ahead..

Good morning everyone, it’s Robert W. Baird, not Blair. Operator, I will correct that.

But I guess my first question is really surrounding your outlook in hydraulics and what I am wondering here your comment certainly pointing towards slowing end markets and some of your peers that have reported have seen that as well, but then you maintained your guidance and you talked about orders in a quarter book to bill being above one, so can we maybe try to flush out what’s really going on here, it seems like your orders are good, your outlook is unchanged, but you are talking about slower markets, how do we – how should we think about what’s really going on with the business and would you specifically in terms of maybe outgrow in the market?.

Yes. Good morning. Yes, exactly as you said. So the book to bill ratio is still above one, but we have recently probably over the last, it’s fair to say over the last four weeks to six weeks seeing softening in the very – in the end markets where we have seen exceptional growth over the last 18 months to 24 months.

And I am here referring mainly to construction machinery into material handling. Besides those end markets, obviously the recreational markets have been under pressure for a bit longer, already as you know that it’s very much consumer driven at the end of the day and we are coming off a very staggering growth numbers over the previous years.

We referred to the 50% organic growth on the electronics side. So we are working of a pretty solid and stable backlog on the hydraulics side and anticipating a sluggish development or maybe even a further softening in some of those key end markets that we serve, that gives us still confidence that we can maintain guidance for 2019..

I appreciate that Wolfgang, but curious what I am struggling with.

If I am looking at your comparisons in Hydraulics, right, especially if you look at them on a 2-year stack basis, as you move from the first to say the third quarter, your comparisons are getting almost 20% harder in hydraulics and I understand that you do have a backlog, but obviously we don’t really know what the amount of that backlog is, so on tougher comparisons with end market slowing is there enough in your backlog or do you have enough visibility to still feel comfortable with the outlook or should we be sort of preparing ourselves for maybe a reduction in the outlook in the second quarter based on sort of the trends that you are seeing exiting Q1?.

Well, as you know historically, obviously visibility with regard to the legacy business to the Sun business is probably three months to four months where we can basically say we have good visibility and know pretty well what is going on.

This has gotten a little bit better with the acquisition of Faster, as 80% of Faster business is tied to OEMs and there we are dealing with concrete OEM schedules here.

But I mean to summarize again based on what we are seeing right now and based on the degree of softening that we are seeing, obviously we have to make some assumptions of what these end markets will do over the balance of the year considering the stability of the backlog we have, also taking into consideration of inventory in the channel, we feel pretty comfortable that we can meet the revenue guidance in the Hydraulics segment..

Okay, that’s fair.

Let me ask you really quick on the electronics, I am not entirely clear what this intentional shift in the customer base that you are talking about really means, it sounds to me like you are – for the lack of a better term walking away from some customers for some specific reasons, so I guess what I am wondering here is, is this not something that you contemplated three months ago when you issued the guidance, what changed and why now?.

Good question, Mig. I mean we have been contemplating this for 2.5 years, since we went through due diligence with Enovation at the time. So this was a point that deserved our attention already at that stage. So we knew that down the road, we would address this at any given point in time.

And it’s simply goes back to the overarching philosophy that we follow from our Helios Technologies perspective.

We obviously don’t want to put too many eggs in one specific basket and we want to position ourselves that we can diversify the business at any given point in time as far as customers are concerned, but also as far as geographies and specific end markets are concerned.

So this move as I reiterated earlier on, gives us the opportunity to do exactly that.

To further diversify our access to more customers, predominantly global customers, if we are pushing for that global expansion as you know, and it will also give us the opportunity to tap into adjacent end-markets that we are not necessarily serving today or if we serve them not to the degree, we want to serve them.

So, the timing for this is obviously – is – can always be questioned, but it’s been on our radar screen for almost 3 years since we started due diligence at the time back in 2016..

Well, the timing is just sort of interesting to me, because you’re talking about end-market slowing a little bit in the Electronics as well. So, in theory, this would be a year in which you might actually need that extra volume rather than getting rid of that extra volume.

Do you sort of feel as if you need to free up this capacity now, is that the idea here?.

No, it’s – I mean, to be very outspoken and frank here, it’s a deliberate move to take a short-term hit for the mid and long-term benefit of the corporation. This will position us better in terms of Vision 2025, because we are getting access to additional customers we want to be tied to that we have not been tied to in the past.

And as I indicated earlier on, I mean, we have experienced over the last probably 6, 9 maybe 12 months specific inquiries for exactly such products and services, but we were bound by contractual restriction, so, in exchange for specific long-term contractual volumes and we want to resolve that.

We want to put ourselves into a position, where from a long-term perspective, we are better off. So, it’s a short-term hit for a mid-term and long-term benefit. I think that describes it in the best way, Mig..

Perfect. That’s very helpful. Last question for me is on free cash flow. Tricia, maybe can you give us a little bit of help with how you’re thinking about that? And how does that earn-out play into this – in the second quarter that we’re seeing that outflow for what? Thanks..

On the free cash flow, we’re still targeting 10% of sales. So, in the first quarter, we didn’t hit those targets, but we have some pretty marked improvement plans with the businesses, with new target for the working capital component of those. The earn-out payment does play into that – and that – we had to make that payment in early April.

So, we are not sure that we’re going to be able to improve the debt position from the end of Q1 to the end of Q2 significantly given that we had to make that large cash payment, but for the remainder of the year, we still have confidence that we’re going to be able to generate the cash flow to continue to pay down the debt..

Okay. Thank you..

We have a question from Jeff Hammond, KeyBanc Capital Markets. Please go ahead..

Hey, good morning..

Hey, Jeff..

Good morning, Jeff..

So, I think you said here the cadence over the final 3 quarters would be similar.

Can you just talk about how you’re looking at the cadence for Hydraulics versus Electronics particularly as we go through this transition in Electronics?.

Yes, the cadence for Hydraulics is actually, exactly evenly balanced over the remainder of the year, right, Tricia?.

We showed a little bit of growth over Q1, but relatively steady than in Q2, Q3 and Q4, but it is growth over what we saw in Q1 per our expectations.

And on the Electronics side, I think we mentioned last quarter that we do have model year roll-outs coming in Q2 and Q3, so we’re expecting slightly better top-line results in Q2 and Q3 with our general seasonality that we see in Q4 with a little bit lower revenue..

Okay, that’s helpful.

And then just on the Electronics change, can you give us what verticals, that’s impacting?.

What are you referring to, Jeff, when you mean verticals?.

End-markets.

Is it a particular end-market or is it pretty broad based?.

It’s relatively broad-based, but as I indicated, obviously we are opening up our ourselves for adjacent markets, where these products and services can be applied. So, it’s coming from a more narrow end-market exposure to opening up a pathway to a broader end-market exposure.

Does that answer your question?.

Yes.

What are some of the adjacent markets you’d be able to bump into then?.

Well, it’s in industrial and mobile applications, it’s actually both, and then also in the Ag market. So, this move is also intended to help us and to accelerate even further the generation of revenue synergies with some of the other group companies that we have. In this particular case, Faster, obviously as Faster is in the Ag market..

And then just on hydraulic margins, I understand the CFP dilution, but your margins were down fairly substantially year-on-year against what was pretty easy comps, because you had all the headwinds last year, and I’m just trying to understand what’s going on there, if there is anything outside of some of the plant costs that are still around?.

No, there is nothing else specifically going on. We had a pretty slow start in January, that was the main reason, but we have seen very satisfactory results the following months including going into Q2 already.

So, we’re pretty confident and with having I think this consolidation project under our belt now is really the time to optimize and ramp up productivity and efficiency and output. So, we feel actually pretty good where we are right now. So, there was nothing else – there is nothing else in the cards..

Okay.

And then just last one, Tricia, can you just give us the new depreciation number for the year versus what it was before?.

Yes, depreciation for the year is now $18 million to $20 million..

Okay, thanks..

You’re welcome, Jeff..

The next question is from Nathan Jones, Stifel. Please go ahead..

Good morning, everyone..

Good morning, Nathan..

Good morning..

I’ll start in a bit more positive note and say congratulations on having to payout that full earn out on Enovation Controls so it’s a good thing to pay that money out?.

Absolutely. Thank you..

Thank you..

A quick follow-up on this shipping strategy on the Electronics business.

Can you maybe give us an estimate of what the revenues that you’re walking away from there? And do you have direct thought to the kinds of things that you’re planning to book in 2021? Have you had these conversations with customers? Are they showing interest in these kind of products now that they’re are available? Just any color you can give us on the magnitude of what you’re getting out of in ‘19 and what you can see to in ‘20 and ‘21?.

Yes, let me start with the second question first, Nathan. So, we are basically by releasing these contractual obligations, we are positioning us for a number of concrete development opportunities. And I mentioned during my remarks already that there are specific SOPs lined up for 2020 and 2021.

So, the answer to your second question is yes, we have concrete RFQs and projects on the table that will materialize in SOPs in 2020 and 2021. For the first question, now you have to understand this only impacts a certain range of products with existing customers, we still continue doing business with those customers.

So, the ramp down also depends obviously how these customers develop with regard to the purchase of the other products and services, where we of course work very closely and collaborate very closely with them.

So, I wouldn’t want to quantify and throw out the numbers here, because it depends on obviously resolving the contractual obligation that are long-term contractual volume bound, but on the other hand, we continue to do business with these customers in other areas of our product portfolio..

Okay. Couple of questions on some of the cost saving fee. You guys talked about being able to generate an additional 15% of capacity out of the CVT consolidation.

Can you talk about the cost reductions you’re expecting to generate out of that, where you are in that process and how we should expect those to ramp up? And then any color you can give us on the cost savings on the shift for our Faster manufacturing into Italy?.

Yes, maybe we start with the second question again, first. So, basically, parts supply out of Italy would translate into roughly a 15% cost reduction. That’s pretty much what the analysis show and we feel pretty comfortable and pretty confident that we will reach or exceed that goal.

To the first part of the question, so, obviously, this is all a result of this – the endpoint of the site consolidation I think puts us into an excellent position to drive efficiencies. And as Tricia pointed out during her remarks, so that puts us into a position of seeing, I think gradual margin improvement over the balance of the year.

Overall, I would like to look beyond only the legacy Hydraulics business overall.

As you know very well Nathan, we are targeting roughly getting back to roundabout a 40% gross margin level across all the different businesses and obviously the CVT legacy business after this site consolidation will contribute to that for the remaining 3 quarters this year.

I think once we have reached that level by the end of this year or beginning of next year, I think it will be relatively difficult to further improve margin, but it would bring us back to really superior gross margin levels by the end of this year..

That’s helpful. I have one last question around the tariffs. I think when tariffs were implemented last year, you guys had some supply chain disruptions particularly around the electronic components, I think that were like ceramic capacitors or something that you had availability issues with last year.

Do you feel like you have supply sorted out so that any disruption that might be caused by this increase in tariffs or tariffs on new sets of products or anything like that could disrupt the availability of components that you need rather than just increase the cost?.

So first of all, you’re exactly right. So, we had those type of challenges about 12 to 15 months ago. Those challenges have been resolved already mid of last year, I think through long-term agreements with those key suppliers for those specific electronic components.

As far as the tariffs are concerned, because I mean we are not sourcing everything or all these components out of China to begin with I – we are not overly concerned that, that would impact the Electronics business and the gross margin level of the Electronics business at this stage..

We have already resourced, some of those are secondary, sourced them after that issue, so I agree with Wolfgang that it should not be an issue..

There have been dual sourcing activities in place also deviating then from only China sourcing..

Great. Thanks for taking my questions..

Sure, Nathan..

[Operator Instructions] We have a question from Brian Lau, Sidoti. Please go ahead, sir..

Good morning, everybody. I’m on for Joe Mondillo this morning.

Just to touch on the depreciation again, what prompted the adjustment from what you reported in Q4?.

Yes. We made some changes to the assumptions in the 2019 depreciation model that was originally built back at the beginning of the year, and we had to revise the forecast for some inconsistencies in the inputs from the acquired businesses specifically around the purchase price adjustment assumptions that they had made in that model..

Okay. Thanks for that.

And then around Faster and its exposure to just Ag in Europe in general, how did that business performed in the first quarter and how do you kind of see that trending throughout the year?.

So, I think overall, Brian, we are really happy with the post-merger integration of Faster. So, obviously, we just had the first anniversary last month. As you know, about 60% of the business is exposed to the Ag market, and it’s about 20% or 25% that is as exposure to the construction machinery equipment market. The Ag market has been challenged.

Luckily, Faster has a big footprint across all the major sectors within the Ag market and they’re pretty globally positioned. So, we can dampen the downturn of the Ag market into softening rather well. We are pleased with the performance with what we’re seeing there.

Even more importantly than just looking at the current performance and very encouraging for us is all the new product development that is going on, so a lot of new pipelines and a lot of new projects in the pipeline with existing and new customers around the world.

So, we’re pretty pleased where we are today as far as the performance of Faster is concerned.

Nevertheless, having said that, we would like to see a little bit more exposure to industrial end-markets and there we have efforts in place that the legacy business of Helios, namely Sun Hydraulics will pull Faster more into the channel and provide more access to the classical industrial end-markets.

I think if we can accomplish that over the next couple of years, we are very well positioned for the future..

That’s helpful. Thanks for that.

And the last one from me, on the fourth quarter call, you stated you were hoping to reduce inventory levels, any update on that?.

Yes, I mean, we’re still working pretty actively with the businesses to bring down the inventory.

Overall, I don’t think we made significant progress in that in Q1, but it’s kind of a slow process to work through all of that and understand where we have excess inventory and certainly in the CVT business with the continuing demand that we’re seeing there, we want to make sure that we have the product in place to be able to ship as much as possible including our backlog items..

I would like to add here, I think at this stage of the cycle and where we – in times where we have been seeing orders outpacing shipments for a very long period of time, the optimization of working capital is important, but it’s secondary. Our prime focus is obviously on operating margins and the generation of free cash flow.

But nevertheless, as Tricia said, there is room for opportunity. We started an extraordinary project now giving very specific and tougher targets to the individual business in order to bring the working capital further down. But as I said, it’s secondary.

Operating margin and the generation of free cash flow is in the forefront of thinking and acting right now..

Alright, appreciate that. Thanks for taking my questions..

Sure..

There are no further questions at this time. I’d like to turn the floor back over to management for closing comments..

Thank you for your interest in Helios Technologies and for your participation this morning. I also want to take this opportunity and thank all of the hardworking Helios employees, who are driving these results. May I draw your attention to our online Annual Report, which is available on our website.

The proxy is also available for our Annual Shareholders’ Meeting to be held in New York City on Thursday, June 13, 2019. Additionally, we look forward to updating all of you the second quarter 2019 results in August. 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 and have a good day..