Allient Inc Q2 FY2024 Earnings Call

Greetings and welcome to the Allient Inc., Second 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, Deborah Pawlowski of Investor Relations for Allient. Please go ahead.

Thank you, Joe, and good morning, everyone. We certainly appreciate your time today as well as your interest in Allient. Joining me on the call are Dick Warzala, our Chairman, President, and CEO; and Jim Michaud, our Chief Financial Officer. In fact, join me in welcoming Jim to his first earnings call with us. He just joined Allient on June 3rd of this year. Dick and Jim are going to review our second quarter 2024 results and provide an update on the company's strategic progress and outlook, after which we will open up the line 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 and uncertainties and other factors are discussed in the earnings release as well as in 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 as well as the slides. With that, please turn to Slide 3, and I will turn it over to Dick to begin.

Thank you, Debbie, and welcome everyone. Before we begin discussing this quarter's results, I'm excited to introduce our new CFO, who has been with us for just over two months. During this period, Jim has actively engaged with our team to understand our processes and support the advancement of our Simplify to Accelerate NOW strategy, leveraging his experience with similar initiatives in past roles. As a financial leader with a wealth of knowledge in both multinational public and private companies, Jim has a strong background in establishing high-performing finance operations and transforming organizations, making him a valuable asset to our team. We believe Jim's contributions will be crucial in helping us achieve our strategic objectives. Regarding the quarter, I am proud of our team's efforts in tackling the market challenges we've encountered. While the quarter started on a positive note, we experienced a marked decline in demand in June. This downturn was evident across most of our markets but was particularly pronounced in industrial automation, where we see ongoing destocking, as well as in the powersports market, reflecting a drop in consumer demand. Many public companies in similar sectors have reported similar challenges and a subsequent decrease in year-over-year revenue. It's important to note that we see the delay in orders as a result of inventory adjustments, sustained high interest rates, and political uncertainty. Our diversification provides some relief, as we continue to benefit from macro trends such as electrification, energy efficiency, and automation. However, our actions to Simplify to Accelerate NOW are particularly timely. As previously discussed, we are on a fast track to reorganize for improved productivity and stronger earnings potential. Given the current market landscape, the approximately $5 million in annualized savings we have achieved so far are more crucial than ever. Our decremental margin reflects weakness in revenue, an unfavorable mix, and inventory reserves. The mix impact involved a shift from higher-margin incremental industrial automation sales to lower-margin sales from our latest acquisition. We anticipate that our simplification efforts, in conjunction with the execution of our integration plans and the increased capacity from acquiring SNC, will enhance our margin profile in the future. Our Simplify to Accelerate NOW plan is particularly significant in light of the current market dynamics. We executed $5 million in annualized cost reductions in the second quarter and are working towards another $5 million in annualized savings in the second half of 2024. A key part of our restructuring involves transferring production activities from various U.S. operations to our existing lower-cost facilities in Mexico. Moreover, we have reduced our workforce across most global operations to align with expected demand. Jim will elaborate on the restructuring charges and inventory adjustments associated with these initiatives. While we are decisively working to lower our cost structure, we continue to implement programs aimed at driving future growth. We remain confident in our long-term strategy and the foundational strength of our value proposition. Now, I will turn it over to Jim for a detailed review of the financials.

Thank you, Dick, and good morning, everyone. This is my first earnings call with the company, and I want to begin by expressing my appreciation for the warm welcome I've received from the team and the chance to work with such a talented group. In my brief time here, I've been impressed by the commitment and resilience of our team. I'm thrilled to be part of Allient and contribute to our ongoing success. Today, I will provide an overview of our financial performance for the quarter, highlighting key areas of focus. Starting with the second quarter revenue of $136 million, this reflects a year-over-year decline of 7%. The impact of foreign currency exchange rate fluctuations was slightly negative, affecting us by $700,000. During the quarter, our vehicle markets faced a 17% decline in sales, mainly due to reduced demand in powersports and ongoing weakness in the agricultural sector. However, this decline was somewhat mitigated by increased demand in commercial automotive attributable to the rollout of new programs we have secured. The industrial market experienced a 3% decrease, despite improved power quality sales, particularly in the HVAC and data center sectors, and additional sales from our recent acquisition. These positive developments were overshadowed by lower demand in industrial automation and within our pumps and material handling sectors. Our medical markets also experienced a decline, largely driven by ongoing softness in medical mobility products and solutions, a trend we've seen continue over several years. Additionally, the bankruptcy of a major customer in this area has impacted demand. In the aerospace and defense sector, sales decreased mainly due to program timing within the space industry. Nonetheless, we are seeing encouraging developments on the defense side with several significant opportunities. The shift in our revenue mix across markets over the past 12 months indicates that the industrial vertical remains our largest market, representing 46% of total sales in that period, an increase of 500 basis points. The space industry saw 14% growth, reflecting strong demand for power quality. On a trailing 12-month basis, industrial automation benefited from improvements in the supply chain environment but has recently adjusted as the industry resets its inventory levels. Vehicle market revenue remained stagnant over the same period, with higher demand in commercial automotive balanced by lower demand in powersports and agriculture. Both the medical and aerospace and defense sectors saw declines on a trailing 12-month basis, consistent with the dynamics of the previous quarter. Sales to the distribution channel, while a minor part of total sales, accounted for 4% over the trailing 12-month period. Gross profit was $40.7 million, with a gross margin of 29.9%. The 140 basis point decline was mainly due to lower volumes resulting in under absorption and an unfavorable mix, including the expected margin dilution from the SNC acquisition and $1.2 million in non-cash inventory reserves. Half of the inventory write-down related to the earlier mentioned bankruptcy, with the remainder primarily due to changes in projected demand. We believe our core business can achieve a higher margin profile, but we need to work towards that. Lower gross profit, along with $1.5 million in restructuring and business realignment costs and increased engineering expenses, affected operating income, which totaled $4.9 million, resulting in an operating margin of 3.6%. Costs associated with restructuring were mainly severance-related. Operating expenses were 26.3% of revenue, an increase of 320 basis points, with 110 basis points of that attributable to restructuring costs. We are committed to enhancing our profitability despite current market conditions. Net income stood at $1.2 million, with earnings per diluted share at $0.07. Adjusted net income was $4.9 million, or $0.29 per diluted share, accounting for the non-cash amortization of intangible assets to meet the accounting standards of an innovative, acquisitive business. The effective tax rate for the quarter was 20.6%, and we expect our full-year 2024 income tax rate to range between 21% and 23%. We utilize adjusted EBITDA as an internal metric to measure our progress and operational performance. Given margin pressures, adjusted EBITDA was $13.9 million, or 10.2% of revenue. We aim for a mid-teen adjusted EBITDA margin and have initiated simplification measures to achieve consistent performance. Regarding cash generation and our balance sheet, year-to-date cash from operations was $17.4 million, an improvement from the prior year due to working capital efficiencies and non-cash adjustments that helped offset lower net income. Capital expenditures for the first half of the year totaled $5.3 million. While we are still investing in several growth opportunities, we are refining our plans to focus on high-potential, high-value projects. As a result, we have adjusted our 2024 capital expenditure forecast to a range of $11 million to $15 million, down from our previous expectation of $13 million to $17 million. Inventory turns decreased to 2.9 times since year-end, while our days sales outstanding remained steady at 56 days. Total debt was approximately $237 million, increasing since year-end 2023 due to the SNC acquisition, though we paid down $3.3 million this quarter. Net debt, after accounting for cash, was around $206 million, making up 43.6% of net debt to capitalization. According to our credit agreement, our bank leverage ratio was 3.29 times. Our financial priorities include improving cash conversion and reducing debt.

Thank you, Jim. Orders increased 12% sequentially in the quarter driven by power quality projects and the ramp up of our commercial automotive programs. The sequential improvement in demand is somewhat encouraging, although there is an impact on orders as our customers continue to reduce inventory levels. Additionally, we are experiencing delays in the launch of certain projects which may be a result of the upcoming election and expected decrease in interest rates. Importantly, while we are getting some order push-outs order cancellations are minimal and being addressed appropriately. We expect the slowdown will extend through this year and into 2025. The decline in backlog is attributed to continued improvements within the supply chain, as lead times were reduced and we ship products that were in our backlog as a result of the previous market conditions. Our outlook is outlined on Slide 13. We are taking decisive steps to align our business with current market conditions. We anticipate the challenging environment to persist through the second half of 2024 with our annualized revenue run rate expected to fall below $500 million over the next few quarters. This projection reflects substantial inventory rebalancing by our customers, as the supply chain returns to normal, some market erosion and a relatively weak industrial automation environment. We expect that the reduction of uncertainties settling of lower interest rates and normalized inventories should go back to stronger revenues sometime in mid-2025. As we streamline our operations, we believe we can enhance customer service and strengthen our long-term competitiveness. Our goal is to make Allient easier to do business with and accelerate our speed to market with new product innovations. This strategy is also expected to position us to better handle the current macroeconomic environment and industrial challenges. We aim to achieve our target of $10 million in annualized savings this year and to identify and execute further actions beyond this target to ensure we emerge as a stronger, more resilient enterprise with higher earnings power. With that operator, let's open the line for questions.

Thank you. And our first question comes from the line of Greg Palm with Craig-Hallum.

Yeah. Thanks. This is Danny Eggerichs on for Greg today. I guess maybe just digging into more what you saw and what you're seeing in June, the kind of significant fall-off in demand. You said that was kind of weighted towards industrial automation and powersports. I guess as we've moved through July now and into early August, I guess how has that changed? Are you seeing some of that weakness spread across the other end markets or I guess just anything more you can give on end market geography what you're seeing quarter-to-date so far?

Sure, Danny. I would say to you that we see a continuation of what we experienced in June. And I think just to be clear, we had mentioned that we started the quarter quite well. April and May were relatively solid and then June was a significant drop off. We do expect that that will continue as we mentioned here through the remainder of the year and potentially into 2025. Looking at the incoming order rates and as you're asking to look out and what has occurred in July and so forth, there were some mixed signals. We did see a couple of encouraging signs that may suggest things will come back. But it's hard to gauge based on one month. I would caution us not to get carried away that we did see a couple of positive signs there and that things were going to change drastically. So, sticking with what we've stated here, the industrial automation, the rebalancing that we saw for inventories and the impact it had especially on us and the other markets. And we didn't talk much about geographic markets, but certainly Europe was impacted. And again, some mixed signals. So, for us right now our emphasis is going to be on getting the business adjusted, readjusted, and aligned to take costs out to become a more profitable company based on a lower cost base. That's really our focus and it will continue to be our focus this year and into next year.

Yes. It seems like there are mixed signals and some uncertainty about visibility. The run rate of $500 million for the second half suggests that while there might be gradual improvement early in 2025, there is also the possibility that inventories could start returning before reaching normal run rates in mid-2025. Should we expect gradual improvement starting early next year, or do you anticipate that the $500 million run rate will continue into the first quarter of next year before significant improvement begins?

Yes. Based on our current understanding, I expect this trend to continue into Q1. If any changes occur and market dynamics shift, we will keep everyone informed. Given this anticipation and the $500 million annualized run rate, it is crucial for us to keep streamlining and reorganizing to reduce costs and enhance profitability. Additionally, as we mentioned, we anticipate an extra $5 million in cost savings in the second half of 2024, which is largely identified and will be implemented early in that period. We are adjusting costs and realigning the business to navigate the market's fluctuations and uncertainties we discussed. While things could change rapidly if specific circumstances arise, we are managing our operations based on what we can control, and we will make it happen.

Sure. And on that added $5 million now $10 million of cost take-outs, I know you mentioned you're still looking for additional opportunities. Do you feel like there's some more levers to pull if things continue to worsen or stay at this kind of level for longer than you're expecting? Is there more cost take-outs just kind of buoy some of that profitability?

Yes. This will not be influenced by whether the markets continue to decline. We have thoroughly examined everything and have identified additional opportunities. It is just a matter of how much we can implement in a short timeframe.

Okay, great. I will leave it there. thanks.

Thank you, Danny.

And the next question comes from the line of Brett Kearney with American Rebirth Opportunity Partners. Please proceed.

Hi Dick and Jim. Good morning. Thanks for taking my question.

Good morning Brett.

Great to hear some of the new commercial vehicle awards ramping up. Curious with the puts and takes in the global economy what you're hearing from customers and some of the other recent new vehicle programs you've won? And kind of what customers are looking for in kind of pushing forward with those ramps as well?

Sure. It's noteworthy that there has been attention on the electric vehicle sector. Most of our solutions are neutral regarding whether the engine is combustion or electric. We noticed a decrease in demand during the second quarter, which was essentially a delay of one month. It seems adjustments have been made, and we expect steady demand moving forward. While I don't anticipate an increase beyond our current levels, we do have additional programs in the works that will not affect this year but should gain momentum next year. The impact we faced was brief, and hopefully, everything has been adjusted for now, leading to consistent demand ahead. The main challenge arose from inventory adjustments at key customers who went from a rapid shipping pace to a sudden need for recalibration, which was a significant shift.

Excellent. Very helpful. And then, if I can just ask one more on A&D. Just curious, as you look out the next year or two what you're seeing I guess both space market as well as traditional defense opportunities for the company?

Yes, this is very encouraging. We have previously mentioned that we have been working on several applications, which needed to ramp up at some point. Some projects were delayed and there were challenges in decision-making, but there is a substantial number of projects underway. We are beginning to observe a gradual increase in demand in some areas where we anticipated it to have already emerged. The aerospace and defense sector is a positive highlight, as well as the medical field, where we are also seeing promising opportunities.

Perfect. Thanks so much, Dick.

Thank you, Brett.

And our next question comes from the line of Ted Jackson with Northland Securities. Please proceed.

Thanks. I was a little concerned. I wasn’t getting recognized by your system for your question queue.

I see you around there, Ted. You’re there.

So I’m out there. I pay attention, Dick. Welcome Jim aboard. Although, I think he missed the boat, went straight into the water. So but hopefully I had a follow-up on that. It will now turn around and you’re getting at the bottom Jim – you’re getting at the bottom, that what I meant to say and nowhere to go. So my questions are a couple of things. First of all, on the $5 million cost savings that you've already done and the $5 million that's coming, how should we think about how that rolls through the model with regards to kind of OpEx and gross margins?

Sure. Our primary focus is on fixed costs. Jim can provide more details on the reduced fixed manufacturing costs, but our main emphasis has been on operating expenses. As volumes decreased, variable costs also went down, but we are not reporting those numbers. We are specifically reporting the incremental savings, although we did consider the difference in direct labor costs between US and Mexican labor, which was a relatively minor factor. The majority of the savings have come from operating expenses, along with some reductions in fixed manufacturing overhead. Is your question regarding the timing beyond that?

That was kind of the next part of, how would we think about it. I mean, it sounds like your $5 million is already kind of done. So we can think about that coming play in the second half of this year. And then, the next $5 million sounds like we'll see maybe some of that in fourth or first quarter. I mean, it's kind of what I interpreted, but some color on that would be great too, Dick.

Yes, you are correct that the first $5 million is already in place, and we have accounted for it, so we will see the benefits immediately. The next $5 million we discussed has already been implemented in the second half, and I can say that most of it will be completed early in that period, allowing us to start seeing benefits from it as well. As we enter the next year, we will fully realize the $10 million in cost reductions. Additionally, there are other measures we can take, but we need a bit more time to ensure they are executed properly. More improvements are on the way.

Okay. My next question is just going into revenue mix and guidance. I mean, you saw weakness pretty much across the business. I mean generally, speaking with the ones that really stood out for you being industrial automation and let's call it, recreational vehicles. When you look at your outlook this $500 million run rate that we are to expect to see for the next several quarters, can you provide some color with regards to where that weakness will be concentrated from an end market perspective? I'm going to assume it's the markets that have already been addressed, but I want to make sure. And then from a geographic perspective, where that weakness might be? And if you can kind of tie all that together that would be great. Thanks.

We anticipate weaker demand in the power sports segment, which reflects overall market trends as indicated by our customers. The industrial sector presents some uncertainties, and we are taking a cautious stance, preparing for a slow recovery. However, there is potential for improvement by the fourth quarter of this year. While we expect a general decline in other markets, aerospace and defense, along with certain medical applications, are showing some growth. We are approaching this situation carefully while also making aggressive moves to strengthen our foundation and achieve our established margin improvement goals. In Europe, the overall market has declined by 8% to 10%, particularly impacting our segments, although we are seeing some increases in specific areas. As we analyze the situation, there are mixed signals suggesting a potential return to growth, but we will continue to plan carefully and take decisive action to align our cost structure with our margin goals, which we have been discussing for the past few years.

My final question is this: Given your current challenges with the macro environment and the ongoing business restructuring, can we assume that the growth strategy focused on mergers and acquisitions will be put on hold while you work on stabilizing the company, or are you still actively pursuing opportunities in that area? That's my last question.

It's fair to say that we are focused on cash and reducing our debt. We continue to identify and develop future opportunities, but in the short term, we would need to encounter something truly exceptional and approach it differently than in the past. Our emphasis is on improving our internal operations and preparing for long-term acquisitions. However, we are not actively pursuing opportunities available in the market at this time.

Okay. All right. Thanks for taking my question.

Thank you, Ted.

Thank you. This concludes our question-and-answer session. I'd like to turn the call back to Dick Warzala for closing remarks.

Thank you everyone for joining us on today's call and for your interest in Allient. 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 third quarter 2024 results in November. Thank you for your participation and have a great day.

This concludes today's conference. You may now disconnect your lines.