Allient Inc Q3 FY2023 Earnings Call

Good morning, and welcome to the Allient Inc. Third Quarter Fiscal Year 2023 Financial Results Conference Call. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Craig Mychajluk, Investor Relations.

Yes. Thank you, and good morning, everyone. We certainly appreciate your time today as well as your interest in Allient Inc. 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 third quarter 2023 results and provide an update on the company's strategic progress and outlook, after which we'll open 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 allient.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 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'll turn it over to Dick to begin. Dick?

Thank you, Craig, and welcome, everyone. Before we jump into the quarter results, I just wanted to remind everyone that we had our inaugural Investor and Analyst Day at the end of August, where we highlighted our expanded available markets and how we plan to leverage our proven process to ensure we achieve our future goals and objectives. Please visit our Investor Relations website where you can view a replay of the event or the transcript. Now on to the quarter. We continue to execute our strategy and delivered solid top-line results, record gross margin and robust cash generation that enabled us to reduce our debt and make an acquisition during the quarter. Once again, our industrial markets led the way with 32% sales growth over last year's third quarter, largely driven by industrial automation projects and power quality solutions focused on HVAC. Oil and gas end markets also contributed to our industrial sales growth with continued improvements within the supply chain environment, which supported the shipping of some long lead projects. Our other three targeted verticals experienced a contraction during the quarter. Those numbers don't tell the whole story as there are a number of positive elements within each. Aerospace and defense sales reflected program timing, largely within the space industry during the quarter. On the defense side, we have experienced a high level of quoting and activity over the last few quarters, and we secured a large defense order, which is reflected in our third quarter orders. I will talk about our orders and backlog later in the presentation. Within our vehicle markets, our automotive customers are ramping up as expected this year, although the growth was more than offset by lower demand within agricultural vehicles given the softness in Europe, largely influenced by the Ukrainian conflict. Lastly, medical sales were nearly flat as we continue to see a return to a more normalized sales environment focused on surgical and instrumentation-related end markets. We did experience softness in medical mobility, which largely reflects a reduction in the demand that we experienced during the last few years for those products. Driving higher margins continues to be a focus, and we saw a nice expansion of our gross margin during the quarter. The 32.7% gross margin rate does set a new high watermark for Allient and largely reflects the favorable mix from the end markets I just highlighted. On the operating performance, you will notice we had a jump in business development costs of about $1 million year-over-year. Those expenses were in support of the recent acquisition and some limited operations rationalization to position us and drive stronger operating leverage in the future. Overall, we delivered net income per share of $0.41. And on an adjusted basis, net income per share was $0.61. On a year-to-date basis, we generated significant cash from operations of more than $27 million as we have seen modestly improved inventory turns. We did utilize some of that cash to reduce our debt balance by more than $11 million and to acquire Sierra Motion at the end of the quarter. While Sierra Motion is a relatively small acquisition, it is very strategic and enhances both our application design and development efforts and our customer-facing market strategy. Sierra Motion excels at providing rapid product development, prototyping and low-volume production to improve speed of play for customers. We further believe we can leverage their team's skills and capabilities to advance our integrated motion solutions strategy and to expand our reach into our targeted end markets. We also see the potential to enhance their capabilities by leveraging the Allient global manufacturing footprint in order to provide larger-scale production capabilities for Sierra Motion customers. Looking ahead, we still see exciting opportunities as we expand our presence in targeted market verticals, launch innovative solutions and further streamline our business for greater efficiency. With that, let me turn it over to Mike for a more in-depth review of the financials.

Thank you, Dick. Starting on Slide 4, we provide some details regarding our top line. Third quarter revenue increased 8% or $10.9 million to $145.3 million. The favorable impact of exchange rate fluctuations on revenue was $1.8 million in the quarter. Excluding FX, organic revenue growth was 7%. The growth rates for our four targeted markets are noted on the slide, and Dick reviewed the permanent changes within each. The acquisition of Sierra Motion did not have a material impact on sales during the third quarter. Slide 5 shows the change in our revenue mix by market on a trailing 12-month basis and the drivers behind the change. Industrial continues to be strong and remains our largest market, making up 43% of total TTM sales. That's an increase of 500 basis points since the comparable period in 2022. The 38% growth in the industrial space was driven by the same market as the current quarter. Defense program timing contributed to substantial growth and performance in A&D and the 200-basis point increase in share for the TTM period. Medical growth has benefited from a more normalized sales environment, and vehicle market revenue was comparable on a trailing 12-month basis as commercial automotive and power sports demand offset weaker agricultural demand. As highlighted on Slide 6, our third quarter gross margin was 32.7%, up 50 basis points from the prior year period. Higher volume and favorable mix more than offset elevated raw material costs. Consistent with our stated objectives, you can see the progress we are making by executing our strategy and the annualized churn. Moving on to Slide 7. We delivered third quarter operating income of $11.9 million or 8.2% of sales, which was down 50 basis points. Operating costs and expenses as a percent of revenue were 24.5%, up 100 basis points, of which 70 basis points was attributable to higher business development costs in the quarter as we continue to rationalize our manufacturing footprint and execute our M&A strategy. On Slide 8, we present GAAP net income and adjusted net income, along with our adjusted EBITDA results. Our net income and diluted EPS have been adjusted for certain items, which we believe provides 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 1% to $6.7 million or $0.41 per diluted share, and on an adjusted basis, was up 3% to $10 million or $0.61 per diluted share. The effective tax rate was 23% in the quarter, and we adjusted our expected income tax rate for the full year 2023, down slightly to be approximately 23% to 25%. Adjusted EBITDA increased 5% to $20.8 million or 14.3% of revenue. 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 during the company's position at the end of the third quarter. Total debt was approximately $224 million, down $11.1 million from year-end 2022. Debt net of cash was about $201 million or 48.1% of net debt to capitalization. Our bank leverage ratio was 2.9x. We generated $27.1 million of cash from operations year-to-date, a significant increase in cash usage during the prior year period. The increase reflects higher net income and improved working capital management. Based on our cash flow projections, we expect to continue to drive strong cash flows consistent with historical trends. Year-to-date capital expenditures were $7.9 million and were largely focused on new customer projects. Due to project timing and supply chain impacts, we adjusted our 2023 CapEx expectations to now range between $12 million and $15 million, down from $16 million to $20 million. Inventory churn improved to 3.1x in the third quarter compared with only 3x last year, and our Days Sales Outstanding (DSO) was at 57 days, largely reflecting timing and mix of customers. With that, I'll now turn the call back over to Dick.

Thank you, Mike. Slide 11 shows our orders and backlog levels. Third quarter orders of approximately $155 million resulted in a book-to-bill ratio of 1.1x and a backlog of nearly $310 million. Order levels were up 23% year-over-year and 13% sequentially, largely due to a $31 million defense market order received during the quarter. This order was from an existing program and is expected to convert to sales over the next two years, with shipments beginning early next year. Our backlog increased 4% from the sequential second quarter of 2023, reflecting defense order and strong demand for power quality solutions, partially offset by continued improvements from the supply chain environment. This has enabled the shipping of some long lead projects as customer order patterns returned to a pre-COVID-19 environment. As a result, we do expect our backlog to decline in the near term as our book-to-bill ratio drops below 1. The time to convert the majority of the backlog to sales is within the next nine months. Turning to Slide 12. We expect our business for the remainder of the year to reflect a pre-COVID-19 environment and be consistent directionally with our fourth quarter results from prior years. This means there is a higher likelihood of seasonality for holiday shutdowns and customers managing their own inventory levels at year-end. Demand is expected to continue at relatively strong levels within our industrial markets and to benefit from our increased market presence around industrial automation, material handling and power quality solutions. Our other targeted markets are expected to exhibit puts and takes from the end markets similar to this past quarter. Driving cash conversion and paying down debt is a priority, and we will continue to focus on this area as we round out this year and move into 2024. Our debt reduction efforts are expected to support our planned M&A activities, which is a key element of our overall growth strategy. As always, we are actively growing potential opportunities and building out our M&A pipeline. The increase in global unrest we are all experiencing has the potential to present additional challenges in our day-to-day operations, but we are confident that the Allient team has the experience and dedication to navigate through these uncertainties while still remaining focused on executing our long-term strategy. Overall, we are excited and confident in our future, and we believe we are well positioned to create additional value for all of our stakeholders. Lastly, for those that didn't get a chance to see our Investor Day presentation, the image on the left is what we call the House of Allient. It is a refined structure that layers on a strong vertical market focus on top of our key technology pillars of motion, controls and power. This is the basis of how we plan to accelerate our future success. With that, operator, let's open the line for questions.

We will now begin the question-and-answer session. Our first question today is from Greg Palm with Craig-Hallum Capital Group.

Maybe just starting with the outlook. Early November, normally, you don't have great visibility in year-end inventory management shutdowns, et cetera, but sort of directionally guided for kind of that decent sized seasonality versus Q3. So I'm just kind of curious, is that kind of what your visibility levels are, your confidence around that? Is that kind of what you're hearing from customers? Or is it more on the basis of, look, it's a pretty uncertain macro environment out there or you're just wanting to add maybe an extra level of conservatism in there?

Well, that's a lot of stuff that we added there. I think as we know and maybe for our shareholders that have been here over several years, the reason why we highlighted pre-COVID-19 environment is that we have in prior years gone through the seasonality and the fourth quarter would reflect that. And many times, the fourth quarter was uncertain because especially some of our larger customers would conserve cash and hold shipments until after the first of the year and so forth. And so that comes into play, and we really don't know what that impact is and how much that's going to affect us until late in December. With regard to our visibility, we see what we would call a normal pre-COVID-19 environment with some seasonality. So we are going to be cautious, and we're going to say that we cannot anticipate what might happen later in December. But given what we have in our backlog today, we do see some of that seasonality coming into play. And let's just call it the normal environment that we've operated in prior years.

That makes a lot of sense. And in terms of the quarter itself, one of the highlights was gross margin. And I know you talked about mix, but I'm hoping you can go into a little bit more detail around it. Because if we look at mix by end market in Q3, it doesn't differ a whole lot versus what the mix by end market was in either Q1 or Q2, but under a slightly lower level of revenue, you still improved gross margins quite a bit by either of those quarters. So maybe just help us understand a little bit of that thought out there.

Mike, do you want to answer, and I'll add to it.

Sure. Well, currently, I think we've spoken before that within our four market verticals, there are niche markets, and I would say margins can differentiate significantly. Within Industrial, I think we've highlighted in the past areas like automation, oil and gas, HVAC, and those are areas where we enjoy some premium margins that have been strong, but were particularly strong in Q3. And then from an A&D perspective too, again, there's differentiation between what markets we sell into within A&D, whether it's space or defense. As we've been highlighting the beginning more defense orders recently, and we've had an uptick in shipments. I think we've done a good job to protect ourselves from a pricing standpoint. We've been opportunistic with some of those orders as well that have helped with margins. But from a general perspective, we continue to drive from the strategy, margin improvement whether that's through rationalization or driving costs out from a global supply chain approach or the like. I would say, there's an underlying current of those activities behind the mix as well.

Yes. And I think, Greg, it really says it all that we have a wide variety of customers and a wide range of end markets. Certainly, the solution set that we offer. Mike talked about premium pricing, I'll mention it's more of a pricing that reflects the markets and the end applications that we're working on. It so happens that in those markets that we've seen accelerated shipments over prior quarters or prior years, those provide some enhanced margins versus some of the other product lines that we would have shipped in the past. But again, it's a continued process that we're working through. We talked about delays in getting price increases through and so forth and the impact of those. Some of that came into play as well. But it is primarily a reflection of the shipments and the mix that we did have in the quarter and our emphasis on some of those markets that we've had in the past, even in acquisitions and investing in current operations.

The next question is from Ted Jackson with Northland Securities.

So just Greg had actually brought up many of the topics I really wanted to drill into, but I'll ask a few around it. So let's just start with CapEx. So you've taken CapEx down. If I think about CapEx for $24 million, would we be thinking that you would go back to kind of your sort of more like the $16 million to $20 million range? Or are you going to, on a go-forward basis, keep it a little closer to the trunk of the tree with regards to some of your expenditures?

That would be my expectation, Ted. The reason we didn't hit our original projected number is driven by customer patterns and behaviors in terms of driving projects. Projects haven't gone away, but just in terms of customers' engineering resource availability to drive some of those things. And then supply chain issues, as it just tends to slow things down across the board as well. I think the environment continues to get better. As I said, these projects are still in line to take off here in the future, and there'll be capital needs to support those projects that we expect will just push somewhat into 2024 but still be in line with that range you described. That's kind of the target internal target to manage our CapEx spend within that range.

Again, and I'll add to that, Mike gave you directionally where we should be. And I will say to you that there's a real emphasis internally on looking at the return on investment and some of the opportunities that we have. There's been some caution, but we do see that there's significant opportunities to continue to reinvest in our operations with a stronger focus on ensuring that the investments we make are in high-value programs and encouraging internal initiatives. I would expect our CapEx investments to be slightly down next year, but I will also say that we are seeing real opportunities internally to enhance our operating performance, and those require some investments. So we are absolutely encouraging that. The slight change being that as we continue to grow as a company and refine our systems and processes, we are really looking at funding those opportunities that provide the best return.

Kind of just a macro question, maybe around industrial. I mean, Rockwell reported this morning, and I haven't gone through the release; stocks down. So clearly, there was some unhappiness with something that came out of those numbers. And then clearly, Rockwell and most of the bigger integrators like that, Rockwell and Emerson and such, I wouldn't say that the last quarters for them were home runs either. I mean, we're definitely in an area, and you're highlighting it yourself, Dick, that people are cautious regarding 2024. But if I think about, say, like Rockwell and Emerson of companies like that, is it fair for me to infer from kind of their commentary that it's part of the same what's impacting their business as headwinds for you as well? And it's a fair inference that you're kind of, for better or worse, tied to them? Like how do I think about that in terms of a relationship between those companies and Allient?

Well, first off, a conscious effort that we made many years ago was to diversify our business. We think that diversification has served us well so that I'd love to see the day when everything is firing on full cylinders here, and we're seeing everything growing and expanding in a very positive manner, but that's not the reality. We always see that there are while we see certain of our markets that are growing and expanding and exhibiting certain successes, even within our medical markets and some of the instrumentation that we provided, we saw consistency that many other companies didn't. While you saw others that were really heavily focused on those markets grow fast, they dropped as fast. I think we take great pride in our efforts to diversify our business and to minimize the impact of anyone market. We've set our goal, if we could set a goal here for the four key markets we've identified being 25% each year, we'd be very happy. That's 25% each, maybe over a long term, but we still have additional investments to make in those markets to increase our share while not necessarily decreasing our top line in the other markets, but growing the business in order to achieve that. So yes, as our major customers feel impacts, we will certainly feel it as well. I will say to you that because of our diversification, we feel more confident that we can ride through some of these downturns in any single market.

I agree with all of that. Sticking on kind of individual market things, just going over to the vehicle market, you had an important customer in that area, and they're clearly facing their own macro headwinds. They also, though, are seeing—they have had a bunch of new product launches as well, and given the aggregate market and kind of the sports vehicle market, if you would, is weak, but here's a new product going out there. How do we think about that vertical as it relates to Allient?

I think from the standpoint of looking at that particular market, we have to mention that when we talk about sports utility vehicles and so forth, much of that is used in the industrial marketplace or in commercial applications. So there's the consumer side of it, and then there's the business side. I do think, depending on the sentiments, you might see a downturn in consumers; the larger share of that business for us is really driven around the commercial and industrial end uses. I would tell you that, yes, we don't see any significant impact there. We see pretty stable year-over-year. And that's for a couple of reasons: continue to expand our reach into that market, to expand our customer base, as well as the emphasis to focus more on the commercial or industrial product versus the consumer product. So that's another factor. Of course, we can be impacted by it. We're not driving the demand in the end market. But is the diversification of our business and the impact that it could have today versus let's go back 10 years ago, it's a much smaller percentage of our business today than it was back then. And to answer some part of your question specifically, I mean we have been and continue to be active participants in new product launches with those customers.

I got two more for you, and they're a lot more fun. One is you have this new defense win, and congratulations on that. A lot of investors have wondered if you're going to see some pickup in activity within aerospace and defense with all the conflicts going on in the world. Could you provide a little more color in terms of the application that drove that win? Are you seeing further pick up strengthening in terms of activity projects within that vertical that could prove to provide some growth or strength as we think about the coming quarters or year?

Sure. So first off, we expect that the coming quarters will show increased quoting and activity. Part of that increase is the volumes that we're seeing. That win was in munitions. Munitions are being consumed at a high rate, and we are on many of those programs. We fully expect that this will continue with other programs. I mean, they're being consumed and need to be replenished. Yes, there were stockpiles, which surprised us as how big they were, but they do have to be replenished. So from a munition standpoint, we are designed into many applications, and we fully expect that over the coming quarters and year, we'll see increased activity in orders that need to be replenished. What we are hearing is that the delay in some of these orders is not due to our ability to deliver. We are faster than other suppliers can be for the end product. What's delaying some of this is the inability for other suppliers of content to provide their products and solutions. So as that catches up, we expect demand to continue to increase. These are long-term programs that we've been designing for years. It's not a matter of if, it's a matter of when. Another side of the defense business shows some trends that are longer term, but we do see some acceleration. We think we're very well positioned. We acquired FPH in Canada, whose key core technology is composite lightweighting products, as well as the ability to do application engineering and assembly of electromechanical systems. The combination of electromechanical systems with lightweighting technologies is now especially driven towards the electrification of vehicles, and we are a major element of that. We are well positioned and seeing activity there.

Well, I'm going to plug your Investor Day because—and I can tell you're very enthusiastic about the composites and the electrification because you were just as enthusiastic in New York. So I will look forward to seeing what happens within that business because you're clearly fired up about it. My last question is just, and again, more simple. It's just talking about the M&A pipeline. Congratulations on the acquisition. I know it's a very important part of the growth for the company and obviously, a key driver of getting to your long-term growth goal of $1 billion in sales. What's the environment like with regard to the M&A front? Can you give some color around the pipeline, kind of what you're seeing with valuations? The competition with regards to other competitors or private equity, given what's happening with the cost of capital?

Sure. M&A is an ongoing process for us. Of course, we have a balancing act here to understand the capital markets and how we're going to fund these and what we're going to do. We had a big flurry in the recent past, and we brought out great amounts of technology here that we have not fully leveraged yet, and we're working on leveraging. We are very focused on certain opportunities. We are building longer-term relationships for additional opportunities, and we are very selective in that process. But it's ongoing, and we fully plan to continue to manage our business in that area from an M&A standpoint, consistent with what we did in the past. We're not going to overpay; we will pay a fair price. It has to be additive in certain areas, and we take a long-term view on acquisitions that may not immediately deliver but are strategic and can drive long-term growth. I would say that our emphasis and focus has been in the recent past. We also opened up about highlighting Allient and our three pillars. This expands our opportunity to look at value-added, strategic acquisitions beyond just motion. We do have several viable opportunities that we believe could yield significant growth for the future. We're actively exploring these potential avenues.

Showing no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Well, thank you, everyone, for joining us on today's call and for your interest in Allient. We will be participating in two upcoming conferences: The Baird Global Industrial Conference on November 9 in Chicago; and then the ROTH Technology Conference on November 15 in New York City. As always, please feel free to reach out to us at any time, and we look forward to talking with all of you again after our fourth quarter 2023 results. 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.