Allient Inc Q1 FY2024 Earnings Call

Greetings and welcome to Allient First Quarter Fiscal Year 2024 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Craig Mychajluk, Investor Relations. Thank you. You may begin.

Thank you. And good morning, everyone. Appreciate your time today as well as your interest in Allient, Inc. We are here with Richard Warzala, President and CEO; and Jackson Trostle, our Corporate Controller. They are going to review our first quarter 2024 results and provide an update on the company's strategic progress and outlook, after which we'll open up for Q&A. The financial results were released yesterday after the market closed. If not, you can find it at our website at allient.com, along with the slides that accompany today's discussion. Please turn to slide 2 for the safe harbor statement. We may make forward-looking statements during the formal discussion, as well as during the Q&A, regarding future events that are subject to uncertainties, as well as other factors that could cause actual results to differ materially from what is stated on today's call. These uncertainties and other factors are discussed in the earnings release, as well as in the documents filed by the company with the Securities and Exchange Commission, which can be found on our website or at sec.gov. During today's call, we will discuss some non-GAAP measures which we believe will be useful in evaluating our performance. The presentation of this additional information in isolation does not substitute for results prepared in accordance with GAAP. We have provided reconciliations of non-GAAP measures in the tables accompanying the earnings release and slides. Now, I'll turn it over to Dick to begin.

Thank you, Craig, and welcome everyone. Before delving into the quarter discussion, I'd like to provide an update on our ongoing search for a new CFO. The process has been productive, yielding a pool of high-caliber candidates, and we anticipate welcoming an external candidate on board very soon. Given the timing, Mike graciously agreed to extend his tenure as CFO into the end of June, which will facilitate a smooth transition of his duties. Due to prior planned commitments, Mike couldn't join us on today's call, and Jackson Trostle will be filling in for him. I would like to take this moment to extend my heartfelt wishes to Mike as he embarks on his retirement. Throughout his tenure, Mike has been an outstanding partner and has played a key role in establishing the framework necessary for us to support the levels of growth we've achieved over the years. Under his leadership, he has also cultivated a strong support team, laying a solid foundation for our continued success in the future. I would also like to express gratitude to two other individuals for their guidance and support over the years. Jim Tanous, our Director since 2014, has chosen not to stand for re-election, resulting in a reduction of our board size to six members after yesterday's annual meeting. Jim's steadfast dedication, insightful guidance, and invaluable contributions have left an indelible mark on our company's trajectory. Similarly, I extend sincere appreciation to Joe Kubarek for his over 12 years of service to Allient, including as Secretary and Corporate Counsel. Joe has been a constant force over the years and his guidance has been instrumental in supporting our needs as we executed numerous acquisitions and realized excellent organic growth over the years. On behalf of the entire Allient family, I extend our sincerest thanks to these three individuals for their unwavering commitment and contributions. Now let's turn our focus to the results. The past quarter has been a testament to our resilience and adaptability. Moreover, our commitment to operational excellence and cost management has bolstered our margins and fueled bottom line growth along with strong cash flow generation. Given improved lead times, customer order patterns are normalizing to a pre-pandemic environment and excess supply is being taken out of the channel, which has had an impact on our order rates. Demand from our end markets was mixed, reflecting the various states of supply normalization within each market, with some pockets of weakness in Europe. Our top line came in at nearly $147 million for the quarter. On the plus side, our vehicle markets continued to benefit from the ramp of automotive programs, and industrial markets have increased at least double digits for each of the last 12 straight quarters, largely driven by industrial automation projects and power quality solutions. This market has also benefited from the improved supply chain and acquisitions. We reviewed the acquisition of SNC Manufacturing on our last earnings call as we completed the transaction in early January. SNC is a well-established company with locations in the U.S., Mexico, and China, and their offerings are complementary to our current power quality capabilities. While SNC has some medical and A&D business, the vast majority of their revenue will show up within our industrial sector. As a reminder, this was our first tuck-in acquisition in support of our power technology pillar and we are excited about the synergies that are developing as a result. We saw margin expansion across the board, with gross margin up 80 basis points, operating margin up 40 basis points, and adjusted EBITDA margin up 60 basis points. Overall, net income per diluted share increased 8% to $0.42 a share, and on an adjusted basis, net income per share was $0.58, up 5% for the quarter. Stronger earnings combined with improved working capital led to cash generation of $9.2 million, a record level for a first quarter. With that, let me turn it over to Jackson for a more in-depth review of the financials.

Thank you, Dick. Starting on Slide 4, we highlight our top line. First quarter revenue increased 1% or $1.2 million to $146.7 million. The impact of foreign currency exchange rate fluctuations was favorable, $0.2 million. Sales in our vehicle markets increased 12% during the quarter, driven by the anticipated escalation of certain automotive programs. Partially offsetting this growth was the continued decline in the demand for agricultural vehicles, given the softness in Europe stemming from geopolitical tensions, notably the Ukrainian conflict. Industrial markets were up 10%, lifted by recent acquisitions, and heightened end market demand within industrial automation, electronics, and power quality solutions, particularly those for the HVAC markets. A&D sales saw a decline of 22%, primarily attributed to the timing of certain space industry initiatives. We did see an uptick in defense demand throughout the quarter, which helped somewhat mitigate the impact of this timing. Medical markets also saw a decline, primarily due to the persistent softness in medical mobility products and solutions, a trend that has persisted over the past few years. Slide 5 shows the shift in our revenue mix across markets over the trailing 12 months and the catalysts for each change. Industrial maintained its position as our largest market and was 45% of TTM sales, a noteworthy expansion of 500 basis points. The robust 25% growth in the industrial vertical limits the trends from the recent quarter and reflected the improvements in the supply chain environment, which facilitated the delivery of long lead projects. Vehicle market revenue was up 7% on a TTM basis and reflected the same demand drivers as the recent quarter and also included higher demand for power sports. Similarly, aerospace and defense as well as medical sales demand also had similar drivers as the first quarter. Lastly, sales through the distribution channel, which are a small component of total sales, were up 4% for the TTM period. As highlighted on Slide 6, gross margin expanded 80 basis points to 32.3% for the quarter on higher volume, favorable mix, and pricing, along with a continued emphasis and usage of our lean toolkit throughout the organization. These impacts are more than offset by elevated raw material costs and remaining supply chain disruptions. Moving to Slide 7 for our operating performance. You will notice we had an increase in engineering and business development costs for the quarter, which largely reflected recent M&A activity. Helping partially offset this was lower general and administrative costs, which were 40 basis points lower as a percentage of sales year-over-year. Overall, operating income increased 6% to $12.1 million or 8.2% of revenue, a 40 basis point improvement. On Slide 8, we present GAAP net income and adjusted net income, which we believe provides a better understanding of our earnings power, inclusive of adjusting for the non-cash amortization of intangible assets, which reflects the company's strategy to grow through acquisitions as well as organically. First quarter net income increased 9% to $6.9 million or $0.42 per diluted share, and on an adjusted basis was up 7% to $9.5 million or $0.58 per diluted share. The effective tax rate was 21.8% in the first quarter of 2024. We expect our income tax rate for the full year 2024 to be approximately 21% to 23%. We use adjusted EBITDA as an internal metric and believe it is useful in determining our progress and operating performance. Adjusted EBITDA increased 5% to $20.0 million, or 13.7% of revenue, up 60 basis points. Slides 9 and 10 offer a snapshot of our cash flow and balance sheet. Notably, we experienced a robust cash-generating quarter, amounting to $9.2 million of operating cash flows, marking a significant increase from the $3.6 million in the prior year's first quarter. This achievement is particularly noteworthy, considering that the first quarter is traditionally a higher operating cash consumption period. The year-over-year increase was attributed to elevated net income and enhanced management of working capital. Our projections indicate a sustained momentum in driving strong cash flows, aligning with our historical trends. Capital expenditures for the quarter were $3.0 million and largely focused on new customer projects. We expect 2024 capital expenditures to be in the range of $13 million to $17 million. The increase in cash utilized for investing activities during the first quarter of 2024 was primarily attributed to the acquisition of SNC. Additionally, the investing activities for both the first quarters of 2024 and 2023 included a deferred payment of $6.25 million related to a prior acquisition. Inventory turns were 3.0 times and our DSO was at 55 days for the quarter. Total debt was approximately $240 million, up from year-end 2023 due to the SNC acquisition. Debt net of cash was about $209 million or 43.9% of net debt to capitalization. Our bank leverage ratio was 2.89 times. Reducing debt remains at the top of our priorities regarding the use of capital. Lastly, we recently extended the maturity of our existing $280 million revolving credit facility for five years to 2029. Borrowings for the revolving facility bear interest on a sliding scale rate based on leverage of 1.25% to 2.5% over SOFR. In addition, for added flexibility in locking in favorable rates, we entered into a $150 million fixed-rate private shelf facility under which $50 million of borrowings occurred on March 21, 2024. The fixed-rate $50 million debt bears interest at 5.96% and will mature in March 2031. With that, I will now turn the call back over to Dick.

Okay, Jackson. Slide 11 shows our orders and backlog levels. As discussed on previous calls, the shift in our backlog reflects ongoing enhancements within our supply chain environment. These improvements have facilitated the shipment of several long lead industrial projects as demand returns to a more normalized pre-pandemic level, with customer ordering patterns adjusting accordingly, as reflected in our book-to-bill. The year ahead will undoubtedly pose challenges as we continue to adapt to these evolving dynamics. However, this presents an opportunity to optimize our working capital and bolster cash flow. It is also important to stress that there are exciting initiatives on the horizon as we progress through 2024, and we are strategically positioning our organization to capitalize on significant opportunities across our targeted verticals. That leads to the highlighted actions on Slide 12. Our strong commitment to our strategy guides all of our key decisions. With the unveiling of our new strategic model, 'Simplify to Accelerate NOW,' we embark on a journey aimed at refining our organizational structure, eliminating redundancies, and optimizing our operations. In pursuit of sustained earnings growth and increased cash generation, our teams have identified key strategic actions for this year and into 2025. Realigning and rationalizing our footprint represents the largest opportunity, but also the most complex. This includes the consolidation of our brands under the Allient banner to include our motion controls and power technologies. By doing so, we ensure a more cohesive approach to foster improved market and customer alignment, enhanced market clarity, and focused teams that can better serve our diverse global customers. Our commitment to simplicity extends to customer interactions with dedicated selling units and solution centers offering specialized expertise and comprehensive system-level solutions. We must eliminate complexity in processing orders and transactions and focus on speed to win new business. As a result, we aim to centralize customer entry points and leverage our cutting-edge systems to automate processes to reduce transactional costs wherever possible. Internally, we want to foster a common business language facilitated by our lean toolkit, ASC, ensuring seamless collaboration across all levels. By defining and supporting the needs of the business as a whole, we're driving out redundant costs and strengthening our foundation for future growth. Lastly, elevating our pace and reducing our product development time to market is expected to deliver tangible value and stands as a top priority. This means reducing the complexity of designs by taking smaller incremental steps and adapting as we move forward. By doing so, we enhance agility, responsiveness, and ultimately customer satisfaction. These initiatives are being implemented in phases and some are still being fully vetted. While we expect benefits in 2024, ongoing improvements will be realized over the next two-plus years and will be offset by certain one-time costs to implement. Ultimately, we expect our executed actions to result in a more cost-effective leveraging of our resources and to provide us with a $10 million-plus effective improvement in EBITDA over this timeframe as actions are implemented and gain traction. We believe our efforts and actions are consistent with and will support our goal of achieving 100 basis points improvement in annual margin, which will come from a combination of both gross margin expansion and operating expense reduction. During 2023, it is important to note that we enjoyed elevated shipments in certain markets as the supply chain normalized and our customers accepted shipments for orders placed during the height of when lead times were extended. In 2024, we expect this normalization to have a $30 million to $40 million headwind on our top line, which will be mostly offset by the SNC acquisition. While the SNC acquisition will help offset the top line, it will not fully offset the pull-through incremental margin we had enjoyed as a result. Ultimately, the impact of our cost reduction and profit-enhancing activities will help offset the bottom line pressures that are expected to persist in the near term. In support of our strategic goals as a company, we will aggressively and proactively adjust the organization as required to ensure we establish a sound and strong foundation for the future. In closing, I want to reiterate our unwavering enthusiasm and confidence in the trajectory of our company. As we look ahead, we are energized by the myriad of opportunities that lie before us. With a firm commitment to innovation, new product development, and operational excellence, we are primed to capitalize on these projects and further elevate our performance over the long term. As we embark on the journey ahead, rest assured that our vision, strategy, and determination will continue to drive our success in the coming year and beyond. With that operator, let's open the line for questions.

Thank you. At this time, we'll be conducting a question-and-answer session. Our first question comes from Greg Palm with Craig-Hallum Capital Group.

I guess starting off with a little bit more color on what you're seeing out there in various end markets geographies. Is it stable relative to where we were a couple months ago? Any notable changes you want to highlight or call out?

Yes. I would say to you that there's more clarity on what we expect to see here in the coming months ahead. And I think certainly we pay very close attention to the performance of our customers. As we've seen and are hearing from them, they're expecting that organic growth rates will be down, which certainly would reflect on our organic growth. I mean, the impact would be relatively similar to what we see there. So I would say to you that, yes, there are certain markets that are having some challenges. I do think it's still a part of the normalization of demand as commitments for orders that have been placed months ago are being fulfilled and inventories are full. We'll have to see when that will start to return to full normalization, meaning that consumption is increasing or at least leveling out to the point where those inventory reserves are being consumed and then replenished. I'll say that's primarily in the industrial markets, Greg.

Well, I was just going to ask, you mentioned inventory levels. Do you have a sense on where inventory levels are? I mean, I know it varies across customer bases, but just in general. And should we just assume that book-to-bill is going to run below 1 in the near term as a result of what you're saying?

Yes, it may be below 1 in the near term, but I think we're going to see that gap is closing. We're starting to see some encouraging signs that there is business now orders are being released that hadn't been released for a while, which was resulting in the negative book-to-bill. But I would say to you that there's definitely improvement in that area. So there are some encouraging signs coming in the near term.

And then I guess just lastly, thinking about some of the operational improvements that you're making specifically around the 'Simplify to Accelerate NOW' strategy, do you feel like you got some of that benefit in Q1 or is that still to come? And can you give us any more color around the timing? I know you mentioned $10 million when it's all said and done, but when should we see that sort of full run rate of cost improvements?

For your first question, have we seen any impact of that in the first quarter? The answer would be no. When will we start to see it? There's been a very comprehensive review of all operations, looking at all areas of cost and so forth and expenses. We're working through the details, and we've identified certainly some major opportunities for us that will begin very shortly. So I would say to you, without providing any more details, it's a complete rationalization of where we are. We're beginning to move forward. Part of the process is not just to look at reducing cost, but how can we align much better to service our customers. I think that's key. It's critical because we've built the basis of business in different markets, and we think we can better service those markets and gain additional market share. There are opportunities to increase the EBITDA generation, profit generation, from improved business levels by leveraging the synergies we have in place, and there are also opportunities by restructuring and realigning to be more focused on the markets we serve and create an expertise that better services our customers. Those will start in Q2 and will continue throughout the year. That's what I would say to you. Again, with some of the actions, there will be some one-time costs. We'll be very clear on what those are as we identify and relay them to the marketplace. But I think that's about as much as I can cover right now without giving you more specifics, which we're still working on.

Our next question is from Gerry Sweeney with ROTH Capital Markets.

Not quite a repeat of Greg's question, but curious as to demand, how much of it is order normalization versus maybe fiscal tightening in the U.S. and in certain other countries. I'm not sure if the economy is slowing down. I'm just curious if you would have any thoughts on delineating between the two.

Yes. I would say to you that as we've watched the book-to-bill ratio, we look at our backlog and the markets, both geographic and the vertical markets, it wasn't unexpected. I think we've talked about it for several quarters that it really was going to happen. And I think typically, as I look at our business and we pay attention to what's happened with our customers, we typically lag that. Where we've seen some reduction in demand for our end customers, we held up. We're looking at what their forecasts and projections are for the near term, and I think we're modeling in that we're going to follow that. I wanted to point out that the gap of the negative book-to-bill ratio is closing. We've seen some encouraging signs where certain projects that we expected to begin resuming deliveries are now happening. Europe is still a question mark, especially Germany, where they're talking about major reductions in demand and so forth throughout the economy. That's the one area that we're watching closely, although we'll have to say that in other parts of Europe, we're starting to see that same trend where the order patterns or shipment patterns are improving. So it's going to be pretty telling here over the next couple of quarters. We bottomed out and we normalized inventories and we're now starting to supply to real demand, not just filling channels.

And I do know that you had spoken about order normalization for some quarters, and it sounds as though it's tracking as expected, but there are some pockets that it's still a little bit of wait and see. Is that a fair summation?

It is. And again, as I mentioned in the conference call here, the headwind that we faced, it was interesting because we received orders and multiple-year orders where the supply chain could not supply key components. Our customers honored the deliveries when the supply chain opened up, and we were able to get components. It elevated the shipments from last year, which were depressed from the prior year and will have an impact into this year, as I mentioned. So if we think about that demand, and the questions I can anticipate maybe coming here is we have this headwind of the top line, that was incremental top line based upon the existing base of business and offset by the acquisition of SNC. This acquisition comes in as a full company with fully loaded expenses and operating costs, so it's not the same profit generation from an incremental standpoint.

Just one more from me, then I'll jump in line. Inventories, turnovers, DSOs, what is the target or what would be more of a normalized level? I know it's in the slide deck. It was 22, 23, and I think 24, but we had COVID. You also have a bunch of acquisitions since that time frame. I'm just curious if you have a target where you want to take that, regarding working capital.

I'll let Jackson answer that.

I would say, it wouldn't be accurate to say we'll revert back to exactly where we were pre-COVID because a portion of the business has changed along with our acquisition since then. In the DSO range, I'd say based on our customer mix, there should be improvement, but I wouldn't expect it to be below 50 in the near term. For inventory turns, we're driving towards, I'd say in the 3.5 range at the end of this year, into the first quarter of next year would be our expectation. We're certainly driving to find opportunities to exceed that internally where we can.

Our next question comes from Ted Jackson with Northland Securities.

Dick, I want to delve into the efforts you're making regarding restructuring operations and business. I have a few questions around that. I want to start with the brand consolidation. So if I understood you correctly, you are going to eliminate all the different names from the various acquisitions and everything's going to Allient, and then am I understanding that you're going to centralize a lot of operations across those businesses? The reason I ask that is what is going back into your M&A. In the past, it seemed to me that the strategy for Allient was to buy smaller companies that fit within your world, giving them the resources to grow their businesses, usually keep the management team in place and really let them run it. When I listen to what you're doing, it sounds like there is a change in the strategy, and how do you see that impacting your ability to bring in some of the acquisitions?

Sure. There's a lot of questions in that first question, Ted, so let me go ahead. So first off, the parent company is named Allient. If you go back in time, when we began the roll-up in the motion side of the business and how we handled brands under Allied Motion, you'll see that we took a logical approach to changing the names over time. Some have been fully changed, while others have been maintained longer due to their brand recognition. We realize as a company that we want to compete as one entity, and that's our strength. By coming out with a new brand, Allient, connecting what matters, and leveraging all of our pillars, we're working hard to identify within the vertical markets. That gets into some of the realignment that I'm talking about. We'll discuss further the opportunity to bring multiple technologies from the different pillars into the vertical markets as a unified solution. There are many reasons for doing this. But if you don’t do that, each entity gets treated as an individual company. If you want to get qualified with larger customers and open the door for multiple products, it becomes very difficult and restrictive. So having a unified company will strengthen our services and customer focus. We're retaining management and key individuals, but restructuring for cost efficiency.

I appreciate the clarification. It sounds like there is a shift in here. You're going to centralize a lot of the behind-the-scenes operations for cost effectiveness. How does that play into your sales efforts? What are you doing on that front?

That's a fair question. We will not have one Allient sales force, but we can leverage many of the products and solutions in certain markets to certain customers. Our structure is already in place, and what we’re doing is enhancing that. For example, in defense vehicles, we went through a strategy session to identify what we are selling into this market and how many different applications we are servicing. We found that it’s significant, and our new customer-facing teams will be fully knowledgeable to support everything we can offer. This allows us to streamline operations instead of dealing with multiple locations for orders, which complicates transactions. The goal is to simplify our process, thereby enhancing customer experiences.

It sounds like you are consolidating back-office systems, likely involving new ERP and CRM systems. Is that correct?

We've been doing that for multiple years now. We've converted the majority of acquisitions to a common system, although some smaller ones still have room for improvement. We have a competent team overseeing the implementation, and it has been done successfully. We're in the later stages of completing conversions and cutovers to a unified system. We're operating effectively with our existing reporting tools and are close to the finish line for broader integration and improvements.

We have reached the end of the question-and-answer session. I'd now like to turn the call back over to management for closing comments.

Thank you, everyone, for joining us on today's call and for your interest in Allient. We will be participating in the Craig-Hallum Investor Conference on May 29 in Minneapolis. As always, feel free to reach out to us at any time, and we look forward to talking with all of you again after our second quarter 2024 results. Thank you for your participation, and have a great day.

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.