Allient Inc Q2 FY2023 Earnings Call

Good day, and welcome to the Allied Motion Technologies Second Quarter Fiscal Year 2023 Financial Results Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Mr. Craig Mychajluk, Investor Relations. Please go ahead, sir.

Yes. 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 second quarter 2023 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 accompany today's discussion. If you are reviewing those slides, please turn to Slide 2 for the safe harbor statement. As you are aware, we may make 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 as well as other factors that could cause actual results to differ materially from what is stated on today's call. These risks, 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 will 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. With that, please turn to Slide 3, and I will turn it over to Dick to begin. Dick?

Thank you, Craig, and welcome, everyone. And I'd like to start the call with some off-script comments, as I have something I would like to relate to everyone. Sadly, Dick Smith, our former CFO, CEO and Chairman of the Board, passed away this past Sunday after a brief illness. Dick was the first one that brought me into Allied at that time halfway 22 years ago, and for that, I will forever be grateful. Dick was a great friend, partner, and he exhibited the highest levels of honesty, integrity, and willingness to do what was right for the company. Beyond that, Dick was a family man, and family always came first. Our thoughts and prayers will go out to Dick and his family. Rest in peace, Dick. We will miss you, and you will not be forgotten. Now I'll start with the script as we have written here. So first off, we continue to successfully execute our strategy by delivering record sales with double-digit organic growth and strong operating leverage, which translated into a measurably improved bottom line and solid cash generation. Our 20% top line growth reflected strength in each of our four targeted markets, highlighted by continued strong demand in our industrial markets, which increased 39% over last year's second quarter. What drove our industrial strength were industrial automation projects, power quality solutions for oil and gas and HVAC, and continued demand for material handling and vehicle handling systems. We also benefited from shifting some of the long lead projects that were in our backlog. Aerospace and defense markets grew 11% during the quarter due to incremental contributions from acquisitions and defense program timing. Vehicle market sales increased 7% due to continued ramping of commercial automotive programs, partially offset by lower agricultural vehicle demand in Europe. Lastly, medical markets were up 3% overall. Driving higher margins continues to be a focus. And while we saw some contraction in gross margin for the quarter, which was largely impacted by mix, we are seeing the leverage play out in our operating performance as we delivered record operating income of $12 million with a margin of 8.2%, which was up 210 basis points. Given the improved operating performance, net income per share increased 45% to $0.42 per share. On an adjusted basis, net income per share was up to $0.58 per share. We generated significant cash from operations of $13.7 million and reduced our debt balance by $9.4 million during the quarter. Our orders were up sequentially, further emphasizing demand in the market, while our backlog was down since the first quarter due to continued improvements within the supply chain. I will talk about this performance later in the presentation. The first half of 2023 has positioned us for a strong year. Our entire team is energized by the continued growth and operational successes throughout the company, and we expect to continue executing our strategy well into the future. With that, let me turn it over to Mike for a more in-depth review of the financials.

Thank you, Dick. As a reminder, our results include the acquisitions completed during the second quarter of 2022. Starting on Slide 4, we provide some details regarding our top line. Second quarter revenue increased 20% or $24 million to a record $146.8 million. The unfavorable impact of exchange rate fluctuations on revenue was $0.4 million in the quarter. Organic revenue growth was 17%. Dick touched on the quarterly sales highlights for our targeted markets and end market demand. One other sales channel, which is still a small component of our total, is distribution, which has continued to see solid growth and was up 17% in the quarter. Slide 5 shows the change in our revenue mix by market on a trailing 12-month basis and the drivers behind that change. Industrial continues to be strong and remains our largest market, making up 41% of our total TTM sales. The 40% growth in the industrial space is driven by the specific markets identified. A significant portion of our backlog reduction occurred with customers in our industrial markets as well. Solid organic growth, defense program timing, and contributions from acquisitions contributed to substantial growth and performance in A&D. Medical growth has benefited from the gains in the medical mobility market, and vehicle market revenue was up slightly on a trailing 12-month basis as commercial automotive, power sports, and truck demand more than offset weaker agricultural demand in Eastern Europe, driven by current geopolitical events. As highlighted on Slide 6, our second quarter gross margin was 31.3%, down 110 basis points from the prior year period. Higher volume was more than offset by unfavorable mix and remaining global supply chain disruptions. Consistent with our stated objectives, you can see the progress we are making by executing our strategy in the annualized chart on the right of Slide 6. Moving on to Slide 7. You can see the results of our strong revenue growth and the leverage inherent in our operations as second quarter operating income increased 60% to a record $12 million or 8.2% of sales, which was up 210 basis points. Operating costs and expenses as a percent of revenue were 23.2%, down 310 basis points. On Slide 8, we present GAAP net income and adjusted net income, along with our adjusted EBITDA results. Our net income and fully diluted EPS have been adjusted for certain items, which we believe provide a better understanding of our earnings power, inclusive of adjusting for the noncash amortization of intangible assets, which reflects the company's strategy to grow through acquisitions as well as organically. Net income increased 48% to $6.8 million or $0.42 per diluted share. And on an adjusted basis, net income was $9.5 million or $0.58 per diluted share, up 21%. The effective tax rate was 23.9% in the quarter due to discrete tax benefits and geographic mix. We adjusted our expected income tax rate for the full year 2023 down slightly to be approximately 24% to 26%. Adjusted EBITDA increased 26% to $20.4 million or 13.9% of revenue, which was up 70 basis points from the second quarter of 2022. 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. As a reminder, in the first quarter, we made a $6.25 million deferred cash payment for our prior acquisition, which was reflected in our cash position at the end of the second quarter. Total debt was approximately $228 million, down $8.3 million from year-end 2022. Debt net of cash was about $203 million or 46.2% of net debt to capitalization. Our bank leverage ratio was 3.06x. We generated $17.3 million of cash from operations year-to-date, a significant increase from cash usage during the prior year period. The increase reflects higher net income and improved working capital due to stronger inventory turns. Based on our cash flow projections, we expect to continue to drive strong cash flow this year consistent with historical trends. Year-to-date, capital expenditures were $6.1 million and were largely focused on new customer projects. Due to project timing, we adjusted our 2023 CapEx expectations to now range between $16 million and $20 million, down from $18 million to $23 million. Inventory turns improved to 3.3x in the second quarter compared with under 3x last year. Our DSO was stable at 55 days, largely reflecting timing and mix of customers. With that, I'll now turn the call back over to Dick.

Thank you, Mike. Turning to Slide 11, our orders and backlog levels in the second quarter show orders of approximately $137 million, resulting in a book-to-bill ratio of 0.9x and a backlog of nearly $300 million. Although there continue to be some near-term challenges with pockets of weakness in Europe, we still see excellent long-term opportunities for growth and value creation across our global platform. Our backlog decreased 3% from the sequential first quarter of 2023, reflecting the continued improvements in the supply chain as we reduce our lead times and accelerate shipments of several long lead products. As we mentioned last quarter, we expect our backlog to decline slightly over the coming quarters as our book-to-bill ratio drops below 1. The time to convert the majority of backlog to sales is within the next 9 months. Turning to Slide 12. Demand is expected to continue at relatively strong levels within our industrial markets, which should benefit from our increased market presence around industrial automation, material handling, and power quality solutions. On the defense side, we are experiencing a significant increase in inquiries with the ability to leverage our comprehensive product portfolio to develop solutions for several new and emerging applications. Our medical markets have returned to a more normalized sales environment focused on surgical and instrumentation-related end markets. Lastly, we are still anticipating modest growth within our vehicle markets as the supply chain continues to improve and demand schedules from our customers ramp up this year and beyond. As we demonstrated this quarter, driving cash conversion and paying down debt is the focus. We will continue to focus these efforts as debt reduction will support our planned M&A activities. On that note, we are actively grooming potential opportunities as we build out our M&A pipeline, a key element of our overall growth strategy. While uncertainty remains in the global markets, we are confident that we can continue to successfully execute our proven strategy well into the future. Before we open up for Q&A, just a reminder for those of you that are interested, we will be hosting our inaugural Investor and Analyst Day at the NASDAQ on Wednesday, August 23. The event will kick off at 11:00 a.m. Eastern and will culminate with us ringing the NASDAQ closing bell. The Investor Day will be a great opportunity for you to hear more about our company and the actions we are taking to: number one, expand our available markets; two, further strengthen and grow our market share; three, leverage our global manufacturing and engineering capabilities to ensure we achieve our goals and objectives. And last but not least, help you gain a better understanding of how we plan to leverage our success in the past and continue to execute our proven process well into the future. Please visit our Investor Relations website for more details on the event. With that, operator, let's open the line for questions.

And the first question will come from Greg Palm with Craig-Hallum Capital Group.

Sorry to hear the news about Dick. So condolences to his family and all of you. So I guess maybe we can just start by kind of recapping what you're seeing out there. It sounds like maybe a little bit of softening in certain verticals or geographic areas. So maybe just a little bit more color on kind of real time, what you're seeing and then we can go from there.

Overall, we were well prepared for the order intake during the past few years, which may have been somewhat inflated. As the supply chain normalizes, we anticipated adjustments in schedules and a likely decrease in incoming orders. We have noticed some of that. However, our 20% revenue increase suggests we are well positioned, and we are not overly concerned about the future. There will be fluctuations in markets, and we are aware of areas that could be problematic, as mentioned by Mike, including some geopolitical issues. Nevertheless, there are still strong opportunities for us to maintain the performance we've delivered in the past. We might experience less volatility from quarter to quarter due to our diversified portfolio compared to previous years. Overall, the strong numbers from this quarter demonstrate significant growth, and we are confident we can continue this trend moving forward.

And I know you've talked about some of that elevated order activity in the past quarters or past few years. Do you have a sense of what kind of inventory levels are? I mean, is that a concern at customers or some customers? Or just you feel like they're in a position where it's just more of a real-time demand thing?

It varies by customer. Some customers are more conservative and place orders for longer durations while they are in the pipeline. We're seeing some adjustments, but we have great communication with our blanket customers. There's some reshuffling, which we expected. We aren't concerned that business is diminishing or that there will be a significant drop in the future. We aren't seeing that. As anticipated, after going through these situations, we observe the typical historical patterns of supply chain shortages and longer lead times, with orders being placed much earlier based on forecasts. We've experienced similar scenarios, but it's not as drastic as past adjustments. It's different for each customer, as they all manage their businesses in their own way, and it largely depends on their individual circumstances.

Yes. Okay. Operationally, another good quarter where you saw solid margins, good operating leverage. I know you've talked about gross margin expansion on an annual basis. I think you've targeted 100 basis points. Are you still comfortable with that in light of some of your comments on a more muted sort of demand volume outlook? Or do you still think there's ways that you can take some costs out? And I'm just curious, are you still seeing or incurring some of the elevated supply chain costs that we've been talking about over the past year or have those basically ended at this point?

No, I think there are a couple of questions here. First off, we have stated that our goal is to increase gross margin. We also need to consider that overall operating margin is part of the gross margin. So our future focus will be on the combination of improvements in both gross margin and operating margin, which will help us achieve the targeted 100 basis points per year. It's important to be clear about this going forward. Operating margin can be challenging due to product mix, which can make it difficult to analyze results from quarter to quarter or year over year. As you know, the mix of our products varies depending on specific markets and sold products, leading to fluctuating margins. We do have certain products with much higher gross margins due to the intellectual property involved and the content we provide in our solutions. Therefore, we are committed to meeting our goal of a 100 basis points improvement through a combination of gross margin and operating margin enhancements.

The next question will come from Ted Jackson with Northlink Securities.

Congrats, had a very solid quarter, guys. So a couple of questions. One, just because following up on the prior kind of Q&A commentary. I understand supply chains normalizing out and some, call it, floating around if you would, with regards to orders and shipments. But you also feel pretty confident that you're going to be able to continue to show growth on an organic basis in the second half of the year. Is that what I picked up from all that dialogue?

Yes, I think we are confident in our ability to continue growing organically. I want to clarify that previously, we experienced more seasonality in our business from quarter to quarter. Currently, we are observing a more normalized shipment rate quarter-over-quarter, influenced by our backlog, which includes items waiting for supply chain issues to resolve. Looking ahead, we expect this trend to continue. As for the fourth quarter, we'll provide updates as we get closer since it has been unpredictable in the past, depending on customer behavior. Overall, we are seeing greater stability and less cyclical variation in shipments quarter-over-quarter. It's typical for Europe to experience a drop in Q3 due to many countries shutting down for several weeks in August, which affects July and August. However, I want to emphasize that the cyclical patterns we observed in the past will be less pronounced moving forward.

Okay. Just to help clarify a little bit. Regarding backlog, how much of your backlog is expected to ship in the third quarter?

I would say that our backlog includes items with confirmed release dates or production days, which vary by customer. Depending on the lead times, once they provide a planned or forecasted order, it officially enters our backlog. However, many of these orders are fulfilled quickly, often within the same quarter. To answer your question, over 95% of our backlog for the third quarter is firm, including blanket orders that may fluctuate throughout the quarter. So, it's essentially secure for the third quarter at this point.

Yes. The dynamic of our backlog hasn't changed, right? We have stated that what's in the backlog, most of it will ship within the next 6 to 9 months.

Okay. And then shifting over, just out of curiosity, I know Rockwell is a distribution channel for you and they reported results earlier in the week and honestly, they had some difficult performance in the stock as well. One of the things that impacted them during that quarter and probably really the only thing was that they put this new distribution center in place and it caused a little bit of a hiccup in terms of timing with regards to some revenues. And I was curious, given your exposure to Rockwell, is there anything within that, that has played out for Allied Motion, and is there anything that we need to think about on that front?

Not really.

Okay. And then, Dick, in the last few press releases, there has been a consistent conversation about Europe and certain areas experiencing some softness. Regarding this current quarter, is there any change in that weakness compared to the first quarter? Or is it simply a continuation of the same general concerns, particularly due to the impact of the Ukraine war?

Yes. What I would say is that surprisingly, the bookings in the first and second quarters have performed well despite our expectations of some impact from Europe. While we have observed some additional softness in booking levels, our backlogs remain strong. Factors such as energy prices and the Ukraine war continue to have an effect, but the reality is that bookings have stayed robust. We have noticed a slight decline in recent months, but it is also holiday season in Europe, making it difficult to predict.

Yes. You're not the only one that has that problem. My last question is just on the vehicle business. You commented on the commercial vehicle business and the strength you're seeing within there, and it's offset some of the ag side of things, which clearly is from the small ag equipment market. But in the commercial vehicle side of the equation, there's clearly been some, call it, forward demand pull-through because of emission rule changes and stuff. Given that market dynamic, how do you see that part of your vehicle business performing as we roll out of '23 and into '24? And maybe you could give a little color with regards to the exposure within that line item that the commercial vehicle market is relative to the aggregate?

Sure. We're not providing specific details about the overall percentage of sales. When we discuss the overall vehicle market, I can say that the impact on our commercial automotive sector is not very significant. We have observed an increase in volume and demand. However, there are offsets, particularly in agriculture equipment and programs we are collaborating on with our OEMs in Eastern Europe, which are currently inactive. Until this situation impacts our shipments more compared to the ramp-up in commercial automotive, we would be happy to see demand for agricultural and construction equipment in Eastern Europe return to expected levels, even if it means slower growth in automotive. This would likely have a positive effect on our margins. The diversification of our company is one of our strengths. While some markets may be experiencing softness, other markets are growing, and we plan to continue this trend in the future. We value the benefits of the commercial automotive sector, particularly the discipline it fosters in quality control and cost management. However, we also want to ensure we're not overly reliant in this area. To answer your question, we have seen an increase and anticipate continued increases, but the offsets are currently more substantial than the increases we are experiencing in that market.

And the income is coming from the new programs that we have been discussing for the last couple of years.

Our next question will come from Brett Kearney with Gabelli Funds.

I was going to follow up on the vehicle, new program awards. You kind of covered it some in your prepared remarks and in the discussion right there. But just on whether those program launches are still kind of on the original timetables. And maybe if you could remind us kind of the ramp schedules there? And then also, the customers and products you're supporting there on some of the new programs seem to be that product set seems to be growing nicely globally. Maybe opportunities if you guys perform there as you have done historically longer term with some of these customer relationships you've developed?

Yes. I mean, those programs are all delayed through COVID. And so they definitely were pushed. And I would tell you that we look at the original forecast that we were provided for programs and, let's say, without COVID, and without supply chain we're probably two years behind. So nothing has changed in terms of what we expect our annual revenue base to be in that area. Programs are moving forward. It's just a matter that they were pushed out, and the ramp-up was delayed, but it's clearly ramping up. Okay? So I would tell you that next year, we'll be at what we stated for the new program shipment levels will be at full level of what we've stated, okay? So they are moving forward, and they're moving forward nicely.

Excellent. Okay. And then I think just last one, we've covered the topic of destocking across the industrial channel. Maybe we've heard from some folks that there's some inventory adjustments taking place on the medical OEM side. It seems like the applications you guys are on there kind of insulate you, but maybe what you're seeing positives and negatives on the medical side of the business?

Yes. I would say that if you look back to the COVID period and examine the products that were being shipped during that time compared to those that were not, it's clear that things have normalized over the past year or year and a half to a pre-COVID state. Our instrumentation, surgical equipment, and related devices, including oncology and surgical robotics, are performing well. We’ve seen a 3% increase overall year-over-year. However, there may be some adjustments taking place which could mean the growth rate might be higher, and it's been somewhat of a hindrance to our overall growth compared to other areas. On a positive note, things have remained stable and consistent. We haven't really detected any significant restocking activity, so I'm not sure where that's happening, but we haven't experienced it ourselves.

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks. Please go ahead.

Well, thank you, everyone, for joining us on today's call and for your interest in Allied Motion. As always, please feel free to reach out at any time, and we look forward to talking with all of you again after our third quarter 2023 results. In addition to the Investor Day at Nasdaq, please join us at the Northland Capital Markets Conference on September 19 in Minneapolis. Thank you for your participation, and have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.