Allient Inc Q2 FY2025 Earnings Call

Good morning, and welcome to the Allient Inc. Second Quarter Fiscal Year 2025 Financial Results Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Craig Mychajluk, Investor Relations. Please go ahead.

Yes. Thank you, and good morning, everyone. We certainly appreciate your time today as well as your interest in Allient. Joining me today are Dick Warzala, our Chairman, President and CEO; and Jim Michaud, our Chief Financial Officer. Dick and Jim will walk through our second quarter 2025 results, provide a strategic update and share our outlook. We'll then open up the call 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're 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 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 as well as the slides. So with that, please turn to Slide 3, and I'll turn it over to Dick to begin. Dick?

Thank you, Craig, and welcome, everyone. We continue to build momentum in the second quarter, delivering record gross margin, strong profitability and exceptional cash generation. This performance reflects the consistent execution of our operational priorities and the alignment we are seeing across our markets, organization and strategic roadmap. Revenue increased 5% sequentially and 3% year-over-year, supported by solid demand in data center infrastructure, defense and select high-value medical applications. While powersports within the vehicle market remained under pressure, we did see healthy sequential growth from that vertical. It is worth noting that approximately $3 million to $4 million of revenue was pulled into the second quarter as customers accelerated shipments due to concerns around supply constraints in heavy rare earth materials. Gross margin reached a record 33.2%, up 100 basis points sequentially and 330 basis points from a year ago, driven by a favorable mix, higher volumes and continued improvement in operating discipline. This translated into meaningful EBITDA growth and a significant increase in profitability with net income up 58% from Q1 and nearly fivefold year-over-year. We also generated $24.5 million in operating cash during the quarter, another record, which enabled us to further reduce debt and strengthen our balance sheet. Our Simplify to Accelerate NOW program remains central to our performance, driving efficiency, aligning with evolving customer needs and enhancing responsiveness across our global operations. The operational foundation we have built is delivering results even in a dynamic external environment, including tariff and material supply challenges, particularly in heavy rare earths, where we are actively managing constraints. The initiatives we put in place are tracking well, both in terms of cost savings and operational agility. For example, our restructuring launched as a cornerstone of the 2025 effort is on track and expected to play a meaningful role in achieving the $6 million to $7 million in targeted annualized savings this year. Looking ahead, we remain focused on building on this momentum, executing with discipline, scaling the benefits of our transformation initiatives and advancing toward our long-term financial and strategic objectives. With that, let me turn it over to Jim for a more in-depth review of the financials.

Thank you, Dick, and good morning, everyone. Let's begin with Slide 5. Revenue for the second quarter was $139.6 million, a 3% increase year-over-year and up 5% sequentially. This growth was driven by continued strength in our aerospace and defense programs, industrial markets, especially HVAC and data center infrastructure and select medical applications. Revenue growth also benefited from a favorable foreign exchange impact of $2.4 million. Sales to U.S. customers accounted for 55% of total revenue, in line with last year. The geographic and end market diversification of our portfolio remains a key strength. Looking at our market performance, Aerospace and Defense grew 13%, reflecting program timing and strong execution. We continue to see a healthy pipeline of opportunities in the defense sector and believe this market will remain a solid contributor to growth as we move forward. Medical was up 4%, led by solid demand for surgical instruments. The industrial market increased 3%, driven by continued strength for HVAC and data center market applications where our power quality solutions are needed. We are also encouraged by early signs of recovery in industrial automation, where demand has been challenged over the past year given the inventory destocking. We are beginning to see more consistent activity and ordering trends. Vehicle revenue was down 7% due to ongoing softness in powersports, although we did see sequential sales improvement in the vehicle market. Now turning to Slide 6 for the composition of our revenue over the trailing 12 months, along with the key catalysts driving these changes. We have seen a meaningful shift in mix with growth in higher value industrial and aerospace defense solutions helping to offset ongoing pressure in the vehicle market. This evolution reflects not only external market dynamics such as softness in recreational spend and volatility in automation, but also our deliberate effort to focus on more resilient margin-accretive applications. The industrial sector is our largest market and reflects similar impacts as the recent quarter. Aerospace and defense continues to be a growth driver. Meanwhile, our vehicle exposure has been intentionally refined. While near-term demand in powersports remains soft, our proactive repositioning away from lower-margin programs is helping to protect profitability. Overall, our revenue mix today is more diversified, more balanced and better aligned with where we see long-term opportunity, and that puts us in a strong position to manage near-term headwinds while driving sustained performance. On Slide 7, we are pleased to report a record gross margin of 33.2%, up 330 basis points from last year and 100 basis points sequentially. This improvement marks our fourth consecutive quarter of expansion. Key drivers included favorable mix, higher volumes and ongoing implementation of lean manufacturing disciplines as well as our Simplify to Accelerate NOW program. Slide 8 highlights our operating leverage. Operating income more than doubled to $11.7 million with operating margin rising 480 basis points year-over-year to 8.4% and improving 180 basis points sequentially. SG&A was 14.7% of sales, down 60 basis points from last year, demonstrating cost discipline despite inflationary and incentive-based pressures. Restructuring and business realignment costs were $1.1 million in the quarter, supporting future margin improvement. Turning to Slide 9. Net income increased to $5.6 million or $0.34 per diluted share. On an adjusted basis, net income was $9.5 million or $0.57 per diluted share, up from $0.46 per share in Q1 and $0.29 per share in the prior year. Our effective tax rate for Q2 was 23.1% as we continue to expect our full rate to land between 21% and 23%. As for interest expense, we did see an increase despite lower debt levels. As we discussed last quarter, this was largely due to the expiration of 2 favorable interest rate swaps late last year, which were replaced at higher prevailing rates. While still competitive in today's market, they are not as favorable as the prior arrangements. Additionally, our amended credit facility carries a modestly higher spread contributing to the increase. That said, our overall interest burden remains manageable, and our strong cash flow is enabling continuing deleveraging. Adjusted EBITDA increased meaningfully to $20.1 million or 14.4% of revenue, driving strong conversion on higher volumes and a more favorable mix. This represents margin expansion of 420 basis points year-over-year and 120 basis points sequentially. Turning to Slide 10. We delivered record operating cash flow of $24.5 million in the quarter, up 76% sequentially and nearly 3 times the level generated in the same period last year. On a year-to-date basis, operating cash flow now stands at $38.4 million, more than double what we achieved in the first half of 2024. This strong performance reflects both profit growth and disciplined working capital execution. Our inventory turns improved to 3.1x, up from 2.7x at the end of the year. This was driven by tighter demand alignment, better planning and continued progress under our Simplify to Accelerate NOW initiative. At the same time, our days sales outstanding improved, signaling stronger collections and more efficient conversion of sales into cash. We used a portion of our cash to reduce debt by $20 million in the quarter, bringing us to the balance sheet discussion on Slide 11. We ended Q2 with nearly $50 million in cash and lowered our net debt by $35.8 million year-to-date, bringing our leverage ratio down to 2.3x compared with 3x at the end of last year. Our bank-defined leverage ratio, which excludes certain items like foreign cash, was 2.9x, well within covenant levels. Capital expenditures were $3.2 million through the first half of the year. We have refined our full year 2025 capital expenditures outlook to a range of $8 million to $10 million compared with the prior estimate of $10 million to $12 million. Overall, we are executing well across all 3 of our financial priorities for 2025, improving inventory turns and working capital, maintaining cost discipline and reducing debt. These efforts position us well to continue expanding profitability and create financial flexibility for strategic execution. With that, if you advance to Slide 12, I will now turn the call back over to Dick.

Thank you, Jim. While our book-to-bill ratio was modestly below 1 at 0.97, demand trends remain steady in key sectors like industrial, where our power quality solutions continue to perform well and in aerospace and defense, where we are seeing continued traction with both legacy and new programs. Backlog ended the quarter at $236.6 million, down slightly from Q1 and prior year levels as customers continue to manage through inventory normalization. The majority of our backlog is still expected to convert within 3 to 9 months, which is consistent with historical patterns. Importantly, we are seeing signs that the destocking cycle is largely behind us, especially in the industrial automation end markets. Order activity is becoming more consistent and quoting volumes are improving in several key verticals, which gives us confidence heading into the second half. That said, we do expect third quarter sales to be sequentially lower due to the $3 million to $4 million in revenue that was pulled into Q2. While Europe is showing signs of stabilization, the region has not fully recovered and Q3 is typically a seasonally weaker period in Europe. As we look ahead, our strategy remains unchanged to drive sustainable, profitable growth while delivering lasting value to our customers, employees and shareholders. We continue to align the business around margin-accretive technology-forward solutions that meet the evolving needs of our customers in motion, control and power. The benefits of our Simplify to Accelerate NOW program are clearly reflected in our performance through margin expansion, operating leverage, improved working capital and stronger cash flow. We remain proactive in managing external risks, including tariffs and rare earth supply dynamics. Our mitigation strategies are proving effective, and we are confident in our ability to protect both supply continuity and profitability. More broadly, we are encouraged by constructive signs across our served markets, supported by long-term trends in electrification, automation, energy efficiency and precision control. This includes seeing early signs of recovery in industrial automation and steady momentum in aerospace and defense. The operational foundation we have built, the strength of our balance sheet and the momentum behind our core initiatives positions us well to execute through the second half and to drive long-term value well beyond. With that, operator, let's open the line for questions.

Today's first question comes from Greg Palm with Craig-Hallum Capital Group.

Congrats on the results. So I just want to maybe understand, again, kind of what you're seeing out there. So it sounds like you're feeling good that the destocking is in the rearview mirror. You're starting to maybe see some green shoots in industrial, A&D remains strong. Anything else you want to maybe call out or highlight?

No, I think you've hit the highlights.

In the area of A&D, could you remind us what your major exposure areas are? Also, how do you view visibility for the remainder of this year and next year? How strong is the demand?

Sure. Well, A&D, certainly in some of the applications that we work on, we do get some good visibility, long-term visibility, and we work on longer-term contracts. And we continue to do that. So we are seeing some very positive results. We've made some significant improvements in our operating capabilities, some of the restructuring we've talked about here that's underway that solidifies operations and gives us and provides a greater strength within certain facilities. I think that's playing out well. We're meeting with key customers on a regular basis. And I think from a legacy business standpoint, and some of the applications we're on, we do see that there is some opportunity to increase volumes and to hopefully expand margins as we've consolidated the operations. Some of the new applications with government programs or military programs, there's usually risk, and there's no guarantee that those programs come to fruition. We have seen a few cancellations. We've seen a few programs move to the right. We're seeing other programs moving to the left, meaning accelerating. So it's a mixed bag right now. We feel there's a transition going on in terms of the way warfare is going to be fought and the types of vehicles or devices that are going to be needed for that. And I do believe that our team is well positioned to capitalize on it as we move forward. So there will be some minor bumps along the way, but we feel we're on track, and we're in a good position to capitalize on those as they move forward.

Okay. Great. And then maybe lastly, on the rare earth magnets, which I know we talked about a lot last quarter. I mean, on a relative basis, given what's happened in the last month, are you feeling better, worse, the same? What's the risk profile there?

Our team has put in a tremendous effort to stay engaged with all of our operations, and we have a solid outlook on what we believe is coming. We have seen some improvements, but we must remain cautious as most of the materials we discuss are sourced from China, and there is always the possibility of short-term changes. We are beginning to see some progress, with licenses being approved. However, we still have some exposure; we previously mentioned that between 1 million and 3 million shipments could be affected for the remainder of the year. Additionally, we experienced some accelerated shipments or pull-ins into Q2, likely due to concerns regarding heavy rare earth materials, prompting our customers to secure supply in advance. As previously stated, this could influence our third quarter shipments, but we do not have enough visibility into our customers' plans. While we acknowledge there might be an impact, we also understand that customers might choose to pull ahead again if we have materials available. Therefore, we noted that Q2 was somewhat higher than anticipated because of the pull-aheads, and Q3 may also be affected. However, we are not entirely sure how our customers will respond and whether they will maintain inventory or continue with regular supply while holding some safety stock. We are seeing these trends, but we are encouraged by some positive signs indicating that things are easing and returning to a more normal state.

The next question is from Ted Jackson with Northland Securities.

Congratulations on a very nice quarter. I've got a few questions. Going back into the pull forward of revenue, just out of curiosity, within your reported segments, where was most of that pull forward coming from segments like Industrial, Medical, Vehicle, et cetera?

Yes, there are two areas in medical related to the types of materials typically used in high-performance solutions. When we refer to heavy rare earth, it generally indicates higher performance solutions, which involve, for instance, smaller yet higher energy magnets to produce more power. The need for these higher performance materials arises either from size constraints or the requirement for true high performance that necessitates using such magnetic materials. I would mention medical, some high-end industrial applications, and defense. Additionally, I want to reiterate that our company has been proactive for more than 10 years regarding these cycles. It appears that every 7 to 8 years, magnet prices face pressure, increasing by 300% to 400%, requiring collaboration with customers to secure sufficient material and adjust surcharges accordingly. In this instance, we faced the additional challenge of not being permitted to receive this material, which added stress. Given past experiences, our company has actively pursued product designs that minimize or eliminate the use of heavy rare earth materials, and we will continue to do so in the future to mitigate this risk. We have taken steps in this direction for years, and we have seen success.

Well, that would be great. And then the fact of the matter is as these barriers to trade come in place, it's driving the development of the domestic market, which over the longer-term would probably be quite big. So we'll see how it plays out over the next decade or so. On the magnet supply, I mean, I know as all this came in place that you guys were on top of it and smart and did bring in some heavy earth high-end products into inventory to be in front of it. When you look at where you are with that, I mean, at what point would it become an issue if God forbid, the Chinese just stopped things again. I mean do you have enough supply to get you through the remainder of this year? I mean do you have supply that will take you into '26. And I'm not saying that you're going to run out of it. I'm just saying just kind of understanding like what level of safety stock you put in place.

It varies, and there are several approaches we are taking to manage the situation. I'll have Jim discuss the actions we've implemented in our supply chain to secure materials. It varies because if you've observed that certain items, like magnets and heavy rare earth materials, will not be shipped from China to the U.S. for defense purposes, the U.S. doesn't want them, and China won’t ship them. This situation has been ongoing and has created opportunities domestically, but it will increase pricing and costs. The government has also taken measures to address this in the future, and we are closely involved with these developments. It's challenging to provide a specific timeline since it depends on the products, the safety stock we hold, our supply chain status, resource allocation, and identifying redesign options. Worst-case scenario, if we can't obtain products, we need to consider design alternatives that we can expedite for customer approval. Typically, the design and approval process for such applications is lengthy, but similar to what we experienced during COVID, obstacles can be removed when necessary to speed things up. If that happens, our engineering team may shift focus from new projects to sustaining and corrective measures. As I mentioned, we are well informed about ongoing developments. There are positive changes ahead, but they will take time to materialize. Jim, do you want to elaborate on some of those?

Yes. I mean I think you saw an example of that in yesterday's news where Apple announced that they're making an investment in manufacturing here in the U.S. and part of it had to do with the fact that the government is investing in putting in infrastructure related to our own exploration in rare earth materials and so forth. So I think we're very encouraged by that. We've been in discussions with a lot of suppliers and as many are, understanding who's going to be a player, who's going to be able to produce and when. So I think we're well in tune with that. And I'm actually very encouraged that some of those opportunities are going to come online sooner than I think any of us expected. And hopefully, we'll participate in that.

You may want to mention you went to Washington and talked to the government officials.

Yes. I did have an opportunity to go to the Department of Commerce and met with several of the individuals involved in trade talks and so forth and very, very informative. And as I mentioned, they are obviously helping many companies, not dissimilar to ours in identifying opportunities to look at alternate sources and where those are and the like. So there's a great collaboration, I would tell you, between companies and the Department of Commerce to ensure that companies like ours are being supported, and we understand what the alternatives are.

I have two more questions. First, regarding the buzz and momentum surrounding unmanned vehicles and drones, I'm curious about your exposure to this market and the division between commercial and industrial applications. It might not be significant, but it's a hot topic right now. I have one more question after that.

I'll answer it very quickly. It's a hot topic for us as well.

So you guys are...

You said short. You wanted a quick answer, I gave you a quick answer. Yes, we see it as you do. There's definitely some opportunities, and we're well positioned to capitalize on some of this. And without getting into a lot of detail on it for competitive reasons, I mean, it is something that's on our radar.

I’ll leave it there. My last question is, as your efficiency initiatives start to show results, you're effectively enhancing your margins and ensuring the business generates cash and provides returns to shareholders. You've been reducing your debt, bringing your business to targeted leverage ratios. Historically, you've pursued growth through acquisitions. As you move out of some strategic realignment and restructuring efforts to make the business more efficient and pay down debt, what’s your current approach to mergers and acquisitions? How active are you in that area? Are you planning to resume acquisition efforts? That's my last question.

Yes, we have never completely halted our investigations or identified opportunities in the marketplace. Instead, we focused on establishing communications with key future opportunities that we believe align strategically with us. We are committed to maintaining this momentum as we identify efficiencies and transform our business operations. The streamlining process will persist, and we believe it significantly improves our efficiency and speed. This approach, which we refer to as Simplify to Accelerate, has become ingrained in our company's operations and is here to stay. It is beneficial and complements our AST initiatives as well as our lean toolkit and training efforts. We feel confident that we are positioning ourselves well for potential acquisitions. We will exercise caution to ensure that any acquisition aligns strategically and adds value to our efforts. The value from our recent acquisitions has come from certain technologies and market penetration we were seeking, along with positive contributions to our average gross margin. Any future endeavors must meet those criteria. We are actively monitoring the landscape and have identified several opportunities that we will pursue when the timing is appropriate.

The next question comes from Craig Cosgrove, a private investor.

Mr. Cosgrove used to be a controller for us in one of our operations. I'm guessing maybe by mistake. He's followed us very closely and has been a strong supporter since he's left. So maybe he hit the button by mistake.

We'll move on to our next question. It comes from Orin Hirschman with AIGH Investment Partners.

Congratulations on the results. Just a couple of random questions. In terms of the data center business, just one question. Is the power conditioning more to protect the servers? Does it protect the cooling equipment? Is it for both? And then a follow-up on that on the data center side. I don't remember exactly the number I don't have it in front of me, but maybe you almost doubled year-over-year. Please correct me if I'm wrong. Could the business be up that much this year again? Do you have enough capacity even if there was enough to meet that type of demand?

The first question pertains to the addition of our equipment and its impact on the data center. You mentioned cooling, which is indeed one aspect we focus on. However, more importantly, it's about the quality of the power and the efficiency it provides. As we have discussed previously, we offer a very high performance and high-power solution in the market. Enhancements in power quality can lead to significant returns.

Does the customer get that? Like is that the customers are sophisticated enough to understand that if there's a 1% improvement in that quality of power, how much that means to them?

Well, I can't speak for the customers, but I can directly for all the customers, but I think they certainly do understand that with the demands for power and the infrastructure that has to go into place and someone that has a more efficient and more operation absolutely would probably have an edge.

And just part B and C on that question, if I may.

We are definitely increasing our capacity in response to growing demand. While we don't specifically categorize it, HVAC is one area that is expanding for us as part of the industrial sector. Demand continues to rise, and we anticipate this trend will persist due to the projected growth of data centers and the requirements for our equipment. We will also be expanding our main facility that produces these products. Additionally, we have been able to leverage our acquisition from last January, enhancing our electromagnetic capabilities in Mexico and Wisconsin. The synergies we've gained have been crucial in positioning us to meet this demand. We have already made investments and will continue to invest in increasing our capacity.

Okay. Two other questions, if I may, just jumping around. Just in terms of the automation side, there was some clear signs of a bounce back. I think it's your largest or one of your largest customers had a positive book-to-bill. Just give us some qualitative talk through on what that means for you on the automation side.

Sure. In the past, we provided a lot of details about a specific operating unit and its impact on our performance during the supply chain crisis, how things improved when conditions opened up, and how we faced a drop again due to overstocking. We believe we have turned a corner now, moving towards normalization, which should positively influence our future performance. Signs indicate that things are definitely improving, and we anticipate seeing results as we progress through the year.

Did you see some of that already in this past quarter?

We saw an improvement. So we've seen gradual improvement sequentially in Q1 over Q2. So we did see improvement, but we're continuing to see more improvement as we move ahead to get us to the point of normalization. So yes, a little bit, but we expect more coming forward.

My last question, which I think someone else mentioned, is about the munition side. Several companies have indicated that they are facing capacity constraints. I've even heard of a major company like Northrop Grumman or Rockwell offering to finance capacity expansion for a vendor, and I've observed two instances of that recently. My question is whether that business is continuing to grow for you. Are you experiencing capacity constraints in that area as well?

No, we previously undertook a restructuring to consolidate some operations a few years ago, about three to four years back. We have two primary operations for munitions applications that are now being combined. Additionally, we chose to expand our facility to accommodate future growth, which has positioned us well. To answer your question, we are not facing any capacity constraints.

Okay. Are you seeing the same as other vendors in terms of the desire from your...

What we've seen is that there can certainly be some concerns on the supply chain side, but we've been working on sourcing for a while now, especially since the conflicts began and the initial inquiries about projected demand. Over time, I’m not sure if you had invested in us yet, Orin, but we had discussed that the inquiry level was quite high, even though we hadn’t seen any purchase orders to encourage capacity increases. However, we have seen the orders materialize, and we are beginning to ship at higher levels. We were prepared and did significant work in advance since we were receiving requests for much higher volumes. Thus, we were readying our supply base as well as ourselves, and the results are now evident.

This concludes our question-and-answer session. I would now like to turn the call back to management 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 to you all again after our third quarter 2025 results. Have a great day.

The conference has now concluded. Thank you for your participation. You may now disconnect your lines.