Allient Inc Q1 FY2022 Earnings Call

Greetings, and welcome to the Allied Motion Technologies Inc. First Quarter Fiscal Year 2022 Financial Results. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Craig Mychajluk of Investor Relations. Please go ahead.

Thank you, and good morning, everyone. We certainly appreciate your time today as well as your interest in Allied Motion. Joining me on the call are Dick Warzala, our Chairman, President and CEO; and Mike Leach, our Chief Financial Officer. Dick and Mike are going to review our first quarter 2022 results and provide an update on the company's strategic progress and outlook, after which we'll open it up for Q&A. You should have a copy of the financial results that were released yesterday after the market closed. If not, you can find it on our website at alliedmotion.com, along with the slides that will accompany today's discussion. If you're reviewing those slides, please turn to Slide 2 for the safe harbor statement. As you are aware, we may make some forward-looking statements on this call during the formal discussion as well as during the Q&A. These statements apply to future events that are subject to risks and uncertainties and as well as other factors that could cause actual results to differ materially from what is stated on today's call. These risks and uncertainties and other factors are discussed in the earnings release as well as with other documents filed by the company with the Securities and Exchange Commission. You can find these documents on our website or at sec.gov. I want to point out as well that during today's call, we'll discuss some non-GAAP measures, which we believe will be 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 non-GAAP to comparable GAAP measures in the tables accompanying the earnings release and slides. So with that, please turn to Slide 3, and I'll turn it over to Dick to begin. Dick?

Thank you, Craig, and welcome, everyone. Our results continue to demonstrate the successful execution of our strategic growth initiatives. First quarter revenue grew 13% to nearly $115 million with organic growth representing 5.3%. Our industrial market saw strong demand, resulting in market growth of 46% over last year. We are benefiting from continued economic recovery in a number of submarkets, including material handling, pumps, oil and gas, industrial automation and instrumentation. Recent acquisitions also contributed to the growth in our Industrial and A&D markets. While we are doing relatively well on the top line, the challenge, like many others, is on margins as supply chain issues and inflationary pressures on logistics, energy, materials, and labor continue to persist. We are actively managing these challenges and believe our operating performance will reflect our efforts over the long term. This includes being proactive on pricing and realizing the full potential of our margin-enhancing acquisitions. Excluding nonrecurring items, we achieved adjusted net income of $3.8 million or $0.24 per share for the quarter versus a reported net income of $2.5 million or $0.16 per diluted share. Order levels continue to be strong, and we ended the first quarter with a record backlog of $289 million. I will talk to this performance later in the presentation. And with that, let me turn it over to Mike for a more in-depth review of the financials. Mike?

Thank you, Dick. As a reminder, our results include the acquisitions of ORMEC Systems on November 2, 2021, ALIO Industries on November 4, 2021, and Spectrum Controls on December 30, 2021. Starting on Slide 4, we provide some detail regarding our top line. First quarter revenue increased 13% to $114.8 million and reflected the higher demand in the industrial markets, as Dick discussed, and approximately $11 million of incremental revenue from acquisitions. The unfavorable impact of exchange rate fluctuations on revenue was $3.2 million in the quarter. Excluding FX, revenue was up 16% and organic revenue growth was 5.3%. It is also worth noting that we estimate the impact of supply chain constraints on the revenue was approximately $6 million to $7 million in the first quarter. The recent acquisitions contributed to the A&D group growth of 27% in the quarter. Partially offsetting were lower sales in the vehicle markets of 5%, largely due to broad supply chain challenges within commercial automotive. Medical markets declined 8% due to the lapping of a strong prior year period that was still benefiting from pandemic-related sales. Sales to U.S. customers were 56% of our total compared to 51% in last year's period, and the balance of sales were to customers primarily in Europe, Canada and Asia Pacific. The mix shift reflects the impact of our fourth quarter acquisitions that largely sell to the U.S. market. Slide 5 shows the change in our revenue mix by market on a trailing 12-month basis. Sales to industrial markets were up 34%, benefiting from new solution offerings and continued economic recovery in a number of verticals as well as contributions from our recent acquisitions. Vehicle markets were up 10% on strong truck, agricultural and construction demand. While acquisitions contributed to the year for space and defense growth in the recent quarter, that market is still down due to defense program timing. The change in medical markets reflected similar pandemic-related impacts in the first quarter. As depicted on Slide 6, our gross profit was down 40 basis points from the year-ago period. Higher volume, improved mix and accretive acquisitions were offset by continued global supply chain challenges with rising materials, transportation and labor costs. Despite these challenges, gross margins improved 50 basis points from the sequential 2021 fourth quarter. Moving on to Slide 7. First quarter operating income was $4.3 million or 3.7% of sales compared with $6.6 million or 6.5% in the year-ago period. Operating costs and expense as a percent of revenue were 25.4%, up 230 basis points, of which 140 basis points was attributable to higher engineering and development costs largely attributable to the three acquisitions completed in the fourth quarter of 2021. Also contributing to the operating expense increase was higher business development costs of $0.8 million or 70 basis points as a percent of revenue, which reflects our M&A activity as well as activities in optimizing our global manufacturing footprint. These investments and activities reflect our continued commitment to execute on our strategy. As we have stated, we anticipate growing our margins over the long term with a disciplined execution of our lean toolkit AST, combined with leveraging higher volume. On Slide 8, we present GAAP net income and adjusted net income, along with our adjusted EBITDA results. First quarter adjusted net income, which excludes business development costs and other nonrecurring items, was $3.8 million or $0.24 per diluted share compared with $4.6 million or $0.32 per diluted share in the first quarter of 2021. The effective tax rate was 21.3% in the first quarter of 2022 due to discrete tax benefits in the period. We expect our income tax rate for full year 2022 to be approximately 24% to 26%. Adjusted EBITDA was $12.9 million or 11.2%, which was down 60 basis points in the quarter. We use adjusted EBITDA as an internal metric and believe it is useful in determining our progress and operating performance. Slides 9 and 10 provide an overview of our balance sheet and cash flow. Total debt was $178.6 million, up $19.7 million from year-end 2021. Approximately half of the debt increase was attributable to a new finance lease for a manufacturing facility expansion in Germantown, Wisconsin to support continued growth. At the end of the first quarter, debt net of cash was $161.7 million or 45.5% of net debt to capitalization, and our bank leverage ratio was 3.49x. We've consistently demonstrated our ability to deleverage our balance sheet following acquisitions, and it is our expectation that we will continue the strategy to relook for future growth opportunities. We used $13.4 million in net cash from operations, reflecting higher levels of inventory to deal with supply chain challenges and payment of incentive compensation earned in 2021. CapEx for the quarter was $2.5 million and largely focused on new customer projects. We expect our 2022 CapEx to range between $15 million and $20 million and to be focused on growth opportunities. Inventory turns were 3.1x compared with 3.0 at December 2021. Our teams continue to manage our inventory to meet increasing customer demand, combat sourcing and lead time challenges. Our DSO increased to 55 days in the quarter, largely due to timing. With that, I'll now turn the call back over to Dick.

Thank you, Mike. Our backlog and bookings remain robust as highlighted on Slide 11. Orders are more than $155 million in the quarter, up 35% sequentially and year-over-year with strength across most end markets. This represented a solid book-to-bill ratio of 1.4x. Customers continue to place orders with additional lead time to ensure they are in the pipeline given the current supply chain challenges. As a result, we are seeing some buildup in the backlog numbers, which hit another record, increasing 16% over the sequential fourth quarter and up 90% over the prior year period to $289 million. Just under half of the increase in the quarter was from our acquired companies. And the time to convert the majority of backlog to sales is within the next 9 months. As we look forward, we expect demand within our industrial markets to remain strong. Vehicle demand will be muted by supply chain disruptions in the short term, although we are seeing some encouraging signs with production demands being increased for late this year and early into 2023. Demand in our medical markets has been solid as we lap prior year pandemic-related sales, which reflects the continued return of more elective surgeries. We are also expecting to see stronger A&D performance, and we see a lift from our recent acquisitions. On the M&A front, our pipeline is still very active as we continue to pursue opportunities to complement our organic growth efforts. 2022 has started on a solid path, although we do expect that in the near term, we will continue to battle supply chain and inflationary challenges. The Russia-Ukraine conflict and COVID lockdowns in China will provide additional uncertainty on a macro level, and we'll be monitoring these events closely to anticipate and implement the necessary corrective actions to mitigate the impacts. We believe our long-term success is within our control. And to ensure that, we will continue to be driven by our discipline and focus on the execution of our strategy. Through acquisitions and organic investments, we have strengthened our competitive position in several target markets, and we're working hard to leverage these investments as quickly as possible. Each of our recent acquisitions is accretive to our gross margin profile, has expanded our technology base and capabilities and further enhanced our system selling opportunities to create additional value for our customers. Similar to our base business, our acquisitions are not immune from the daily supply chain disruptions and inflationary pressures that impact the efficiency of all businesses. As we work through these challenges, we remain highly confident in our ability to enhance both our top and bottom line performance in the future. The profile of Allied Motion is rapidly evolving in a very positive manner. We remain committed to executing our strategy and fully realizing our potential to emerge as an even larger and stronger enterprise in the future. With that, operator, let's open the line for questions.

Our first question comes from Greg Palm with Craig-Hallum Capital Group.

Starting with the supply chain, it has unfortunately worsened since our last update a few months ago. Are you taking any new steps to address these challenges? Are you signing on new suppliers or shifting some of your manufacturing elsewhere? What are you observing? Any new insights on this?

Yes, Greg. Every day, it seems like there's a new challenge arising somewhere in the company, and our team has been very effective in addressing these issues. Recently, one challenge impacting our welding capabilities was the ability to utilize our corporate buying power to ensure a steady supply of the products we need for production and welding. This ongoing situation prompts us to evaluate our processes, leading to significant long-term improvements. We are examining our processes and making changes to eliminate reliance on certain commodities or components that are in short supply. We are focusing on localizing our supply chain and exploring second sourcing. Our customers are collaborating closely with us to help secure the materials necessary for their products. Although these challenges are here to stay in the short term, they will ultimately strengthen us and enhance our operations because we've put procedures and processes in place to avoid similar issues in the future. To answer your question, yes, we are encountering these challenges, and we are actively working to address them. For electronic components specifically, our demands are typically lower than what you see in consumer electronics or automotive, which means there is a secondary market available in many cases, albeit at a higher price.

Makes sense. Yes. Just to explore further, have you made any significant pricing changes? Or do you plan to implement any to counter the additional inflation in input costs that we've experienced? Additionally, how should we view the direction of gross margins as we progress through the year with the current information we have?

Yes, that's a great question. As we've indicated before, price increases tend to lag behind supply cost increases. By the time we experience those cost increases and look to pass them on, unless they are included in a broader agreement that already addresses commodity pricing, we need to handle them individually. We have been actively addressing this issue. I would say we saw some improvement at the end of Q1 that should carry into Q2 and beyond. However, I wonder how far this can go since we will face pushback from the market. We might start to see some overall resistance, as not everyone will be able to keep raising prices without risking losing their market share. Nonetheless, we did see some positive momentum late in the first quarter that will continue into the second quarter.

It's also that you're largely passing through those increases without additional margin, right? So it counteracts margin growth a little bit too, just passing through those costs.

Yes, makes sense. And then lastly, as it relates to the book-to-bill, that really jumped up versus prior quarters. I mean do you get the sense that those are all real orders? Or could some of them just be kind of inventory builds that potentially could get canceled? Any thoughts there?

I will address the first part, and then I’ll let Mike provide additional insights. There is no doubt that customers are entering the pipeline earlier due to extended lead times. These are confirmed orders with scheduled delivery dates. We only book them when we have a confirmed production date, as our policy states that without a production date, an order does not enter our backlog. The unbooked backlog number we don't report on includes significant automotive contracts. Until we have a confirmed production release date, those orders do not count toward our backlog. So, these are genuine orders. There is a possibility that once supply chain issues are resolved and we start seeing a better flow and increased supply, some orders may be rescheduled. However, what we have will ultimately be shipped.

And just two comments to add to that. I think we saw some really nice performance out of our newly acquired businesses in the quarter relative to the bookings. Some nice wins that were much talked about in due diligence and came to fruition here in Q1. So we're very excited to see that as well. And then going back to the comments about partnering with your customers to secure supply chain. I think there's evidence of that as well in the sense of proactively working with the customers to lock up materials. And in turn, right, you're getting the customer orders increasing just to provide that again with a longer runway. But as Dick mentioned, with defined production dates so that we feel good and confident about it.

Our next question comes from Brett Kearney with Gabelli Funds.

You guys obviously continue to execute very well through a very dynamic, challenging operating environment. Curious on one of those kind of unknowns you had mentioned, Dick, the China lockdown situation. Just how you are viewing that at this stage, both in terms of potential demand from some of your customers, what you're hearing and seeing? And then any potential ripple through impacts on the broader industry from a supply standpoint, just kind of your broad latest thinking there?

Our team in China, located in Changzhou and Suzhou, is performing well despite the challenging circumstances of total lockdowns, which obviously hinder their ability to build products. Looking at the global perspective, our customers in North America and Europe are beginning to focus on localizing their supply chains. This trend is expected to increase, and our strategy has been to adopt a local supply chain approach to lower product acquisition costs and minimize the impacts of rising logistics and fuel expenses. We are not just receiving inquiries; we are now securing orders from customers seeking to switch their supply chains to domestic sources, which is a positive indication. So far, our products manufactured and shipped within China have been largely unaffected, with logistics and components remaining accessible. Increasingly, our business in China is about shipping products directly within the country rather than relying on exports, and this trend is expected to continue. While there are constraints on making design changes with electronic components and other materials sourced from China, I believe that resource localization will ultimately yield a positive impact on our business.

Terrific. That was actually going to be my follow-up question was kind of on reshoring and given the solutions you provide really into many kind of automation applications, whether you're hearing and seeing that from customers, and it sounds like that's certainly the case with North America and Europe?

Yes, I'd like to add a bit more detail. We made a substantial investment in our facility in Mexico a couple of years ago, and they have successfully handled products made offshore, which are mainly used in North America. We've invested in capital equipment in Mexico, which has ramped up nicely. The cost and competitive landscape there is quite favorable, making it a promising area for our operations. We've also just approved a fully automated motor production line that has been in development for two years, and it's now on its way to Mexico to begin ramping up in the middle of the second quarter. This line will produce products previously not made in North America, but designed primarily for North American consumption. We're continuing to pursue this strategy. Simultaneously, we are examining our supply chains in Europe, working hard to localize them and reduce costs. We are actively investing in this area and implementing measures to enhance our operations.

Our next question is from Gerry Sweeney with ROTH Capital.

Just a question on Spectrum Controls. I think with the fourth quarter results, you mentioned that Spectrum was having some challenges with supply chain. And obviously, you're going to go in there and I think use some of your corporate buying powers. How much of an impact did Spectrum have on the margins this quarter? Hello? Did I lose you?

Hello? Operator, did we lose their line?

No. Dick, Mike, are you still with us?

We're here now. We can hear you. Did we lose Gerry or...?

No. He's still here.

No, I'm here. Quite a little bit of a case of COVID, but I thought I asked a bad question. You went quiet, so...

You started asking about Spectrum and then we didn't hear anything after that.

I was wondering about the impact of the supply chain constraints at Spectrum that you mentioned you purchased. How much did it affect the margins for the quarter, and do you anticipate an improvement moving forward?

Sure. We set the expectations for Spectrum coming out of the... After the Spectrum acquisition, we did state that Spectrum would start slow out of the gates. We knew we had some supply chain challenges going in and that they would ramp during the year. We did experience a slower-than-expected ramp in Q1. There were the supply chain challenges that were even more significant. And they are working through them. But we do think that as we progress through the year, we will start to see improvement. We'll see improvement, and we will start to realize our ability to ship a very strong backlog that we have there. So it was a negative. It was definitely a drain on our operating results in Q1, and we expected it to be neutral. And our expectation right now is if it's neutral in Q2, the results for Allied will be much better than they were in Q1, let's put it that way.

Okay. That was sort of my expectation. Actually, I thought it was going to be a little bit more negative in the first quarter. But suffice to say, they're being rectified, and as it fixes itself or you fix it, I should say. That headwind should turn to a tailwind, just in terms of aggregate numbers and margins.

Yes. And again, we're seeing great order wins in the business as we're talking really purely a supply chain constraint here with electronics that's driving the disruption.

Sure. Thank you, Gerry, and thank you everyone for your patience. Are there any more questions from the operators?

There are no more questions.

I will conclude here. For those interested, we will be participating in the Barrington Spring Virtual Investor Conference on Thursday, May 19. Additionally, Allied will be exhibiting next week at the Healthcare Robotics Summit in Boston and at Automate in Detroit the week of June 6. If you are in those areas, it would be a great opportunity to see how the system configurations are developing, review the new acquisitions, and get a good look at the evolving profile of Allied. You will easily notice this change if you attend those shows. As always, feel free to reach out to us at any time. We look forward to speaking with all of you again after our second quarter 2022 results. Thank you for your participation, and have a great day.

Thank you. This concludes today's conference. You may now disconnect.