Helios Technologies Inc (HLIO) 2018 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to Helios Technologies Second Quarter 2018 Financial Results. (Operator Instructions)

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

Thank you, Jen, and good morning, everyone. We certainly appreciate your time today for our second quarter 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 will also find slides there that will accompany our discussions today.

If you look to the slide deck on Slide 2, you'll find our safe harbor statement. As you may be aware, we will make some forward-looking statements during this presentation and also during the Q&A. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from where we are today. These risks and uncertainties and other factors are provided in the earnings release as well as other documents filed by the company with 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 with some highlights for the quarter, Tricia will go through the details of our financial results, and then we'll turn it back to Wolfgang for his perspective on our outlook before we open up the lines 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. Our key members around the globe have been working very diligently to advance our Vision 2025 within both our historic businesses as well as of our more recently acquired businesses.

Before I get into our results, I just want to highlight yesterday morning's announcement that we have changed our corporate business name to Helios Technologies in alignment with our Vision 2025. This is an important strategic step as we are evolving. As we now have several operating companies under our umbrella, the holding structure provides the parent with an identity that is independent from our operating brand. It is important that the very well-known Sun Hydraulics name and strong brand will remain, but going forward, it will represent our cartridge valve technology business only. So we will now use the Helios Technologies name when referring to the entire organization under the parent holding company.

Our shares will continue to trade using the same ticker symbol, SNHY. Now let me give you an update on our business progress. This is the first quarter that will include the results of the Faster Group. To remind you, Faster is a global leader in quick-release couplers for hydraulic application. As previously announced, we acquired this Northern Italy based business on April 5, just about the beginning of our second quarter. It carried a purchase price of about $533 million. We used proceeds from our February public offering to partially fund it and we also amended our credit facility and used some of that new debt. The amended credit facility also gives us flexibility as we continue to grow well into the future. Our second quarter sales grew by nearly 52% to more than $136 million, a record level for our company. Of the $47 million in growth, about $39 million was contributed by Faster and about $8 million was organic growth. The Faster business grew about 25% over last year's quarter on a pro forma basis.

Regarding our organic businesses, we continue to experience very strong order demand in both Hydraulics and Electronics. In addition, we saw sequential improvement related to supply chain constraints compared with the past 2 quarters. In our Electronics segment, we are now in a position to keep up with current order intake. In our legacy Hydraulics business, we have seen record order levels and expect that shipments in the second half of the year will be stronger than the first half. This is reversing an historic pattern as we work through the backlog and extended lead times created by the strong demand.

We have 2 major projects underway that will contribute to increased throughput and capacity in 2019. Later this month, we will complete the relocation of our Korean business from a smaller lease building into a newly constructed state-of-the-art facility in Incheon, South Korea. This project will be completed ahead of schedule and within the original budgeted amount.

Additionally, we are well underway with optimization of the manufacturing footprint of the 3 Sarasota-based plants. We mentioned this project in last quarter's call and it is expected to be completed in early 2019. This project includes streamlining manufacturing process and product flow in alignment with our LEAN philosophy. In addition, it will provide a platform to expand our engineering and R&D lab capabilities, which are scheduled to be finished by the end of 2019.

The result of these efforts is concentrated manufacturing in 2 adjacent facilities, whereas R&D and engineering will be housed on a separate campus. Overall, we were pleased with the operational improvements realized by our historic businesses during the quarter. We generated a 25.6% adjusted EBITDA margin, up from 24% in Q1 and 20.5% in the fourth quarter of 2017. Finally, as announced yesterday afternoon, we closed on the bolt-on acquisition of Custom Fluidpower based in new Newcastle, New South Wales, Australia.

Please turn to Slide 4, and I'll provide more details. Custom Fluidpower or CFP is Australia's largest independent fluid power solutions distributor. As with most of our distribution channel partners, they're much more than simply a reseller of product. They're very innovative with the strong emphasis on delivering engineered solutions and value-add services from their 8 branch locations across Australia. For the 12 months ended June 2018, they realized about USD 46 million of sales and 9.7% adjusted EBITDA margin.

We really like the diversity of their customer base, ranging from mining and material handling to energy, oil and gas as well as other, as shown here in the upper right box. Comprehensive value-add services they offer are listed here in the lower left box. In addition to Hydraulic manifold systems, they design circuitry, provide IoT and automation packages and even oversee broader turnkey projects. Additionally, there's an attractive aftermarket service component. We have featured one of their proprietary solutions in the lower right box, the Custom Brake power Unit that includes some Sun products.

Please turn to Slide 5, and I'll talk about the strategic significance of this business to Helios. As you know, we believe, it's very important to follow a business philosophy of 'in the region, for the region' all around the globe. Custom Fluidpower gives us a strong physical presence in the South East Asia and Pacific region from which to build, especially given their engineering and design capability. We will leverage the in-roads that our Sun Hydraulics business has made into the region and we anticipate that CFP will accelerate our efforts.

Now turn to Slide 6, and I will summarize the transaction details. We just closed on this acquisition last week for a purchase price of about $26 million in a cash-free, debt-free transaction. The enterprise value amounts to about 5.6x EBITDA on the trailing 12-month basis. It was funded as a 36% cash and 64% equity transaction, so we paid about $9.3 million of cash and issued 333,065 of SNHY shares. We have targeted approximately USD 2 million of EBITDA synergies by 2022, which will be driven by initiatives to increase sales in the region.

Regarding the financial impact to Helios, we expect that the acquisition will be EPS accretive in the first year and that the transaction ROIC will exceed our cost of capital within a year. It is also worth noting that our net debt to trailing 12 months EBITDA is 2.6 after this transaction.

With that overview, I will now turn the call over to Tricia to review the financial results for the quarter and first half year in a bit more detail.

Thank you, Wolfgang, and good morning, everyone. Let's begin on Slide 8 with the review of our second quarter consolidated results. Sales were up 52% compared with last year's quarter. Faster contributed 43% and our organic business sales grew 9%. Most of our products did not have any price increases, so nearly all of that growth is volume. Our Sun Hydraulics price increase was effective on July 1, so it will benefit our third and fourth quarters.

Foreign currency translation had a favorable $400,000 impact for the quarter. I will 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 realized considerable year-over-year growth with the addition of Faster, the EMEA region is now a larger contributor to our sales base. Sales to the Americas, EMEA and APAC regions were 50%, 32% and 18% of the consolidated total, respectively.

Regarding profitability, our consolidated adjusted EBITDA was up 41% over last year's second quarter to $34.9 million or 25.6% of sales. As we discussed last quarter, we continue to see margin pressure related to supply chain constraints and higher material costs. We anticipated that we would see these impacts in Q2, and to a lesser degree in Q3 and Q4. I'll get into this more as we review the segment results on upcoming slides.

Turning to the bottom line. Adjusted earnings per share were $0.43, down 9% compared with last year's second quarter. This year's quarter includes $0.19 and $0.10 per share for amortization and interest expense respectively, compared with $0.05 and $0.02 per share for amortization and interest expense respectively in last year's second quarter. Together, these 2 acquisition-related items had a $0.22 impact on the second quarter comparisons on both the GAAP and non-GAAP basis. Our GAAP and non-GAAP adjusted EPS for the 2018 second quarter also included a $0.05 charge for losses on foreign currency forward contracts related to the Faster acquisition.

I want to point out that our adjusted net income was up 7%, but our average shares outstanding increased due to our follow-on offering, impacting our earnings on a per-share basis. I also want to highlight that our number of shares outstanding as of August 1, 2018 was about $31.9 million given the shares issued to fund the Custom Fluidpower acquisition. I'd like to bring to your attention items that impacted our consolidated results and that we added back for purposes of reporting adjusted EBITDA and adjusted EPS shown here. Please refer to the tables in the back of the press release or slides for reconciliations of GAAP to non-GAAP numbers.

During the second quarter of 2018, we incurred the following: first, $3.1 million for amortization of inventory step-up costs resulting from purchase accounting for Faster. Next, we incurred $3.7 million of costs for acquiring and financing Faster and Custom Fluidpower. Next, we realized the $2 million charge on the foreign currency forward contracts that we entered into when we signed the agreement to acquire Faster to lock-in the euro exchange rate; finally, we recorded a $251,000 charge for contingent consideration associated with the Enovation Controls acquisition.

Please turn to Slide 9 for a review of our second quarter Hydraulics segment operating results. Sales grew 70% to $103.6 million. We saw 41%, 144% and 46% year-over-year growth for the quarter in the Americas region, EMEA and APAC. Those growth numbers benefited from the addition of Faster. On an organic basis, we realized growth of 6% and 21% in EMEA and APAC, respectively, while sales to the Americas declined 1% due to supply chain constraints.

The regional allocation is impacted by a shift based on specific customer requests to have product delivered directly to their East Asian facilities instead of delivery to their North American locations. This inflates the APAC growth and decreases the Americas results for the quarter.

This trend will continue into the future quarters, making comparability a little more difficult, but highlights the global view we have of our business. The organic growth was driven by our increased market penetration and new products as well as broad economic market expansion, partially offset by the impact of supply chain constraints and growing backlog. While gross profit increased by 54% on the higher sales, including the addition of Faster; supply chain issues and material costs increases caused gross profit to decrease to 38%. We will reconcile that change in detail on the next slide. Operating income increased 55%, realizing a reported operating margin of 24.5%. Our selling, engineering and administrative expenses or SEA grew $4.8 million or 52% to $14 million compared with $9.2 million in the second quarter of the prior year. The increase includes $5.3 million for the Faster business, offset by about $500,000 from cost reductions and efficiencies realized by the historical Sun business.

Please turn to Slide 10, and I will reconcile the change in gross profit from the second quarter of 2017 to the second quarter of 2018 for the Hydraulics segment. Gross profit in the 2017 second quarter were $25.6 million or 42.1% of sales. After adjusting for higher volume, we determined that we incurred about $1.5 million or 1.4 percentage points of margin for incremental material cost. This includes materials under long-term supplier agreement as well as those not under agreement. As previously indicated, our Sun Hydraulics business implemented a price increase effective July 1. Given the timing of the increase in mid-year, we expect to realize approximately 1.5% to 2% additional net sales in Q3 and Q4 as a result. Higher production costs unfavorably impacted gross margin by about $200,000 or 0.2 percentage points of margin. This primarily consists of personnel-related costs resulting from inefficiencies caused by the supply chain constraints we've spoken about the past 2 quarters.

With our new long-term supply contracts in place, we are pleased with the progress we've made and expect continued improvement in the third quarter. Next, we did realize favorable currency effect of about $300,000 or 0.3 percentage points of the margin during the quarter, primarily due to the weaker U.S. dollar. Finally, Faster contributed $13.9 million of gross profit to the quarter, realizing 35.9% gross margin on their $38.7 million of sales. The material cost, production inefficiencies and offsetting foreign currency in total impacted our 2018 second quarter gross margin by about 130 basis points.

There were other normal fluctuations, such as varying sales incentives and mix that partially offset the leverage realized on the incremental sales. As we look into the third quarter, we expect further improvement and additional improvement in the fourth quarter.

Please turn to Slide 11 for a review of our Electronics segment operating results. Revenue for the second quarter grew 14% over the second quarter of last year. This was driven by ongoing increased demand in power controls and recreational end markets. In addition, proactive sales incentives and increased demand for our new products developed in the past year also contributed to growth. Gross profit for the segment increased 8%, yielding a gross margin of 43.4% compared with 45.6% in second quarter of 2017. I will reconcile that change in detail on the next slide.

Operating income in the second quarter grew 2% over the second quarter of 2017 with an operating margin of 20% in the 2018 quarter. SEA expenses grew $1 million, reflecting planned investments in selling and marketing initiatives as well as R&D to support our growth strategy and accounting administrative infrastructure costs, partially offset by cost savings from consolidating our HCT business into Enovation Controls.

Please turn to Slide 12, and I will reconcile the change in gross profit from the second quarter of 2017 to the second quarter of 2018 for the Electronics Segment. Gross profit in the 2017 second quarter was $13 million or 45.6% of sales. Similar to the Hydraulics segment, after adjusting for higher volume, we determined that we incurred about $600,000 or 1.8 percentage points of margin for higher material costs. The majority of these higher costs, approximately $400,000, were for excess and obsolete inventory, remaining $200,000 was due to higher supplier costs.

Production costs contributed favorably to the 2018 quarter compared with the 2017 quarter by about $600,000 or 1.8 percentage points. This includes improved efficiencies and a reallocation of application engineers for manufacturing overhead to our SEA reporting line.

Finally, logistics also favorably contributed to the quarter by about $200,000 or 0.6 percentage points. Last year included inbound freight associated with stocking in the former San Antonio facility prior to the completion of the carve-out. There were other normal fluctuations, such as mix and varying sales royalties that offset the leverage realized on the incremental sales. As we look forward to the third and fourth quarters, we expect further improvement.

Please turn to Slide 13 for a review for our first half consolidated results. Sales of $233.5 million were up 37% over last year's first half. Regarding profitability, our consolidated adjusted EBITDA grew 22%, resulting in 24.9% of sales in this year's first half, that was down from 27.9% last year. Turning to the bottom line, our adjusted earnings per share were $0.89, down from $0.90 last year.

Please turn to Slide 14 for our first half review of the Hydraulics segment. Sales of $166.2 million were up 45% over last year's first half. Gross profit increased by 32% on the higher sales, resulting in a 37.8% gross margin, that was down from 41.4% gross margin in last year's first half, which I will reconcile on the next slide. Operating income increased 29%, yielding a 23.3% operating margin, which was down from 26.2% operating margin in last year's first half.

Please turn to Slide 15, and I'll reconcile the change in gross profit from the first half of 2017 to the first half of 2018 for the Hydraulics segment. Hydraulics gross profit in the 2017 first half was $47.6 million or 41.4% of sales. After adjusting for higher volume, we determined that increases in material costs were about $2 million or 1.1 percentage point of margin. As you know, our July 1 price increase will start covering these cost increases in the third quarter.

Recall, we incurred interim labor costs in the first quarter. That cost was a premium we paid for experienced third-party contract labor that was isolated to the first quarter, against trying to keep up with demand and maintain our best-in-industry lead time. These amounted to about $500,000 in the first quarter of 2018 or 0.3 percentage points of margin for the first half. We discontinued the use of this type of labor so these costs did not repeat in the second quarter.

We calculated that supply chain constraints and resulting inefficiencies caused about $1 million or 0.6 percentage points of margin. This include temporary labor and overtime, partially offset by process improvement. Next, we had about $200,000 of extra logistics cost or 0.1 percentage point primarily outbound, but also some inbound freight costs. These were all incurred in the first quarter. Finally, we did realize favorable currency effect of about $800,000 or 0.5 percentage points of margin during the first half, primarily due to the weaker U.S. dollar. The material costs, interim labor, production inefficiencies, logistics and offsetting foreign currency in total impacted our 2018 second quarter gross margin by 1.6 -- by 160 basis points.

There were other normal fluctuations, such as varying sales incentives and mix that offset the leverage realized on the incremental sales.

Please turn to Slide 16 for the first half review of the Electronics Segment. Sales were up 20% over last year's first half. Gross profit increased by 11% on the higher sales, realizing a gross margin of 42.1%, that was down from 45.9% last year, which I'll reconcile on the next slide. Operating income increased 7%, yielding a 20.2% operating margin compared with 22.8% operating margin in last year's first half.

Please turn to Slide 17. Electronics gross profit in the 2017 first half was $25.6 million or 45.9% of sales. Similar to the Hydraulics segment, after adjusting for higher volume, we determined that we incurred about $3 million of higher material costs or 4.5 percentage points of margin. The majority of these higher costs, approximately $2.5 million were incurred in the first quarter.

Looking forward to the second half of the year, we expect supplier increases in ceramic components as well as tariff surcharges. We are actively negotiating with our key suppliers to secure stable pricing. Finally, we calculate approximately $1.8 million or 2.7 percentage points of margin of favorable costs due to improved efficiencies as last year we were in the midst of a carve-out process. There were other normal fluctuations, such as varying sales royalties and mix that offset the leverage realized on the incremental sales.

Please turn to Slide 18 for a review of our cash flow and capital structure. In the first half of 2018, we generated $31.1 million of cash from operating activities compared with $21.7 million in 2017 with the 43% increase driven by higher net income and improved working capital, especially inventory.

We finished the quarter with $29.9 million of cash, $355.2 million of debt and $503.4 million of equity. The significant changes from year-end reflect our equity offering in Q1 and the Faster acquisition in Q2. Subsequent to the end of the quarter, our acquisition of Custom Fluidpower used about $9.3 million in cash and increased our shares outstanding by about 333,000. We also made $17 million payment for the earn-out of Enovation Controls the first week of July.

Wolfgang, I'd like to turn it back to you for your perspective on outlook and our updated guidance before we open the lines for Q&A.

Thanks, Tricia. Please turn to Slide 20. The leading indicators that are important to Helios continue to signal ongoing growth through the rest of 2018. However, the rate of growth in the U.S. and all major global economies is expected to be at a slower pace of growth in late 2018. Leading indicators point to a mild recession in the next 12 to 24 months.

Important to note, we have stated that, 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, increase and broaden relationship with OEMs, penetrate regions where we have white space and continue to introduce new and innovative products and solutions. Separately, we are cognizant of the potential impact of the changes related to tariffs. We have begun to notify customers that if there is a negative tariffs impact, we will pass it on in the form of a corresponding surcharge.

Please turn to Slide 21 for the thoughts regarding our outlook for Helios. Regarding our organic businesses, strong demand and our backlog give us confidence in our growth expectations for the remainder of the year.

From a profitability standpoint, while certain cost pressures will continue into the third quarter as Tricia mentioned, they're declining as a result of actions we have taken. Further, our Sun price increase, which is the first in 3 years is taking effect in the quarter we are currently in and we expect that it will offset the manufacturing cost inflation we have been burdened with over the past couple of quarters. I want to remind you that our investments in our SEA initiatives are necessary and will continue as we are driving top line growth in accordance with our strategy and providing support for our growing organization.

Finally, may I point out that our historic Sun and Enovation Controls businesses are seasonally weakest in the fourth quarter. However, we don't expect this to be the case this year for our Sun business, given the demand we have seen from the marketplace and our strong backlog.

Regarding Faster, we have included this business in our 2018 guidance beginning April 5 when we closed on the acquisition. Faster experienced 25% growth in the second quarter of 2018 over the prior year quarter. Their historical pattern is that the first half of the year is stronger than the second half by a ratio of about 53:47. We continue to anticipate this will likely be the case in 2018.

Please proceed to Slide 22, where we updated our guidance for 2018. Compared with the guidance we provided in May, we are now including Custom Fluidpower for the last 5 months of the year in our Hydraulics segment, so we are expecting revenue between $510 million and $525 million on a consolidated basis. This amounts to consolidated organic revenue growth of 12% to 15%. Unchanged from last quarter, we expect that revenue for our organic Hydraulics business will grow between 13% and 15%, and revenue for our Electronics business will grow between 9% and 13%.

We revisited our consolidated adjusted operating margin guidance and lowered our guidance by 1 percentage point to 21.7% to 23% following our current reporting methodology, which excludes acquisition-related amortization of inventory step-up and intangibles as well as other one-time type cost. Our effective tax rate, capital expenditures, depreciation and amortization guidance have all been updated to include Custom Fluidpower and the impact of purchase accounting based on our latest estimates.

Before we open up the lines for questions and answers, I want to make you aware that we have scheduled an Investor and Analyst Day for later this year. It will be held on Wednesday, October 3 in New York City. If you're available to attend, please contact Kei Advisors, our Investor Relations firm, and the contact information provided within our earnings release.

Now let's open the lines for Q&A.

(Operator Instructions) Our first question comes from the line of Jeff Hammond with KeyBanc Capital Markets.

Really just want to dig on the Hydraulics supply chain constraints, how much do you think that held back sales in the quarter, what's kind of changing in the facilities to kind of help alleviate those supply chain constraints into the second half?

So let me answer the second part of the question first, Jeff. As we said already on the previous call and as we reiterated today, so we're going through basically this consolidation efforts here in terms of streamlining manufacturing, where we bring manufacturing from 3 campuses to 2 basically adjacent facilities here in Sarasota. And by doing so, we're freeing up the third facility pretty much for the engineering and R&D center that we want to invest in over the next couple of years. So as I pointed out earlier on, through streamlining the initiatives here on the manufacturing site, that will free up additional capacity and will shorten throughput, so we can pretty much convert that in additional capacity and output for next year. So we're going through that project that is going to be completed by the beginning of the first quarter 2019.

Okay. And then just on the price increase, how quickly and firmly do you think you can kind of push this through into the second half. It just seems like material costs are kind of weighing on the margin and I just want to get a better sense of how quickly you will alleviate that?

Yes. So the price increase, Jeff, that went into effect July 1. I mean, we gave notification to channel partners and customers already 6 weeks in advance, so during the course of the second quarter already. So we have rolled that out. We are basically calculating on a 1% to 2% net impact on sales for the balance of the year. Everything we are seeing and observing so far, I think, that is going reasonably smooth, probably the 1.5% to 2% might even be a little bit of conservative assumption.

Okay. And then just back on the supply chain, I think, in the bridge, you showed productivity is slightly positive on Hydraulics. Is that -- is there an offsetting supply chain headwind there that's holding back productivity or -- and then as we look into the second half and you pick some of those supply chain, that's the bigger tailwind?

The production cost in the Q2 bridge for Hydraulics is actually a slight downside, $200,000, is that what the number that you are referring to?

Yes, I guess, I was looking at the second quarter number, which was, I think 0.5%...

Yes, on Slide 10, production is slightly down 0.2%.

Was slightly down, okay, yes, yes. Does that number turn positive as these supply chain constraints get alleviated?

Yes, that number will. Yes, that's the assumption, Jeff. That number will turn positive.

Okay. And then just...

That is already a significant improvement over prior quarters. You might recall when we reported that on the bridge during the previous call. So that is depleting over time and is expected to turn positive then.

Okay. And then just on interest, what's driving the much higher interest expense versus just last quarter?

Yes, so LIBOR has gone up faster than what we had planned in our previous guidance. We have taken on a little bit more debt as well related to Custom Fluidpower acquisition. And we have very recently entered into some swaps to fix part of the debt -- the interest rate on the debt. So initially, upfront, you pay a little bit more but we believe longer term, it's the right decision to fix those rates with the swaps.

With the swaps, what's the fixed floating mix now?

It's about half and half right now.

Our next question comes from the line of Charley Brady with SunTrust Robinson Humphrey.

Just on the last question on the fixed floating, what's the rate that you're fixing?

We're fixed at -- so the grid is LIBOR plus whatever tranche we're in. So we are at 2%-plus LIBOR and that fixed LIBOR is about 2.8% for 5 years.

5 years, okay. I just want to clarify on the price increase that went effective July 1. Going into Q3, does that put you price cost neutral, so that there is not a material headwind in Q3, or does that have to take you to Q4 to get there?

It will take until Q4 to get there. We do have some backlogs that is still priced at the old pricing that needs to flow through and that's going to flow through, hopefully, majority of it in Q3. So we don't get the full impact of the price increase right away because of that. So I think, we even said last quarter that we expect that the price increase will cover material cost for the entire year, so will take us through the end of the year to realize that uptick.

I just want to clarify that point. If you think it is going to carry for the full year, does that mean you've been negative headwind here couple of quarters for the first half of the year. Are you saying that for the full year all-in, you're going to be neutral, so that you actually make up everything that was negative in the first half and part of Q3 as well?

Yes, that's correct.

Okay. And then, I guess -- I didn't understand what your explanation was on the Electronics piece, on the, I guess, production, there was something about moving something from that to a sales engineering and administrative category. Can you just repeat and clarify what you said about that?

Yes, part of the decrease that you see -- or increased production that you see in that bridge of pickup for the gross profit is related to a shift of people out of manufacturing overhead and into SE&A as a bit of a restructuring of that business. So the cost don't go away, they just shift into SEA. That already happened for the majority of Q2.

Okay. And then 1 more for me. Just on the price increase, you said you communicated about 6 weeks ago to customers. Do you think that's had any pre-buy effect that might have pulled sales from the second half into the second quarter?

Yes, just to clarify, and so we communicated it about 6 weeks prior to the date of effectiveness. So we communicated it about mid of Q2. To answer your question, yes, I assume probably that elevated order rate is a little bit, but I don't think it is substantial or material because we clearly see that the marketplace is very demand-driven and hardware is being deployed in applications around the world as quickly as it gets available.

Our next question comes from the line of Mig Dobre with Robert W. Baird.

First, if I may, just a clarification on guidance. I understand the revenue has reflected Custom. Can you sort of give us a sense as to what some of the other changes were, [core] and also due to Custom?

Yes, so -- we -- you see the increase on the Hydraulics revenue side that reflects, what we believe, this last 5 months of Custom's revenue will be. We also made an adjustment to line items for amortization, depreciation and interest on the additional debt that we pulled related to that. Additionally, we did adjust -- adjusted operating margins down about 1% and part of that is related to the fact that we're bringing in Custom into the fold and their operating margins are a bit lower than what the traditional Helios businesses are running at. The remainder of that decrease is related to some of the challenges that we're seeing on the gross profit side related to supply chain constraints and inefficiencies.

Right. So of the 100 basis points, Trish, what would you estimated is challenges with margin versus Custom itself?

Yes, about 40% of it is Custom and 60% of it is challenges that the traditional businesses are seeing.

Okay. And then on the depreciation and amortization, the increases -- the $2 million increases there are related to [customization]?

Yes.

Okay. I mean, am I to assume here that on the $20 million of revenue from Custom, there is a $2 million EBITDA contribution given where the margin is running?

Yes, that's fair.

Okay. I'm struggling to see exactly how this is going to be accretive then if we're talking about incremental E&A to assume that you talked about some of the $2 million and $2 million, but I guess, I'm going to take this offline to run through the numbers.

Yes, it's not a full $2 million pick on the amortization, depreciation. I think there were some adjustments also related to the purchase accounting for Faster, especially on the amortization side and some adjustments to depreciation for the traditional business given some of the capital that's coming on board.

Okay. I see. Then, maybe switching to the base business in the quarter. When I'm looking at these gross margin bridges that you provide on Slide 12 and what is it, Slide 10, which -- they're really helpful. So thank you for those. If I'm excluding the material cost-reduction currency acquisitions, logistics, all these items and I'm just looking at sales volume and mix impact, it looks to me like the incremental margin, gross margin in both Hydraulics and Electronics were quite weak. I mean, it was something like 32% in hydraulics, 22% in the electronics and pretty material step down from last quarter. So I'm kind of scratching my head, trying to figure out exactly what happened here and what gives you sort of the visibility and the expectation that in the back half, we're going to see sort of better pull-through on this particular item, sales volume and mix.

As a reminder, on the Hydraulics gross profit, there was a charge for inventory step-up at Faster, about 3-point -- $3.5 million, that's included, I think, in the number that you're looking at.

That's included in the $1.3 million.

No, it's not included. It's included in the calculation on the financial statements. It's actually not on this bridge. It would be part of the $13.9 million. It would be a reduction to $13.9 million.

Right, but I'm not talking about the $13.9 million. So on Slide 10, I'm talking about the $1.3 million contribution from sales volume and mix. As I understand that you're basically saying that on the core volume that you delivered year-over-year, this contributed $1.3 million to gross profit, right?

Right.

Yes.

Right, so if that's the case, then what we're talking about here is that is an implied incremental gross margin of 30-some percent -- about 32.5% last quarter, using the same math, you did something like 43%. So it's either that the mix -- maybe the mix is different, maybe there's something else that's going on here from one quarter to another, but the point is that even if your pricing comes through in the back half and offsets your material cost at 1.4% headwind, the core business has to improve significantly. And I am wondering, again, how do we get there and kind of what happened in the quarter?

So in looking at the volume and the mix, it was offset by sales incentive. So as you recall the historic Sun business has always had a large expedite premium. Obviously, with our backlog in past due we are not recognizing that expedite premium in the current quarters. And we also have a decrease in average sales price because of the volume of purchases, we have volume discount amount. So as volumes go up, the discount becomes higher as well as some of our regional allocation of sales, which sometimes have different margin profiles as well. So those sales incentives pulled off at least $1 million in Q2.

Okay. Do you have any price increases planned for Electronics or was that comment only for Hydraulics?

That comment was only for Hydraulics. The Electronics business price increase at the beginning of the year for a portion of the business, that's primarily related to distribution sales. They have a high amount of OEM sales, so price increases are kind of set by the contracts with the OEMs directly. So we have not been able to affect pricing changes this year in the Electronics business other than the small price increase that went to distribution at the beginning of the year.

As we pointed out last time, the opportunity for pricing changes is with release changes or with new projects coming. We talked about it at the last call.

Right. Two more for me. So kind of going back on your comments, vis-à-vis the backlog in Hydraulics, can you sort of give us a sense here for the magnitude that what we're talking about here, maybe dollar magnitude or however you want to frame it in order to get a little more comfortable with the growth rates on top of comps in the back half?

Yes, I mean, we don't want to go into specific backlog or order dollar numbers. But I mean, I can tell you that we have seen order intake at record levels as we have never seen in the past and even if we do the comparison to peer group, so we see clearly elevated order levels here. That's the main reason, obviously, why the back half, the second half of the year is stronger than the first half, whereas, this was different in the past, as you know, very well, Mig.

Okay. Then, maybe last question on Custom acquisition. So I'm trying to understand that business a little bit better. How much of what Custom does is are some of these value-add services that you mentioned versus just pure distribution revenue, and is there any sort of channel conflict that might be created here, ?how -- what does it mean for any of the other relationships that maybe Custom would have had other OEMs? How should we think about that?

Yes, so first of all, I mean, the majority of the business is value-add, project-based driven, value-add engineered business. There is also a portion of component sales, but the vast majority is engineering-driven businesses. And to the second question, the business there is spread out over many, many manufacturers there and there is no conflict with any other supplier in this case. We did thorough analysis during the due diligence process and that's all -- that's okay.

Our next question comes from line of Brian Drab with William Blair.

This is actually Joe Aiken on for Brian this morning. I was wondering if you talk a little bit more about one of your growth opportunities, which has been to penetrate geographies, where you've historically been weaker. I know you touched on the increased demand in all end markets on the slide. I was just wondering if you can talk a little bit about the gains you've made in this initiative in 2018.

Yes, sure. I mean, we have started about 2 years ago, focusing on some of those geographies. We refer to them as white spots. So that's historically areas where we hardly had any revenue. In this particular case here, obviously, where we are aiming to leverage the position we have with Custom Fluidpower in Australia and try to enter into the Southeast Asian marketplace. Just to give you a practical example, in Southeast Asia, until 3 years ago, I think, we had one single distributor in the entire region. So what we did over the last 2 years, 18 months, we added 4 distributors and 3 integrators, so in the meantime we have 10 channel partners across Southeast Asia, that's mainly Thailand, the Philippines, Indonesia, Vietnam, these countries that are neighboring Australia so to say. So what we're trying to do is here, on one hand, we are signing up channel partners. We will also put some own boots on the ground there, and then, of course, it will be heavily supported out of Australia because this is where we have the engineering capabilities across those 8 offices scattered across Australia. If we look at Custom Fluidpower, their largest office is actually in Mackay that's in the Northern Territory, in Northern Queensland of Australia, that's closer to Indonesia than it is to Sydney. And with their capabilities, they can then help us to better penetrate to Southeast Asian market. You asked in general, if I understand your question correct about this type of markets or geographies, obviously, we are trying to -- additional things in other geographies as well in India, where we have a presence already, but we are still adding people there, signing up channel partners there, so we want to have a better penetration of Indian markets as well. So these type of emerging markets, where a lot of machine building and equipment manufacturing is taking place now, we want to make sure that we are well positioned in those geographies. Does that answer your question?

Yes, thanks for the color. That was very helpful. And then just a quick follow-up, how was your backlog in each of the businesses, Hydraulics and Electronics? How was the backlog compared with this time last year?

Faster, I'm not 100% sure, but backlog also has gone up at least since we did the due diligence fourth quarter last year. CVT, so Sun core business has gone up considerably because of the high order intake that we have been seeing particularly over the last 9 months. And in the Electronics, it's gone slightly up, but not significantly higher than about a year ago.

Our next question comes from the line of Adam Farley with Stifel.

I wanted to follow back up on the sales incentive question for Hydraulics orders. Were there any charges or liquidated damages on past orders or do you expect to see anything there or was it just delayed orders?

It's just the way it fell in place. So there is none that we're not expecting anything for the future.

Okay. Perfect. And then kind of shifting gears for Electronics. I saw the press release called out sales initiatives and new products driving part of the growth, what type of new technology offerings and products you guys are having success with?

Yes, so that's still in line with pretty much the successes that we have seen last year. I mean, we are launching about 10 new products every single year now, the last 2 years back in 2017 and another 10 -- roughly 10 in 2018 here as well. And it's still the same modus operandi at the end of the day. I mean, deeply embedded with the engineering skills of the OEMs, particularly in those growth markets, marine to name one, and this is where we see most of the successes. And we continue to heavily invest into R&D to launch more products and as we move forward from here. So we pretty -- we feel pretty strongly that we have a winning formula in place is the way we go after business. So we will maintain exactly -- doing exactly the same thing that we have been doing over the last 20 months here.

Our next question comes from the line of Jon Braatz with Kansas City Capital.

Wolfgang, you made a comment about tariffs. I'm wondering if you're hearing anything from your customers about tariffs, whether they're being helped on the sales level, mind you, on the sales level, being helped or hurt by all this tariff talk.

Yes, I mean, as you can imagine, Jon, there's lot of disarray and, I would say, in the marketplace right now. So we've been analyzing the situation rather thoroughly over the 3, 4 weeks. So since July 6 actually, since the major announcements have been coming out. And yes, to answer the question, I mean, we are hearing from customers and from OEMs and obviously also from channel partners that are dealing with end customers and with OEMs. And the message, I think, is mixed at this stage, I mean, there are circumstances, where OEMs have understanding and will accept it. And I think there is -- there are circumstances, where people will also push back. So every case here is a little bit different. It's a very -- this's a highly complex topic, where today nobody has clear transparency to be quite honest. Our assumption is that -- we said we notified our customer base. I mean, if we don't directly import anything that falls under the tariff, but if we have -- if we're ending up here with cost increases, we would have to have pass it on, so we notify the customer base.

Okay. Tricia, on your amortization guidance of about $23 million, you had $10 million for the first half, including $8 million in the second quarter alone. If I would extend that $8 million per quarter in the second half, it would be little higher than that $22 million, were there some one-time amortization charges in the second quarter that won't continue?

Yes, there were some one-times for Faster related to backlog that come off relatively quickly.

Okay. Okay. All right. Okay. And where did you include the 3-point -- what line item did you include the $3.7 million in acquisition costs and financial -- finance cost?

That would have been in SEA.

All-in SEA?

Yes.

Okay. All right. And then, looking ahead into the second half, are you -- do you anticipate any additional onetime transaction costs or financing costs or anything like that in the back half of the year?

We do still have some step-up for inventory related to the Faster acquisition, that will take place in Q3, about $2 million that will hit in the cost of materials line, our gross margin. Other than that, there's not a lot that we're anticipating. We will have some costs in the third quarter related to the acquisition of CFP, but it won't be to the degree of the cost that we saw with Faster since it was a smaller acquisition.

Ladies and gentlemen, this concludes today's question-and-answer session. I would like to turn the floor back to management for any closing comments.

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

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.