Earnings Call Transcript - ALNT Q4 2021

Operator, Operator

Greetings. Welcome to Allied Motion Technologies Inc. Fourth Quarter and Fiscal Year 2021 Financial Results Call. Please note this conference is being recorded. I will now turn the conference over to Craig Mychajluk, Investor Relations. Thank you. You may begin.

Craig Mychajluk, Investor Relations

Yes. Thank you, and good morning, everyone. We certainly appreciate your time today as well as your interest in Allied Motion. Joining me on the call are Dick Warzala, our Chairman, President and CEO; and Mike Leach, our Chief Financial Officer. Dick and Mike are going to review our fourth quarter and full year 2021 results and provide an update on the company's strategic progress and outlook, after which we'll open it up for Q&A. You should have a copy of the financial results that were released yesterday after the market closed. If not, you can find it on our website at alliedmotion.com, along with the slides that accompany today's discussion. If you're reviewing those slides, please turn to Slide 2 for the safe harbor statement. As you are aware, we may make some 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'll 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?

Richard Warzala, Chairman, President and CEO

Thank you, Craig, and welcome, everyone. Our overall results continue to demonstrate the successful execution of our strategic growth initiatives. Full year revenue grew 10% to more than $403 million, driven by continued strength across most of our served markets. Our Industrial markets reached all-time highs and were up 19% over last year. Growth in that market reflected strong demand in material handling, industrial automation, pumps, oil and gas, and electronic solutions for motor control and instrumentation. Our Vehicle markets also continued to show strength with 18% growth for the year, largely driven by agricultural, construction and powersports demand. And while demand in this market did increase for the year, we did experience a dip in the fourth quarter due to supply chain challenges. We continue to be encouraged with our Medical market demand, which saw growth for the year despite extremely tough comparisons from last year given the significant demand for our products during the height of the pandemic. While we have seen our commercial aerospace business begin to rebound, our broader aerospace and defense market has continued to be challenged, largely due to the timing of specific defense programs. As I'm sure all of you are aware, operating conditions continue to be challenged given the overall inefficiencies created by the global supply chain constraints and the impacts from cost inflation on logistics, energy, material and labor. On the material side, this has been most apparent with respect to the cost increase of electronic components, which were on allocation and experiencing extended lead times beyond anything we have ever contended with in the past. As a result, we have enhanced our supply chain management capabilities to ensure we are responding quickly to changing dynamics with sound purchasing and logistics decisions. We are actively engaged with our customers and suppliers and have made strategic purchasing decisions on certain critical components, which is reflected in our inventory build this past year. Gross margin expanded to 30% in 2021, and we ended the year with net income of $24.1 million or $1.66 per diluted share. Even when excluding nonrecurring items, adjusted net income was $1.26 per share for the year, which was up 26%. We ended 2021 with a record backlog of nearly $250 million with strong order input across the board. A highlight during the fourth quarter was the closing of the three acquisitions, which are noted on Slide 5. Our acquisition team did an outstanding job getting this completed in a very tight time frame. On our last earnings call, we did spend time discussing the first two acquisitions, ORMEC and ALIO, and we will now provide more color on Spectrum Controls, which we announced on December 31, 2021. Located in Bellevue, Washington, Spectrum has grown nicely by designing and manufacturing a wide range of ruggedized and highly sophisticated industrial I/O and safety I/O modules utilized in automation applications. New product additions include marquee displays and an exciting new one-box Universal Industrial Gateway product that simultaneously supports multiple communications protocols and simplifies the integration of an automation solution. Whether you're modernizing networks, connecting legacy devices or integrating new equipment, the Universal Industrial Gateway provides a cost-effective, flexible solution for systems integrators. Spectrum products are used in a broad range of industrial controls applications and are sold and supported through partnerships with PLC manufacturers and the industrial automation distribution channel. With Spectrum, we further expand the electronic technology capabilities within Allied, and we believe it further enhances our ability to be a higher value-added solution supplier in the industrial automation and industrial controls market. We also believe that we can leverage the Spectrum know-how in Safety I/O and utilize key elements of that in other markets requiring safety functions, for example, Vehicle and aerospace and defense applications. We look forward to our bright future together and welcome Bruce Wanta, Founder of Spectrum, who will continue to lead the business as well as the entire Spectrum organization to the Allied team. In reviewing the three acquisitions, I would note that there are several common themes from a strategic standpoint, including: one, they enhance our customer base, add significant new engineering resources and it brings additional technology and know-how to expand and complement our current capabilities; two, they accelerate our expansion into important markets for Allied including aerospace and defense, automation, robotics, life sciences and medical; three, they provide us with an opportunity to leverage the technologies whereby Allied is better positioned to create higher value solutions for our target markets and our customers; and lastly, we expect that we can leverage our joint channels to market and utilize our global footprint to gain additional market share with our higher value-added solutions. Collectively, we expect the three acquisitions to provide incremental revenue of approximately $60 million in 2022, be accretive to our earnings and generate gross margins that are above our current average rates. In fact, as part of our strategy, we talked about expanding gross margins by one percent year-over-year, and these acquisitions will be instrumental in helping us achieve our goals. With that, let me turn it over to Mike for a more in-depth review of the financials. Mike?

Michael Leach, Chief Financial Officer

Thank you, Dick. As a reminder, our results include the operations of ORMEC Systems from November 2, 2021, and ALIO Industries from November 4, 2021. All share and per share information reflect the April 30, 2021, three-for-two stock split. The Spectrum Controls acquisition closed on December 30, 2021. Therefore, the material impact of Spectrum's financials is found in the backlog numbers, debt positions and general balance sheet. Starting on Slide 6, we provide some detail regarding our top line. Fourth quarter revenue increased 4% to $96.8 million and reflected higher demand in the Industrial markets and approximately $2 million of incremental revenue from acquisitions. The unfavorable impact of exchange rate fluctuations on revenue was $0.9 million in the quarter. Excluding FX, revenue was up 5% in the quarter. It is also worth noting that we estimate the impact of supply chain constraints on revenue was approximately $3 million in the fourth quarter. Excluding our most recent acquisitions, past due backlog is in the $7 million range. For the year, revenue reached a record $403.5 million, up 10%, largely due to double-digit growth in the Industrial and Vehicle markets. Sales to U.S. customers were 54% of our total compared with 53% in last year's period and the balance of sales were primarily to customers in Europe, Canada and the Asia Pacific region. Slide 7 shows the change in our revenue mix by market for the full year period, along with the 2021 growth rate for each market and the drivers behind the change. Our Industrial markets were up 19% and benefited from continued economic recovery in a number of verticals, as Dick noted. Also contributing to the overall revenue growth was demand within our Vehicle markets, which were up 18% and in Medical, which reflected a return of elective surgeries. Partially offsetting was the aerospace and defense markets, which declined due simply to the timing of specific defense programs. Note that the ORMEC business will primarily be reflected in the Industrial and aerospace and defense categories, while ALIO will largely be in the Medical and Industrial channels. Our distribution category, while small now, will expand as the Spectrum business is largely distributor-based and will be reflected in that category on a go-forward basis. As depicted on Slide 8, our gross profit was up for the quarter and full year period. Of note was the margin expansion that was achieved despite the ongoing supply chain and cost inflation challenges. Strategic pricing and mix were the primary drivers of the growth. Moving on to Slide 9. Fourth quarter operating income was down quarter-over-quarter due to an elevated level of operating expenses, which were up 170 basis points as a percent of revenue. Approximately 100 basis points of that increase was attributable to higher business development costs given the three acquisitions completed during the fourth quarter and the continuing optimization of our global manufacturing footprint. The remaining operating expense increase was largely within sales and marketing expense, which reflected higher commissions and incentive compensation as well as trade show costs resuming late in 2021. These investments and activities reflect the continued execution of our strategy. As we have stated, we anticipate growing our margins over the long term with the disciplined execution of our lean toolkit AST, combined with leveraging higher volume and accretive M&A. On Slide 10, we present GAAP net income and adjusted net income, along with our adjusted EBITDA results. Fourth quarter adjusted net income, which excludes business development costs and other nonrecurring items, was $2.9 million or $0.20 per diluted share compared with $2.7 million or $0.19 per diluted share in the 2020 fourth quarter. The effective tax rate was elevated in the quarter at 53.9% due to a $0.5 million valuation allowance of a deferred tax asset in a foreign jurisdiction, and it was also impacted by the mix of income from higher tax rate jurisdictions. We expect our income tax rate for full year 2022 to be approximately 24% to 26%. Full year net income outperformed the prior year on a GAAP and adjusted basis. Adjusted EBITDA margin improved 80 basis points in the quarter to 11.5% and for the full year was 12.4%, up 60 basis points. We use adjusted EBITDA as an internal metric and believe it is useful in determining our progress and operating performance. Slides 11 and 12 provide an overview of our balance sheet and cash flow. We paid down more than $12 million of debt during the year. However, total debt was up, reflecting borrowings for the acquisition activity in the fourth quarter. Collectively, the purchase price for the three acquisitions was approximately $100 million, including deferred payments with a mix of cash and equity components in each. At the end of the year, debt net of cash was $136.5 million or 42.1% of net debt to capitalization, and our bank leverage ratio was approximately 3.0x. We have consistently demonstrated our ability to quickly delever our balance sheet following acquisitions, and it is our expectation that we will continue the strategy to reload for future growth opportunities. We generated solid cash flow from operations of $25.4 million during 2021, despite the continued inventory build to mitigate supply chain issues. Full year CapEx was $13.7 million and largely focused on new customer projects as well as continued ERP implementations. We expect our fiscal 2022 CapEx to range between $15 million and $20 million and be focused on growth opportunities. Inventory turns were down to 3.0x when compared to 3.8x in 2020. Our teams continue to manage our inventory levels well as we work to meet increasing customer demand and combat sourcing and lead time challenges. In addition, our DSO improved to 45 days in 2021. I'd like to reemphasize that we believe we are in a position of strength, and we'll continue to work hard to advance our strategy by investing in organic and acquisitive growth. With that, I'll now turn the call back over to Dick.

Richard Warzala, Chairman, President and CEO

Thank you, Mike. Our backlog and bookings remained robust, as highlighted on Slide 13. Orders were approximately $115 million in the quarter, up 6% over the 2020 fourth quarter with the majority of our major market channels contributing. This represents a solid book-to-bill ratio of 1.2x. For the full year, we had $468 million of orders, which also represents a book-to-bill ratio of 1.2x. Backlog hit another record, increasing 35% sequentially over the third quarter and up 77% over last year's fourth quarter to nearly $250 million. Approximately 80% of our backlog is expected to convert to sales within the next nine months. Included in our backlog is approximately $48 million of incremental backlog from our new acquisitions. As we look forward, we expect demand within our Industrial and Vehicle markets to remain strong. While we will enjoy the benefits from our large automotive contracts that we announced over the last several years, these programs have been delayed and slow to ramp as a result of supply chain issues with electronic components. To be clear, demand has not gone away, but it has been pushed out. As a reminder, once we get into full rate production, we expect to deliver $40 million plus per year in revenue at the peak of the contracts. Also, we will note that the vast majority of these contracts are not included in our stated backlog numbers as we will only release them to backlog once we have been provided firm production release dates. Demand in our Medical markets is expected to be solid and reflects the continued return of more elective surgeries as well as some residual demand from the pandemic. We are also expecting to see a bounce back in our aerospace and defense markets given recent wins, the timing of certain defense projects and the incremental benefit from our acquisitions. We do anticipate that the supply chain pressures will continue well into 2022 before the situation begins to normalize. While we are optimistic on our future, the continuing supply chain challenges have resulted in multiple program launch delays. In addition, we are closely watching the current unrest in Ukraine as it has the potential to further impact and delay the launch of multiple new programs. As we move forward, we will continue to take a strategic approach to enhancing our existing products and technology. Our acquisition pipeline is still very active, and we believe we have the financial flexibility to execute opportunities that meet critical elements of our strategic filter. We have a track record of demonstrated success, and we will continue to pursue external opportunities to complement our organic growth efforts. In summary, while 2021 was a solid year with revenue and earnings growth, and improving margins, we do expect that in the near term we will continue to battle supply chain and inflationary challenges. As we move into the second half of the year, we do expect improving conditions, and we further expect that we will begin to realize the full benefit of our existing base and newly acquired businesses. Most importantly, Allied Motion has a great team. And through this team, we are unwavering and committed to our long-term strategy as we continue to expand and build our foundation to ensure sustainable and continued revenue growth, margin expansion, and enhanced profitability in the future. With that, operator, let's open the line for questions.

Operator, Operator

Our first question is from Greg Palm with Craig-Hallum Capital Group.

Gregory Palm, Analyst

Just wanted to start with maybe some comments from a big picture standpoint. You've got such a broad reach across all sorts of end markets and geographies. Any change in demand trends, whether that's recent weeks? What are you seeing quarter-to-date?

Richard Warzala, Chairman, President and CEO

Yes. Greg, thank you for the question. I would say that what we've experienced and what I think we're going to continue to experience when you talk about order rates and trends is that customers are placing orders further in advance than they were in the past. They need to get into the pipeline, and they want to ensure they're in the pipeline as we've made them aware of certain critical components with extended lead times. So I do think our backlog has been built based upon demand that's further out into the future as a result of the current supply chain challenges that we're facing today. As far as market variations, there's not much change there. There seems to be decent strength across the board.

Gregory Palm, Analyst

Okay. Perfect. And in terms of supply chains, you noted a maybe a newer risk or concern given the conflict in Ukraine. Is that a significant supply base for you or the industry? Or just maybe give us a little bit of color on how that could impact supply chain challenges even further?

Richard Warzala, Chairman, President and CEO

Sure. First of all, from an order standpoint, it has very minimal impact on us. We don't drive much revenue from that market. But from a supply chain standpoint, both material and labor, they're a significant supplier to the European automotive industry. So our concern there would be if the automotive suppliers are not getting their parts, then they're not going to build vehicles, and our programs will just get further delayed. That's where we see the majority of the impact. There are some materials but most—it's not a significant contributor to our direct supply chain. It may be more of a contributor to our customer supply chain, especially in the automotive market.

Gregory Palm, Analyst

Okay. Makes sense. And then last one, just wanted to dig into the acquisitions a little bit more. I mean, can you sort of give us some sense on: a, how the integrations of all three are going? But maybe more importantly, any initial examples of revenue synergies to date, whether that's new customers from sort of your overlap now? Or you mentioned in terms of some of the product and the expertise and having all teams together. I'd like to get a little bit more color on how you're seeing things progress here.

Richard Warzala, Chairman, President and CEO

Sure. Let me first mention that we are going to be attending some trade shows again. At the upcoming Health Care Robotics and Robotic Summit in Boston, it will be the first time we attend that. It will be a limited exhibition for us, but we believe it's an important market and we have some leading-edge solutions from a technology standpoint. With our additions, we'll be showing capabilities that extend us into multi-axis positioning and control at the nano-positioning level. As part of that, there's real pull-through of several Allied products that are utilized in those devices, including drives, controls, motors, both rotary and linear. Allied will be releasing a linear motor product line that's been under development for a number of years and that we feel has good opportunities in the life sciences and medical markets as well as in the automation industries. So there will be a great example of some of the pull-through and the enhanced systems capabilities we can demonstrate. At the Automate Show in Detroit in June, we'll further demonstrate what some of these capabilities are and will have some actual live demo equipment there with the added capabilities. We'll also add some control products from Spectrum, which will include the industrial communications gateway as well as their I/O and safety I/O. Those will be great examples that I would encourage anyone who wants a better understanding of who Allied is and what Allied does to see. We can walk you through from the component side up to the higher value-added system side and really get into some leading-edge technology that these companies have brought on board. One thing I want to highlight a little more is the supply chain challenge, especially in electronic components. We normally don't provide forward guidance into the future, but I would caution everyone. We made the acquisitions with full knowledge and understanding that we would have challenges coming out of the gates with components. That's why, if you listened to my comments about challenges into the first half of the year, we're working very closely; we have a solid backlog. If everything were deliverable and we received the components, it would be outstanding. But we do expect service to be challenged. As we move through the first quarter, it's going to be severely challenged. Second quarter will get better. As we move into the second half of the year, we'll start seeing the true results and benefits from the acquisitions.

Operator, Operator

Our next question is from Dick Ryan with Colliers Securities.

Richard Ryan, Analyst

Dick, you mentioned customers ordering further out than normal. How about—do you have any concerns of double ordering? Are you seeing any potential issues around that?

Richard Warzala, Chairman, President and CEO

No, Dick. I don't think—I'm not going to say there hasn't been some of that. But the reality is what we're seeing is orders being placed with longer lead times. Nothing has jumped out that says demand is unrealistic or beyond what we've seen and can't be supported. It's just that they're getting into the queue earlier. That contributes to some of the backlog build, of course. But we don't have any major experience with double ordering at this point.

Richard Ryan, Analyst

Okay. Great. You mentioned oil and gas in the previous commentary. What with what's going on in the market there, what are you seeing at TCI?

Richard Warzala, Chairman, President and CEO

Demand is very high. Our challenge is getting the product out the door, quite frankly. We talked about the backlog build and the TCI order input rates have been extremely strong. It's not just oil and gas; it's HVAC-related in data farms and cooling and so forth. The demand is up and significant, and we could deliver everything on the books right now if we had the components, but we can't. We're ramping up—we expanded our facility in Germantown. We added about 40% more space to the facility itself and most of that is in the production area. We're positioning ourselves for some nice growth in that operation, but it hasn't been realized yet.

Richard Ryan, Analyst

Okay. Maybe just the higher-level question with all the challenges you guys and everybody else is facing. How do you think you come out of the end of this funnel from a competitive landscape? What do you think your opportunities are to increase market share further or position yourself closer to customers?

Richard Warzala, Chairman, President and CEO

Great question, Dick. Through this whole process, we have stayed committed to our long-term strategy. We have expansion in technology, product offerings and geographic market footprint. One of the things that's exciting is that we've continued to move forward on internal product development to expand our reach into our markets and add more value to the solutions. Adding the acquisitions on top of that and the pull-through from some existing product lines into the new products is very encouraging. Our team hasn't stopped; they're moving forward. Of course, we've had to divert resources that would normally be working on new product and program development to securing alternatives for parts shortages and allocation issues. But overall, I'm excited about what we've been able to do and continue to do: higher value integration, more value and higher gross margins are coming. Programs have been delayed; that's the downside—programs that would have launched by now without these challenges have been delayed. We know they're not gone; they're just delayed. Where we've had solutions provided for that, again, margins increase, which is positive. In some cases, we're not able to deliver those yet because customers haven't moved to new platforms. But overall, our team is doing a great job. We were working on operational improvements at the same time, and those are underway. I think it's the next step for Allied—establishing the foundation to take us to another level.

Operator, Operator

Our next question is from Brett Kearney with Gabelli Funds.

Brett Kearney, Analyst

Dick, you covered it some in your opening remarks, but curious if you could just talk about in aggregate from the three acquisitions you completed in Q4, the talent coming over to the Allied organization, both from a leadership standpoint, but also technical and engineering resources.

Richard Warzala, Chairman, President and CEO

Yes, great question. We are always looking at how to expand capabilities. The market is pretty difficult to add engineering talent. We've been expanding our electronics capabilities over the last several years and grown quite significantly. In aggregate, between electronic and mechanical engineering, we've added approximately 45 new engineers to the company with the three acquisitions, and we're recruiting right now for another seven to ten engineers based upon program wins that will be deliverable in 2022 and beyond. So significant talent added. As far as leadership goes, all three private companies took equity in Allied, which I think shows they believe in the future together, and that's great. We have the talent in place to operate the companies. When we talk about integration, the senior leadership is still there and will remain there, but we will transition over time and begin to integrate into Allied Motion. The way Allied functions with our technology unit concept is that they have ownership of particular technologies and products that they lead for the world, and that's not going to change. We've added talent from an R&D and entrepreneurial capability perspective, and that's exciting because the ideas are flowing and coming together. That's why I mentioned the two shows—look to see what we're doing. We're looking for bigger and better things down the road.

Operator, Operator

We have reached the end of our question-and-answer session. I would like to turn the conference back over to management for closing comments.

Richard Warzala, Chairman, President and CEO

Thank you, operator, and thank you, everyone, for attending this quarter's conference call. I would encourage you to look at the shows that we have coming up that we mentioned we will be at. In addition to that, we'll be at the ROTH Conference next week, our first in-person shareholder and investor conference in quite some time, and we're really looking forward to that. We thank you for your support, and we look forward to talking to you again in our next conference call in May. That will do it, operator. Thank you.

Operator, Operator

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