Helios Technologies - Q2 2023

Transcript

Operator (participant)

Greetings. Welcome to the Helios Technologies Second Quarter 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tania Almond, Vice President of Investor Relations and Corporate Communications. Thank you. You may begin.

Tania Almond (VP of Investor Relations and Corporate Communications)

Thank you, operator. Good day, everyone. Welcome to the Helios Technologies Second Quarter Financial Results Conference Call. We issued a press release announcing our results yesterday afternoon. If you do not have that release, it is available on our website at hlio.com. You will also find slides there that will accompany our conversation today. On the line with me are Josef Matosevic, our President and Chief Executive Officer, and Tricia Fulton, Executive Vice President and Chief Financial Officer. They will spend the next several minutes reviewing our second quarter results, discussing our progress with our augmented strategy, reviewing our updated outlook for the second half of 2023. Then we will open the call to your questions. If you turn to slide two, you will find our safe harbor statement. As you may be aware, we will make some forward-looking statements during this presentation and the Q&A session.

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 have been provided in our latest 10-K filing, as well as our upcoming 10-Q to be filed with the Securities and Exchange Commission. You can find these documents on our website or at sec.gov. I'll also 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 with non-GAAP measures in the tables that accompany today's slides. Please reference slides three, four, and five now.

With that, it's my pleasure to turn the call over to Josef.

Josef Matosevic (President and CEO)

Tania, thank you. Thanks to everyone joining us. Our global team has stepped up to the plate and delivered. We had strong sequential growth in the quarter, with revenue up 7%, including 6% organic growth over Q1. Operating margin increased 140 basis points, while we continued investing to integrate our acquisitions and expand our capacity to meet growing customer demand. This translated to our bottom line increasing 21%. Thank you once again to our global team for their great performance. We have methodically invested over the last three years to develop or acquire new technologies, close product gaps, fill in geographic white spaces, and drive opportunities for growth by expanding our addressable end market. All this work is on the verge of bearing fruit. Currently, we are in our next phase, preparing for another growth cycle, and we are accelerating this transition.

Our customers' appetite for our new offerings is rapidly building. We want to be ready to address the indicated interest. As such, we are pulling forward investments and project timelines to enable this new capacity to take on step change growth starting in 2024. Our innovation and engineering excellence is the lifeblood of this organization. In the quarter, we closed our acquisition of i3, and we are already far along with the integration of i3 remote field service platform into the Helios solution. As a result, recurring revenue could start to show up in our P&L as early as next year. Helios continues driving technological breakthroughs, and we are well positioned to capitalize on many mega trends with our solution. This includes electrification, reducing emissions, and creating more energy-efficient solutions while continuously improving our user interface. Our long-term outlook at Helios is very bright.

In the short term, we are faced with some near-term challenges for the second half of 2023. We are seeing a slower than expected recovery in APAC. About 40% of our CVT Hydraulics volume goes through APAC, with two of our largest distributors located there. In North America, the distributor inventory levels have been trending in the right direction since the end of last year, but also a bit slower than expected. Additionally, our Hydraulic colleagues in Europe dealt with a plant fire in the second quarter. In July, they had to endure a tornado, hailstorm, and flooding. I am grateful to report all of our teammates are safe, which is most important. These macro issues, combined with the natural disasters, is pressurizing our top line for the second half. As a result, our near-term visibility is in fact less clear than our long-term outlook.

We are adjusting to current conditions while continuing to prepare for what we believe will be a very healthy 2024. Before I turn the call over to Tricia to review the financials, I would like to wish her well on her retirement. Tricia has been a cornerstone of our company during her 26 years of service, 17 years of which she served as the CFO. On behalf of the Board of Directors and the entire company, I would like to express our gratitude for her significant contribution. We wish her the best in her next chapter of life. Starting tomorrow, Tricia passes the baton off to our new CFO, Sean Bagan. Sean joins us most recently from a 23-year career with Polaris. He has a proven track record of building, growing, and transforming global businesses into highly productive and profitable operations.

We are excited to welcome Sean to the Helios family. I will now turn the call over to Tricia to review our financial results for the final time. She will hand it back to me for some closing comments. Tricia, please.

Tricia Fulton (EVP and CFO)

Thank you, Josef. Hello, everyone. On slides six through 10, I will review our second quarter 2023 consolidated results. We continued to deliver solid sequential improvements with revenue up 7%. Profitability also improved sequentially, with operating income and net income up 19% and 21% respectively. Adjusted EBITDA expanded 170 basis points, and free cash flow was up $15 million or 475%. We were able to deliver these results even as we drive investments in our future. By market, Australian mining began a recovery and grew significantly in the quarter, both sequentially and year-over-year. Encouragingly, health and wellness increased more than 20% over the first quarter, continuing to build off the floor we hit in the fourth quarter last year.

Agriculture, a large end market for Helios, saw robust growth in the quarter over the year-ago period and modestly improved sequentially. Recreational sales had a solid quarter with high single-digit annual growth and double-digit sequential growth. There were mixed results within the mobile market, with specialty vehicles and construction being the top performers sequentially. As you might imagine, we can have variability from quarter-to-quarter within our market. Our strong revenue growth over Q1 2023 was driven by the Electronic segment, which was up 15%, while the Hydraulics segment was up 3%. Year-over-year, Hydraulics was up 7%, and if you exclude health and wellness, Electronics increased 5% over last year's second quarter. Geographically, we saw growth across all regions sequentially, led by the Americas at 10%. EMEA was 4% growth and APAC at 3%.

Compared with last year, revenue decreased both in EMEA and in the Americas by 5% each, and by 10% in APAC, reflecting macroeconomic conditions. Overall, we had nominal, unfavorable FX impact on revenue of $0.3 million in the quarter. Sequentially, gross profit grew 7%, and gross margin was unchanged over the first quarter. As we would expect on a year-over-year basis, the lower volume impacted our gross profit. The benefits of pricing net of material cost increases, acquisitions, and improved direct labor efficiency on gross profit were offset primarily by lower volume. Our SEA expenses sequentially were down slightly, but up $5.5 million, or 17% compared with the second quarter of 2022. As we have discussed, we are investing heavily in our growth plans and incremental SEA related to acquisitions, integration, growth, and new product development, which are driving the year-over-year increases.

As I mentioned, adjusted EBITDA increased 16% sequentially, and adjusted EBITDA margin of 22% was up 170 basis points over the first quarter level. Even as we make growth investments, we deliver top-tier EBITDA margins as an industrial technology company. Our effective tax rate in the second quarter was 22.9%, up slightly from the prior year based on the mix of earnings in various jurisdictions. Diluted non-GAAP cash EPS of $0.81 in the quarter reflects the impacts I've discussed, as well as a $0.09 impact from higher interest expenses compared to last year. Slides nine and 10 provide visual trends on overall key metrics for the past several quarters.

We estimate that supply chain constraints delayed $14.2 million in sales at quarter end, up sequentially from $12.4 million and down from $15.1 million in the year-ago period. On slide 11, you will find the highlights for our second quarter Hydraulics segment. Sales grew 7% over the prior year period. Acquisitions added $15.2 million. Sequentially, the segment grew 3% over Q1 2023. Gross profit increased modestly, driven by price, efficiency, and acquisitions, partially offset by rising material costs. Gross margin this quarter decreased 210 basis points compared with Q2 2022, primarily due to rising material costs and the margin profile of acquisition. SEA expenses increased by $4.3 million, or 23% year-over-year. The increases were driven by acquisitions as well as growth investments.

Please turn to slide 12 for a review of our Electronics segment. This segment is more concentrated in the U.S., so foreign currency usually does not have much of an impact. Sequentially, as mentioned, we had 15% growth in this segment. Annually, Electronic sales decreased by 24% to $75.2 million, as demand across all regions declined, primarily related to the softness in the health and wellness market. Excluding health and wellness, Electronics grew 5% over last year, driven by recreational, mobile, and agriculture markets. The Electronics gross profit of $26 million grew 24% sequentially, and gross margin expanded 260 basis points. Year-over-year, lower gross profit reflects the slowdown in the health and wellness market. Gross margin increased 150 basis points over Q2 2022 due to favorable sales mix and material costs.

SEA expenses increased sequentially 4% over the Q1 2023 level. Please turn to slide 13 for a review of our cash flow. We had strong cash generation in the quarter, with $28.8 million in adjusted cash from operations. Cash and cash equivalents were $37.5 million, providing us sufficient liquidity. CapEx of $10.5 million, was 5% of sales for the quarter, at the upper end of our expected range to support our growth and expansion plans. Adjusted free cash flow was $68.8 million on a trailing 12-month basis, with a conversion rate of 100%, compared with 79% for the full year 2022. You can see on slide 14 that we have a solid balance sheet and financial flexibility to execute our strategy for growth. Total liquidity at the end of the quarter was $221 million.

Our net debt to adjusted EBITDA leverage ratio was 2.7x, ending the quarter. As you know, we have a well-established track record of managing our leverage ratio as we execute on our acquisition strategy. As we increased above our target level for recent acquisitions, we have been able to quickly de-lever back to or below our target leverage ratio of 2x based on our cash generation. Before I hand it back over to Josef for a review of the outlook and closing comments, I would like to express my gratitude to each and every member of Helios, past and present, for their role in what has been a rewarding career for me. I have had the honor and privilege to work with so many exceptionally talented and brilliant people throughout the years.

I also want to thank all of you on this call as well for being with me on this great journey. Importantly, I have great confidence in the future of Helios, the power of our strategy, and the capabilities of the team to execute on them. Please reference slides 15 to 17 as I hand it back to Josef.

Josef Matosevic (President and CEO)

Thank you much, Tricia. Again, we truly appreciate your dedicated service, first to Sun Hydraulics and then to Helios over so many years. We are moderating our outlook for the second half of the year, giving the factors I mentioned that have reduced near-term visibility. We now expect revenue in the range of $880 million-$900 million, implying the second half will be similar to the first half. We expect more weighting in the fourth quarter versus the third. As a result of the accelerated capacity expansion, we are investing over $10 million. With these revenues and investment expectations, we are moderating our adjusted EBITDA target for this year to $187 million-$196 million, still a healthy 21%-22%.

We intend to get to the mid-20s and beyond on adjusted EBITDA margin over time. We are downshifting our gears in the short term to absorb the one-time macro factors and build momentum to climb our next growth slope. There are clearly a lot of great things coming together at Helios. We are executing against the pillars of our business system. The second quarter demonstrates our ability to protect our business and margins while investing for the future. As we think and act globally, we efficiently leverage our expanding footprint through our new regional Centers of Excellence. We are diversifying our end markets and revenue through our new innovations and solutions to grow wallet share. While our team continuously demonstrate their dedication and tenacity to our shared purpose, we develop our talent by fostering a diverse and customer-centric learning organization.

We have our sights set on driving shareholder value far into the future. As I said earlier, our future is very bright. With that, let's open up the lines for Q&A, please.

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question comes from the line of Chris Moore with CJS Securities. Please proceed with your question.

Chris Moore (Senior Analyst)

Hey, good morning, guys. Thanks for taking a couple questions. Yeah, maybe I'll start with Josef. Josef, can you-- Just hoping you could talk a little bit more about what's transpiring this year. You know, what have you seen so far? Kind of what, what you expect for the rest of the year into 2024 and beyond with, with the investments that you're making?

Josef Matosevic (President and CEO)

Hey, good morning, Chris. Certainly, let me break this down into maybe two parts. The first part is just addressing the current state and the headwinds we are seeing and have been seeing, you know, going into 2023, and then switching over to the more exciting part, 2024 and beyond. When we entered this year, you know, on the OEM side, we usually have pretty good visibility, and that is panning out to be exactly what we expected. On the distributor side, which is very heavily weighted on our Sun Hydraulics CVT business, in North America, you know, we saw elevated inventory levels, but they started to come down pretty nicely. The trend clearly showed month-over-month that the inventories are coming down, and there will be a reorder pattern back to somewhat of a normal.

Then, you know, we had substantial conversations with our distributors in Asia, specifically in China, and there was a pretty good sentiment that the recovery will start taking shape, you know, in Q1, ramping up into Q2 and continuing into Q3. We obviously baked this in the forecast and, and, and clearly we own this, I own this. You know, having gotten that customer feedback, we anticipated stronger orders coming out of Asia, since 40% of our Hydraulic CVT revenue goes into Asia, specifically into China. That didn't pan out. That's on us. We own that. Following by, by, our marine demand has been very stable, but tempering off slightly.

Not falling off the cliff, but tempering off and, and the Balboa business in the health and wellness showed very strong signs of recovery, you know, in Q1, going into Q2, and now kind of plateauing off at, at, at levels we saw in Q1 and Q2. All in, that's what drove us to kind of be a little bit more conservative on the forecast, just by not having enough visibility in the second half and not knowing if China will really recover this year or not recover this year. That's kind of. That, you know, naturally, you know, when you add those three factors between, you know, 40% of volume going into China, you know, distributor inventory is still slightly higher than expected.

You know, we lose leverage on the top line and then, you know, to add a little bit more flavor to that story, to our current state, we had a very unfortunate situation in Europe where we literally lost 10 production days of manufacturing, followed by mother nature kicking in and adding a few more days of loss. All in, that's what drove our pullback in terms of top line. That kind of summarize, Chris, I hope, your first question of the current state. You know, going into 2024 and beyond, you know, we have been saying now for a year and a half, a couple of years, we have methodically worked with some customers.

One is a current customer to our new customer to us, but more importantly, they're also a very new market to us. You know, we went through the initial RFQ stage to an RFP stage, and the appetite got much stronger as the customer needs to make certain strategic decisions before year-end. That accelerated, obviously, our investment portfolio. As part of the processes, they wanna see and review our operations and the lines and the equipment in place before we can hit the ground running. That, that was the main reason why we are adding over 200,000 sq ft of capacity to be able to absorb that new incoming business. That has been in play for the last 1.5 years.

It's, it's finally around the corner, and we're gearing up for that journey, and we have invested year to date over $10 million additional dollars into that, because we truly feel that is the right thing for Helios, and that is the right thing for our shareholders. That's kind of the two answers to your question, Chris.

Chris Moore (Senior Analyst)

Got it. Very helpful. What's the timing, on the additional capacity? Is that first half of 2024, or what do you see at this stage?

Josef Matosevic (President and CEO)

Yeah, our plans indicate, currently, our revised plans indicate that we will be completed by around Q1 of 2024. It's broken down into different geographic territories, Chris. Obviously, a lot of them is in North America between Daman and CVT. There is significant expansion going on in Europe at the Faster location. There's two different phases. Phase one, we're adding an additional 35,000 sq ft-40,000 sq ft, then there's another phase coming in 2024, where we, we will add another 100,000 sq ft. Faster, we'll go from 300,000 sq ft to 600,000 sq ft over time. Then we are standing up a brand-new facility next door to our current one in Mexico, adding another 75,000 sq ft.

If you extrapolate this into potential future orders, you know, we would never add capacity if we wouldn't feel comfortable the demand is coming. The answer to your question is, we should be complete with phase one in Q1 2024.

Chris Moore (Senior Analyst)

Got it. I appreciate that. I, I will leave it there. Thank you.

Josef Matosevic (President and CEO)

Thank you, Chris.

Operator (participant)

Our next question comes from the line of Jeffrey Hammond with KeyBanc. Please proceed with your question.

Jeffrey Hammond (Managing Director and Equity Research Analyst)

Hi, good morning, everyone.

Josef Matosevic (President and CEO)

Morning, Jeff.

Tricia Fulton (EVP and CFO)

Good morning, Jeff.

Jeffrey Hammond (Managing Director and Equity Research Analyst)

Best of luck to you, Tricia.

Tricia Fulton (EVP and CFO)

Thank you.

Jeffrey Hammond (Managing Director and Equity Research Analyst)

I, I wanted to make sure I understand these accelerated costs. Looks like you had $2 million in Q1. Want to know what, what the accelerated, you know, costs were in Q2, and I think you said $10 million in second half. Just wanna verify these, you know, one, what do they entail in terms of, you know, pulling it forward expansion and, and just, you know, to be clear that these are all kind of one-time and go away next year?

Josef Matosevic (President and CEO)

Yeah, Jeff, certainly. You know, year to date, we accelerated costs, you know, around $10 million. Those are OpEx costs, meaning, you know, certain equipment, expediting costs, freight, extra contractors, extra people, standing up the manufacturing cells based on the agreement we have with our customers, where we have visual work aids, where we have work instructions, you know, ergonomic addressable items. Those type of costs is, which drives a lot of dollars, and in many cases, when we ordered the material, the lead times in terms of equipment was much, much longer than we could have waited, so we, we had to pay premium to get the equipment in.

Once that is fully, fully paid, Jeff, the answer to your question is yes, those will be one-time costs, and we certainly expect that to pay back with accelerated and better margins going forward.

Jeffrey Hammond (Managing Director and Equity Research Analyst)

Okay, it's $10 million in first half, $10 million in second half?

Josef Matosevic (President and CEO)

$10 million in first half, that's in the books. Not sure the $10 million will be exactly in the second half, because we, we're gonna watch it very closely here, Jeff. We had a, you know, a couple forecasting boo-boos here when we anticipated strong orders, you know, from the international markets, and we, we obviously own that, so we wanna be a little bit careful, you know, how much do we spend and still protect the margins. There clearly will be additional one-time dollars in the second half in, in the area of $4 million-$6 million, $4 million-$6 million, $4 million-$8 million. Tricia, does this sound right?

Tricia Fulton (EVP and CFO)

Yeah, you know, we still have a pretty big range on the top line of our guidance that, you know, reflects the uncertainty that we have in the top line. At the lower revenue levels, we understand that we can lose a little bit of leverage, so we baked that into the assumptions as well.

Jeffrey Hammond (Managing Director and Equity Research Analyst)

Yeah. Okay, then, you know, you've been talking about this, obviously you're pulling forward, you know, $15 million of costs. You know, I think you mentioned in the, in the prepared remarks, kind of step change, you know, opportunity. I, I just want you to better frame the opportunity around, you know, the, you know, 2024 and kind of the, you know, the pull forward and all the, all the capacity expansions.

Josef Matosevic (President and CEO)

Yeah, Jeff. What we've been talking about here is, is a integrated systems package that two of our customers have been working with us for north of 1.5 years now, and one customer had that product for many different elements of the product insourced, and now they have decided to outsource this as an integrated package. We are due to submit final prototypes next Thursday, and the feedback has been very strong and very complimentary. The other customer is more on the commercial food service side, where we have worked very closely together and feel comfortable now that we are far along, that step change will start to occur in 2024.

From a monetary standpoint or dollars, so to say, look, when you add 200,000 sq ft globally, you know, you're talking about a pretty nice size business, you know, starting in 2024-2027, and we feel pretty good that this is going to happen.

Chris Moore (Senior Analyst)

Okay, thanks. I'll get back in queue.

Josef Matosevic (President and CEO)

Thanks, Jeff.

Operator (participant)

Our next question comes from the line of Mig Dobre with Baird. Please proceed with your question.

Mig Dobre (Associate Director of Research)

Thank you. Good morning. Trish, all the best to you. Working with you for the last 13 years, 14 years, I've always really appreciated your help and insight. Good luck.

Tricia Fulton (EVP and CFO)

Thank you, Mig. I appreciate that. It's been a pleasure.

Mig Dobre (Associate Director of Research)

I, I, guess where I would like to start, I'm, I'm a little bit confused about on what's going on with capacity.

Josef Matosevic (President and CEO)

Mm-hmm.

Mig Dobre (Associate Director of Research)

There are a lot of numbers that, that are flying around there, Faster, going from 300,000 sq ft to 600,000 sq ft. Balboa, or the facility in Mexico, adding 75,000 sq ft.

Josef Matosevic (President and CEO)

Mm-hmm.

Mig Dobre (Associate Director of Research)

Maybe, maybe we can, we can sort of take a 30,000 foot view here, and, and have you outline for us what percentage increase in your square footage or capacity are you currently on undergoing versus maybe where we were one year ago? What exactly does that mean for the company's ability to support revenue or, or, you know, essentially, what are you scaling your business up to?

Josef Matosevic (President and CEO)

Yeah, good morning, Mig. I heard the first part of your question. I don't know if we had a technical issue here, but I apologize. I didn't hear the second part.

Mig Dobre (Associate Director of Research)

Yeah. I, I, I can repeat the question. I'm, I'm, I'm trying to understand the, the changes in capacity here, because, because there's been a lot of numbers that were kind of like floating around between Faster and Balboa and so on. Can, can you maybe talk about what percentage of your existing capacity are you adding? And, and what are you scaling this business up to? What, what sort of annual revenue run rate will this capacity be able to support?

Josef Matosevic (President and CEO)

Okay. For an example, in Indiana, we are going in Mishawaka here in terms of now becoming a Center of Excellence for our manifolds. We are going from 40% to pretty much 70% of capacity. You know, everywhere we're adding capacity, Mig, is based on percentage of volume increase, and also our strategy of Center of Excellence, the regional structure coming to play and in the region, for the region. As we look at the new incoming business with the step change, we are talking about integrated package. When we extrapolated our overall opportunity for the next three years to come and the volume associated with that, and how much we need per square foot, that's what drove the investment globally.

In so many words, with the one particular customer we are working on, there will be absorbing or purchasing an integrated package that has different sizes of manifolds, some cartridge valves, Faster couplings, wire harnesses and Enovation Controls. Every business has a piece of the square footage assigned to that volume, and that's how we came up with the capacity and the hours needed to manufacture that product.

Mig Dobre (Associate Director of Research)

Capacity is going up, what? 20%, 30%?

Josef Matosevic (President and CEO)

It's around 25%, globally.

Tricia Fulton (EVP and CFO)

From a pure square footage perspective, but I think the opportunity really is how we can better utilize all of the square footage that we have with this additional space and the way we're laying out the plants with the additional space.

Mig Dobre (Associate Director of Research)

So-

Tricia Fulton (EVP and CFO)

Hopefully getting more, more out of the 25% than 25%-

Mig Dobre (Associate Director of Research)

Right.

Tricia Fulton (EVP and CFO)

... top line.

Mig Dobre (Associate Director of Research)

I, I appreciate that. And what, what, what exactly is your guess here in terms of, or your goals, in terms of what the business will be able to support as far as total revenues are concerned? Are we talking $1.2 billion, $1.3 billion or more?

Josef Matosevic (President and CEO)

We're talking about an additional... I knew this question will come, so, you know, I'm gonna learn a little bit here from the previous session, the previous forecasting assumptions we have made in particular to my opening comments in Asia. I would say it's around $300 million in addition to our current guidance.

Mig Dobre (Associate Director of Research)

Understood. You're adding the capacity now, the revenue is coming in the future. Are we to infer then that at least until this revenue starts to really materialize and reach kind of like the full rate capacity, we should be thinking that there is going to be an under absorption element from a cost standpoint, which is going to pressure margins into 2024?

Josef Matosevic (President and CEO)

Well, I think, you know, our manufacturing strategy that we have laid out, and you guys understand really well, offsets a significant piece of that, Mig. You know, we also have other levers that we are pulling as we speak to really minimize that risk. At the same time, what we don't want to do is, you know, start cutting in the SEA structure and SEA people, because we're going to need those people as the capacity is finished. Those are all good, they trained folks. I think we have the risk that offering based on our new revised guidance here, and feel we can, we can maintain that. You know, with a little bit of, a little bit of uptick in the recovery in Asia, and, you know, when you look at the distribution inventories, they are coming down.

They are now around $64 million, and traditionally, when they drop down to $61 million, $60 million, you see a stronger reorder pattern. We feel if the volume comes back just a little bit, we can absorb that, those investments and hold our margins.

Tricia Fulton (EVP and CFO)

Mig, this goes back to the comments that we made the last few quarters about step level investments. This really is a step-level investment, and it, it'll take a little bit of time to absorb it. But when Josef talks about these new system opportunities and diversified market opportunities, we recognize that they could come in in, in big chunks. So we need to be able to have the capacity available to be able to take on those orders and to fulfill that demand that's in those markets, Mig.

Mig Dobre (Associate Director of Research)

I see. I want to ask a question about the guidance. You know, you reduced revenue $35 million at the midpoint, if my math is right.

Josef Matosevic (President and CEO)

Yep.

Mig Dobre (Associate Director of Research)

I'm curious to understand how your outlook has changed in Hydraulics relative to Electronics, so what the moving pieces to that $35 million? Then on EBITDA, you know, you cut EBITDA by about $30 million, and, you know, here, I guess I can understand about $10 million of it, right, coming from the lower revenue and volume. Are we to infer that the remainder is all of it associated with these investments? I guess maybe I'm asking Jeff's question in a different way here. Or is there something else other than the investments that's kind of contributing to this EBITDA cut? A lot there, both revenue and EBITDA, though, I'd appreciate that.

Josef Matosevic (President and CEO)

Yep.

Tricia Fulton (EVP and CFO)

I'll start, Mig, and then Josef, you can add on. We were pretty specific in our guidance at the $925 million midpoint. I don't really think we see a whole lot of difference on the Electronic side. Balboa is still about where we thought it was going to be for the year. On the innovation side, we're still up high single digits in our forecasting. The down side, or the constraints really are coming more on the Hydraulics side. We're seeing it in the Sun business related to inventory that we've already talked about, as well as a little bit of a slowdown in the acquisition companies for Daman and Schultes from our original estimates, which both are in the Hydraulics segment. That's really what's driving the majority of what you're seeing in the change in guidance that's coming from the Hydraulics side.

If you look at the EBITDA, certainly, you know, we have the investments that we originally thought maybe were going to curtail a little bit more in the back half of the year, but we expect to continue now. That's, you know, taking into the EBITDA a bit. At the lower revenue levels, we're also losing leverage. We recognize that we're going to have to possibly adjust the cost basis as we go forward if, if we're at the lower end of that range. But certainly it, it is cutting, at least on a short-term basis, into profitability, recognizing that we need to make the investment so that we have 2024 set up well to take on this additional potential revenue that we're seeing from the systems sale and diversified markets.

Mig Dobre (Associate Director of Research)

Okay. My final question: it sounds to me like you're, you're saying that in the Americas business, the primary headwind seems to be destocking. If I understand you correctly, you're to the level of channel inventory now, where that suggests that destocking runs, runs its course. Please correct me if I'm wrong about that. Are we to think then that revenues in the Americas improve sequentially in the back half relative to where you were in Q1? Also in Asia Pacific, how are things trending as we're looking at the month of, you know, July, August? I mean, have things changed either for the good or bad relative to what you've observed in Q2? That'll be it. Thank you.

Josef Matosevic (President and CEO)

In terms of channel inventory, Mig, the data points have been trending in the right direction over the last three months. It started off at $78 million, dropped down to $74 million. Now it's in the 60s. If we would play that data point and put an assumption on it, your comment around, could there be an improvement in the back half? Yes, there could, as long as the trend goes and continues in the right direction. We are baking in certainly risk, just learning from our first half and learning from the feedback we have gotten last year versus where we are here on our actual basis. In Asia, it's, how are the orders trending right now? Pretty much the same that we have seen in the first half.

There hasn't been any improvement yet, but look, I mean, we are looking at this as a near-term, short-term impact. You know, that market will turn, and the inventories are coming down, and eventually this will work itself out of the system, and we're gonna get back to the leverage we usually get with the volume.

Mig Dobre (Associate Director of Research)

Okay. Thank you.

Josef Matosevic (President and CEO)

Thank you, Mig.

Operator (participant)

Our next question comes from the line of Nathan Jones with Stifel. Please proceed with your question.

Nathan Jones (Managing Director and Senior Industrials Equity Analyst)

Good morning, everyone.

Josef Matosevic (President and CEO)

Morning.

Mig Dobre (Associate Director of Research)

Morning, Nathan.

Josef Matosevic (President and CEO)

Morning, Nathan.

Nathan Jones (Managing Director and Senior Industrials Equity Analyst)

Maybe I'll ask a question about the margin profile here. Typically, you guys will see new products come out at better margins. Is that the case with these, you know, large contract awards that you're looking at, you know, hopefully to, to get awarded here in the back half and ramp up into next year? Are you anticipating those to be accretive to the gross margin profile, and, and any color you could give us on how accretive they might be?

Josef Matosevic (President and CEO)

Yeah. Good morning, Nathan. Sorry for the disruption here. The answer to your question is, the way we have quoted this business, and we spend a lot of time on the pricing of the offering, and quite honestly, didn't know exactly how to price it, considering where the supply chain was, is, and in, and in some cases will probably maintain for a longer period of time. The answer to your question is, yes, it will be a healthy margin profile.

At the same time, we have, as you saw, the i3 acquisition brought significant value to our offering, with a service system component that's actually patented and patent-protected, and the adoption rate has started, and that's kind of part of our journey as well, that will further improve our margin profile starting in 2024, as, as i3 will contribute to the journey pretty nicely, and that will extrapolate over the next two or three years into something obviously much larger. As we have said in the past, we want to create a recurring revenue arm for our offering.

Nathan Jones (Managing Director and Senior Industrials Equity Analyst)

Maybe a follow-up on the, on the, on these potential new contracts, new awards here. I mean, we're obviously talking about very significant numbers, and you've talked about, I mean, the words you used in the, in the, prepared remarks were step function, changing growth. Are these contracts, you know, something that go, you know, from zero to 100 fairly quickly, or do they ramp up over a period of quarters? Just any more kind of color you can give us on your expectation for how those layer in over the next year or two?

Josef Matosevic (President and CEO)

Yeah, yeah, look, you know, when you look at our customer base, Nathan, you know, no customer is really larger than 4%-5% in our offering currently. You know, one of those wins, one of those customer wins, will drive that to be our, you know, largest customer, with one of the wins that we are targeting. We certainly, you know, really look forward to that, that step-up journey starting in 2024. Once again, this is one customer we're talking about.

Nathan Jones (Managing Director and Senior Industrials Equity Analyst)

The question is: How would that kind of ramp up? Is it something where you would be expecting production to go, you know, from... You've talked about this being a new customer, or at least a couple of them being new customers. Are they something that, you know, would ramp up to, you know, 10% of, of the contract value in the first year or 20% in the second year? Or does it ramp up more quickly than that? How, how are you expecting that contract or those contracts to ramp up?

Josef Matosevic (President and CEO)

Yeah, our expectation, you know, and this is exactly why we are pulling this capacity ahead. To be able to answer this question, Nathan, with factual data, we need a little bit more time, but it's not gonna start with, you know, $50 million in 2024. You know, we got to finish our capacity. That is so vital to what we, we can commit to our customers as they want to go faster than we can actually absorb right now. If you wouldn't mind, just allow us a little bit more time to be able to answer that question once we get our capacity closer to the, to where it needs to be.

Nathan Jones (Managing Director and Senior Industrials Equity Analyst)

Just one last one.

Tania Almond (VP of Investor Relations and Corporate Communications)

Nathan, I was just gonna add a little color there, too. You know, we would expect, to your question, just about how that comes into the P&L. Typically, it will phase, you know, over a period of time. It's not like it all comes in on day one. You know, once you get that customer signed in, in the door, it will, it will build over, you know, potentially a, a multi-year period. As you get multiple customers in the door, you know, you start having that layering effect. That can help add to that step-level function that we're talking about for 2024.

Nathan Jones (Managing Director and Senior Industrials Equity Analyst)

If you're talking about customers having to make strategic decisions for 2024, these are things that, you know, you should be able to announce to us, or, or you know, the customer should have to move on before the end of the year. Is that right?

Josef Matosevic (President and CEO)

Yeah. One particular customer has to, has to start the changeover by September of actually this, I should say, sorry, one customer has to make a decision in September of this year for production years 2024-2027 and beyond.

Nathan Jones (Managing Director and Senior Industrials Equity Analyst)

Great. Well, I look forward to hearing some announcements in the near term then. Tricia, just add my best wishes for the future.

Tania Almond (VP of Investor Relations and Corporate Communications)

Thank you, Nathan. I appreciate it.

Josef Matosevic (President and CEO)

Thank you, Nathan.

Operator (participant)

As a reminder, if you would like to ask a question, press star one on your telephone keypad. Our next question comes from the line of Jon Braatz with Kansas City Capital. Please proceed with your question.

Jon Braatz (Senior Industrials Equity Analyst)

Good morning, everyone. Trish, I, too, want to wish you the best of luck in your retirement. It was. I enjoyed working with you, and congratulations.

Tania Almond (VP of Investor Relations and Corporate Communications)

Thank you very much, Jon. I appreciate it.

Jon Braatz (Senior Industrials Equity Analyst)

Just want to change the pace a little bit. The fire and the tornado in -- at the Faster operation, how is that impacting the second half of the year?

Josef Matosevic (President and CEO)

The second half, there should not be in terms of Faster in specific, and their expectations we have in place, will stay intact as we were able to get some help with our integrated supply chain. We are back up and running now. We originally planned for Faster actually to manufacture more product within the Hydraulic segment to offset some of the headwinds we are seeing with the CVT business, in particular, to Asia or to China, and still some elevated inventory levels in North America. You know, they were not able to do that through CVT, but certainly met all the expectations that we had on the Faster side. No impact to the second half.

Jon Braatz (Senior Industrials Equity Analyst)

Okay. Okay. Secondly, I think in, in response to one of the questions, one of the earlier questions about the accelerated investments, I, I think I heard you use the term phase one to describe some of this. Is there a phase two? Are, are there additional investments? Of, of course, there's always additional investments, but is there an additional heavy investment program following this investment, these investment decisions?

Josef Matosevic (President and CEO)

The comment about phase one and phase two, Jon, was related to Faster. There's a phase one that is adding, you know, around 35,000 sq ft-40,000 sq ft, and then there will be a phase two that will add around 100,000 sq ft. It's all driven based on upcoming demand, organically, generated through this, product offering system sales and also a data science piece that we have been working with the Faster and the Hydraulics team to integrate with our customers.

Jon Braatz (Senior Industrials Equity Analyst)

Okay. Then one final question. After all this investment is completed and, and the new programs begin and so on, would you... Is there a sense that your, your profitability will be elevated, because of the investments and, and more so than maybe what you were thinking, six months ago, a year ago? What kind of return are we gonna get on that investment?

Josef Matosevic (President and CEO)

Yeah, certainly. Look, I mean, our horizon hasn't changed, Jon. I know this is a bold statement, but we truly, as a team, believe in that. You know, when you couple all the manufacturing investments we have made prior to the capacity, expansion here, you know, creating the Center of Excellence, creating the regional structure, investing in new equipment, investing in supply chain, investing into new products and breakthrough technology, our horizon of being a 40% gross margin company and a 30% EBITDA company is not changing.

Jon Braatz (Senior Industrials Equity Analyst)

Okay. Okay. Okay. All right. Thank you very much.

Josef Matosevic (President and CEO)

Thank you, Jon.

Operator (participant)

Ms. Almond, there are no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Tania Almond (VP of Investor Relations and Corporate Communications)

Great. Thank you very much, operator, thanks everyone for joining us today. We appreciate your interest in Helios and look forward to updating all of you on our third quarter results in November. Please feel free to reach out to me with any follow-up questions that you have. Have a great day.

Operator (participant)

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.