Helios Technologies, Inc.

Greetings, and 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, Tanya Allman, Vice President of Investor Relations and Corporate Communications. Thank you. You may begin.

Thank you, operator, and 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 Joseph Matuszewicz, 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, and 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 3, 4, and 5 now. With that, it's my pleasure to turn the call over to Joseph.

Tanya, thank you. And 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 demands. 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 markets. 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 offering 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 megatrends with our solutions. 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 23. We are seeing a slower than expected recovery in APEX. About 40% of our CVT hydraulics volume goes through APEX with two of our largest distributors located there. In North America, The distributed 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 planned fire in the second quarter. Then 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. Trisha has been a cornerstone of our company during her 26 years of service, 17 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, Trisha passes the baton off to our new CFO, Sean Bagans. 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 then hand it back to me for some closing comments. Tricia, please.

Thank you, Joseph, and hello, everyone. On slide 6 through 10, I will review our second quarter 2023 consolidated results. We continue 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 Q1-23 was driven by the electronics 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 volumes 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 SBA 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 plan and incremental SBA related to acquisition, 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 81 cents in the quarter reflects the impacts I've discussed, as well as the 9 cents impact from higher interest expenses compared to last year. Slides 9 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 hydraulic segment. Sales grew 7% over the prior year period. Acquisitions added $15.2 million. Sequentially, the segment grew 3% over Q123. 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 22, primarily due to rising material costs in the margin profile of acquisition. SBA 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 review of our electronic segment. This segment is more concentrated in the US, so foreign currency usually does not have much of an impact. Sequentially, as mentioned, we have 15% growth in this segment. Annually, electronics 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 22 due to favorable sales mix and material costs. SEA expenses increased sequentially 4% over the Q123 level. Please turn to slide 13 for a view 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. Cap up of $10.5 million with 5% of sales for the quarter. at the upper end of our expected range to support our growth and expansion plan. Adjusted free cash flow is 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 2.7 times 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 two times based on our cash generation. Before I hand it back over to Joseph for 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 Joseph.

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 to $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 targets for this year to 187 to 196 million, still a healthy 21 to 22%. We intend to get to the mid-20s and beyond and adjust the dividend margin over time, but we are downshifting our gears in the short term to absorb the one-time macro factors and build momentum to climb our next growth flow. 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 demonstrates 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.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 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.

Hey, good morning, guys. Thanks for taking a couple questions. Maybe I'll start with Joseph. Joseph, just hoping you could talk a little bit more about what's transpiring this year, What have you seen so far, kind of what you expect for the rest of the year into 2024 and beyond with the investments that you're making?

Good morning, Chris. Certainly, let me break this down into maybe two parts. So 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. So 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 would be expected. On the distributor side, which is very heavily weighted on our Sun Hydraulic CDT business, In North America, we saw elevated inventory levels, but they started to come down pretty nicely. So 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. And then 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. So we obviously baked this in the forecast, and clearly we own this, I own this. So, you know, having gotten that customer feedback, we anticipated strong 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 enough beyond that. Following by our marine demand has been very stable, but tampering off slightly. Not falling off the clip, but tampering off. and Tabogboa business in the health and wellness showed very strong signs of recovery in Q1, going into Q2, and now kind of plateauing off at levels we saw in Q1 and Q2. So 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. Naturally, when you add those three factors between 40% of volume going into China, 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, following by Mother Nature kicking in and adding a few more days of loss. So all in, that's what drove our pullback in terms of top line. So to kind of summarize, Chris, I hope your first question of the current state, going into 2024 and beyond, we have been saying now for a year and a half, a couple of years, we have methodically worked with some customers, some One is our current customer to our new customer to us, but more importantly, to also very new markets to us. And, 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. And that accelerated, obviously, our investment portfolio and as part of the process is they wanna see and review our operations and the lines and the equipment in place before we can hit the ground running. So that was the main reason why we are adding over 200,000 square feet of capacity to be able to absorb that new incoming business that has been in play for the last year and a half. It's finally around the corner, and we're gearing up for the journey, and we have invested year-to-date over $10 million additional into that because we truly feel that it's the right thing for Helios and that it's the right thing for our shareholders. So that's kind of the two answers to your question, Chris.

Got it. Very helpful. And what's the timing on the additional capacity? Is that first half of 24, or what do you see at this stage?

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 Damon and CVT. There is significant expansion going on in Europe. It's a faster location. There's two different phases. Phase one, we're adding an additional 35 to 40,000 square feet. And then there's another phase coming in 2024 where we will add another 100,000 square feet. So FAST will go from 300,000 square feet to 600,000 square feet over time. And then we are standing up a brand new facility next door to our current one in Mexico, adding another 75,000 square feet. If you extrapolate this into potential future orders, you know, we would never have capacity. We wouldn't feel comfortable. The demand is coming. So the answer to your question is we should be complete with phase one in Q1 2024.

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

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

Hi. Good morning, everyone. Good morning, Jeff. Best of luck to you, Tricia.

Thank you.

So I wanted to make sure I understand these accelerated costs. So it looks like you had $2 million in 1Q. Want to know what the accelerated, you know, costs were in 2Q. And I think you said $10 million in second half. want to verify these, you know, one, what's, 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.

Yeah, just certainly. So, you know, year to date, uh, we accelerated costs, you know, around $10 million and, uh, those are APEX costs, meaning, you know, certain, uh, equipment expediting costs, freight, extra contractors, extra people setting up the manufacturing sales based on the agreement we have with our customers, where we have visual work aids, where we have work instructions, ergonomic addressable items, cost is what 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 but 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.

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

$10 million in first half, that's in the books. not sure that $10 million will be exactly in the second half because we're going to watch it very closely here, Jeff. We had a couple forecasting booboos here when we anticipated strong orders from the international markets, and we obviously own that, so we want to be a little bit careful how much do we spend to protect the margins, but there clearly will be additional one-time dollars in the second half in the area of four to six, four to six, four to eight million dollars, Tricia, does that sound right?

Yeah, and, you know, we still have a pretty big range on the top line of our guidance that, you know, reflects some of the uncertainty that we have in the top line. So 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.

Okay, and then, you know, you've been talking about this. Obviously, you're pulling forward, you know, $15 million of costs. So, you know, I think you mentioned in the preparer remarks kind of step change, you know, opportunity. So I just want you to better frame the opportunity around, you know, the, you know, 24 and kind of the, you know, the pull forward and all the capacity expansions.

Yeah, Jeff, so. we'll be talking about here is is a integrated systems package that two of our customers have been working with us for north of a year and a half now and one customer had that product for many different elements of the product in source and now they have decided to outsource this is an integrated package and And 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 that change will start to occur. in 2024 from a monetary standpoint or dollars, so to say, look, when you add 200,000 square feet globally, you know, you're talking about a pretty nice-sized business, you know, starting in 2024 through 2027, and we feel pretty good that this is going to happen.

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

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

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

I appreciate that. It's been a pleasure.

I guess where I would like to start, I'm a little bit confused on what's going on with capacity. There are a lot of numbers that are flying around there. Faster going from 300,000 square feet to 600,000 Balboa or the facility in Mexico adding 75,000 square feet. Maybe we can sort of take a 30,000 foot view here 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 a year ago and what exactly does that mean for the company's ability to support revenue or or you know um essentially what are you scaling your business up to yeah good morning nick i heard the first part of your question i don't know if we had a technical issue here but it

I apologize, I didn't hear the second part.

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

Okay.

So for an example, in Indiana, we are going, and Michel Walker 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, regional structure coming to play and in the region, for the region. So as we look at the new incoming business with the step change we are talking about in the 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 investments globally. So in so many words, with the one particular customer we are working on, they will be absorbing or purchasing an integrated package that has different sizes of manifolds, sound cartridge valves, VESTA couplings, wire harnesses, and innovation controls. So 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.

So capacity is going up, what, 20%, 30%? It's around 25%.

globally.

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. Hopefully getting more out of the 25% than 25% top line.

I appreciate that and what exactly is your guess here in terms of or your goals in terms of what this what the business will be able to support as far as total revenues are concerned are we talking 1.2 1.3 billion or more we're talking about an additional new this question will come so you know I'm gonna learn a little bit here from

the previous forecasting assumptions we have made in particular to my opening comments in Asia, but I would say it's around $300 million in addition to our current guidance.

Understood. You're adding the capacity now, the revenues 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 underabsorption element from a cost standpoint, which is going to pressure margins into 2024. 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 need. And 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 because they're all good, they're trained folks. So I think we have the risk that offering based on our new revised guidance here and feel we can maintain that and with a little bit of a little bit of uptake in the recovery in Asia. And, you know, when you look at the distribution inventories, they are coming down. They are now around $61 million. And traditionally, when they drop down to $61, $60 million, you see a stronger reorder pattern. So we feel if the volume comes back just a little bit, we can absorb those investments and hold our margins.

And Nick, this goes back to the comments that we made the last few quarters about step-level investments. This really is step-level investment, and it'll take a little bit of time to absorb it, but when Joseph talks about these new system opportunities and diversified market opportunities, we recognize that they could come 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 market spaces.

I see. I want to ask a question about the guidance. So, you know, you reduce revenue $35 million at the midpoint, if my math is right. Yep. I'm curious to understand how your outlook has changed in hydraulics relative to electronics, so what the moving piece is to that $35 million. And then on EBITDA, you know, you cut EBITDA by about 30 mil, and, you know, here... I guess I can understand about $10 million of it coming from the lower revenue and volume. Are we to infer that the remainder is all of it associated with these investments? So 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? So a lot there, both revenue and EBITDA, though. I'd appreciate that.

So I'll start maybe and then Joseph you can add on. We were pretty specific in our guidance at the 925 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 downside or the constraints really are coming more on the hydraulic 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 slow down in the acquisition companies for Damon and Schultes from our original estimates, which both are in the hydraulic segment. So that's really what's driving the majority of what you're seeing in the change in guidance is coming from the hydraulic side. If you look at the EBITDA, certainly, you know, we have the investments that we originally thought maybe we were going to curtail a little bit more in the back half of the year, but we expect to continue now for this, you know, taking into the EBITDA a bit. But 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 we're at the lower end of that range. But certainly 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 system sale and diversified markets.

Okay. My final question. It sounds to me like you're saying that in the Americas business, the primary headwind seems to be destocking. And if I understand you correctly, you're to the level of channel inventory now where that suggests that destocking 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? And also in Asia Pacific, how are things trending as... We're looking at the month of July, August. I mean, have things changed either for the good or bad relative to what you've observed in Q2? And that'll be it. Thank you.

Yeah. So in terms of channel inventory, Nick, the data points have been trending in the right direction over the last three months. So it started off at $78 million, dropped down to $74 million, Now it's in the sixes. So if we would play that data point and put an assumption on it, you will 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. But 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, dead market will turn, and the inventories are coming down, and eventually this will work itself out of the system, and we're going to get back to the level that we usually get with the value.

Okay. Thank you. Thank you, Mike.

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

Good morning, everyone. Morning, Nathan. Morning, Nathan. 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 large contract awards that you're looking at? you know, hopefully to get awarded here in the backup and ramp up into next year. Are you anticipating those to be accretive to the gross margin profile and any color you could give us on how accretive they might be?

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 some cases will probably maintain for a longer period of time. So 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 it's kind of part of our journey as well that we'll further improve our margin profile starting in 2024 as i3 will contribute to the journey pretty nicely and they 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 maybe a follow-up on the on the um

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 prepared remarks were step, function, change, and 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. Yeah.

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

And 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, at least a couple of them being new customers. Are they something that, you know, would ramp up to, you know, 10% of the contract value in the first year or 20% in the second year? Or does it go, does it ramp up more quickly than that? How are you expecting that contract or those contracts to ramp up?

Yeah, our expectation is, 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 going to start with, you know, 50 million in 2024. You know, we've 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. So 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 where it needs to be.

And just one last one.

Nathan, I was just going to add a little color there to, 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. So, you know, once you get that customer signed in the door, it will build over, you know, potentially a multi-year period. And as you get multiple customers in the door, you know, you start having that layering effect. So that can help add to that step-level function that we're talking about for 24.

And 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 you should be, you know, the customer should have to move on before the end of the year. Is that right?

Yeah. One particular customer has to, has to start the change over the September of actually this, I should say, sorry, one customer has to make a decision about, in September of this year for production years 2024 through 2027 and beyond. Great.

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

Thank you, Nathan. I appreciate it.

Thank you, Nathan.

As a reminder, if you would like to ask a question, press star 1 on your telephone keypad. Our next question comes from the line of John Brotz with Kansas City Capital. Please proceed with your question.

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

Thank you very much, John. I appreciate it.

Just want to change the pace a little bit. The fire and the tornado at the faster operation How is that impacting the second half of the year?

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 to get some help with our integrated supply chain. But we are back up and running now. We originally planned for FASTA actually to manufacture more product within the hydraulic segment to offset some of the headwinds we have seen with the CBT business in particular to Asia or to China. and still some elevated inventory levels in North America. So, you know, they were not able to do that for CVT, but certainly met all the expectations that we had on the faster side. So no impact to the second half.

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

So the comment about phase one and phase two, John, was related to faster there's a phase one that is adding you know around 35 40 000 square feet and then there will be a phase two uh they will add around a hundred thousand square feet and 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 FASTA and hydraulics team to integrate with our customers. Okay.

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

Yes, certainly. Look, I mean, our horizon hasn't changed, John. 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.

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

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

Great. Thank you very much, Operator, and 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.

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.