Earnings Call Transcript - ALNT Q3 2021

Operator, Operator

Greetings. Welcome to the Allied Motion Technologies Inc. Third Quarter Fiscal Year 2021 Financial Results Conference Call. Please note this conference is being recorded. I will now turn the conference over to your host, Craig Mychajluk, Investor Relations. 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 third quarter 2021 results and provide an update on the company's strategic progress and outlook. After which, we will open it up for Q&A. As part of today's Q&A, we do ask that you limit your questions to 2 or 3 in order to allow enough time for all participants. And you could certainly go back into the queue for additional follow-ups. 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, as well as we did send out a release this morning on another acquisition that went out around 9:30 a.m. Eastern time that can also be found on our website. On the website, you'll also find 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 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 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'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?

Dick Warzala, Chairman, President & CEO

Thank you, Craig, and welcome, everyone. Our third quarter results reflect strong execution from both a sales and operational perspective. Backlog grew by 9% sequentially to a record $186 million with strong order input across the board. Total revenue grew 9% over last year's third quarter to $103.5 million, driven by continued strength across most of our served markets, but in particular, a strong recovery in our industrial markets, which were up 39%. This was primarily led by increased demand for our applications and solutions in automation, vehicle handling, electronics and oil and gas projects. Our vehicle markets continue to outpace prior year comparisons as the third quarter was up 5%, largely driven by construction and truck demand. Powersports demand has still been very solid, though moderated some from its recent highs. The medical markets were down year-over-year given the exceptionally strong demand resulting from the onset of the pandemic last year but did grow 4% sequentially as we have seen a return of more elective surgeries as well as some uptick in COVID-related products and solutions given various variants that have developed around the world. A&D has continued to be challenged, but we are seeing new project activity levels increasing, which is encouraging. We are certainly not alone dealing with the unique factors of the current environment, including inflationary pressures, supply chain disruptions and labor shortages. The effectiveness of the actions we have implemented to mitigate these factors is demonstrated on our revenue growth, margin expansion and increased profitability. In fact, on both a year-over-year and sequential basis, gross margin, operating margin and adjusted EBITDA margins have improved. As a result, net income increased 49% over the prior year to $6 million or $0.41 per diluted share. Even though we did have a fairly significant build in inventory levels as a result of the global supply chain challenges, we did generate positive cash flow of $3.5 million from operations during the quarter, and this enabled us to reduce total debt and further advance our growth initiatives. On Tuesday this week, we announced the acquisition of ORMEC Systems Corporation in Rochester, New York, where they develop and manufacture mission-critical electromechanical automation solutions and motion control products, including multi-axis controls, electronic drives and actuators for the automation and the aerospace industries. Details are provided on Slide 4. This bolt-on fits well strategically as it strengthens our technical expertise and adds a higher level of precision motion control systems and solutions to our offerings. Importantly, we believe we can build a scalable solution to accelerate growth by leveraging their electronics, software and mechanical engineering expertise to create complete electromechanical solutions for custom automation applications. We look forward to our bright future together and welcome Dr. Edward Krasnicki, who will continue to lead the business as well as the entire ORMEC organization to the Allied team. Additionally, this morning, we announced the acquisition of ALIO Industries in Arvada, Colorado. I will refer you to the press release that crossed the wire this morning. And for those of you who may not have had a chance to see it, I will relay that to you now. In the press release, my quote stated ALIO is well-recognized for their technology, know-how and expertise in nanometer level positioning, and we are very excited to add such high-precision positioning and robotic technology solutions to our already powerful portfolio of motion solution offerings. Equally important is ALIO's culture and passion for innovation, customer service and product quality, all traits that align well with what we have built at Allied. We expect that the business can grow rapidly as we leverage our joint channels to market and bring scale to their operations. The press release went on to say, founded in 2001 and headquartered in Arvada, Colorado, ALIO designs, engineers and manufactures nanotechnology motion systems for state-of-the-art applications in silicon photonics, micro assembly, digital pathology, genome sequencing, laser processing and microelectronics. Their expansive product line includes the patented Hybrid Hexapod, which provides for six-axis point precision repeatability, air bearing systems, linear and rotary nano precision systems with both mechanical and air bearing designs and systems customized for atmospheric, clean room and ultra-high vacuum environments. We would like to welcome Mr. Bill Hennessey, the founder and President of ALIO, who will continue to lead the business and join the Allied team. In addition, I'd like to extend our appreciation to both the internal and external support teams at Allied in getting these opportunities over the finish line. As we move forward with record backlog and increasing order trends, we are confident in our initiatives and the strength of our business model. At the same time, we will continue to focus on what we are doing, the markets we are serving, successfully progressing our product development efforts and continuing to leverage our global footprint. With that, let me turn it over to Mike for a more in-depth review of the financials.

Mike Leach, Chief Financial Officer

Thank you, Dick. As a reminder, all share and per share information in our earnings release and slides reflect the 3-for-2 stock split completed in April. Starting on Slide 5, we provide some detail regarding our top line. Third quarter revenue increased 9% to $103.5 million. This is a record high and is the third consecutive quarter of achieving greater than $100 million, further demonstrating the success of our strategy and the benefit of the broad-based recovery underway in many of our served markets. In particular, demand was strong in industrial, improving 39% year-over-year, while vehicle markets improved 5%. On a sequential basis, industrial grew 4%, medical grew 4% and vehicle was up 1%. The favorable impact of exchange rate fluctuations on revenue was $0.8 million in the quarter. Excluding FX, revenue was up 8.5%. Sales to U.S. customers were 56%, in line with the prior year period, and the balance of sales were to customers primarily in Europe, Canada and Asia Pacific. Slide 6 shows the change in our revenue mix by market for the trailing 12-month period. Total TTM revenue was up 11% and reflects the impact of our diversified business model. The economic impact of the pandemic, along with general program timing is reflected in the reduced demand order deferrals within A&D. And though industrial faced significant headwinds from the pandemic last year, our actions and the ongoing improving market conditions are reflected in the 9% gain on a TTM basis. Note that on a go-forward basis, the ORMEC business will primarily be reflected in the industrial and A&D categories. As depicted on Slide 7, our gross profit was up $3.9 million or 14% to $32 million. Our gross margin expanded 120 basis points year-over-year and was up 20 basis points sequentially to 30.9%, reflecting strong volume levels, favorable mix, the impact of pricing and the disciplined execution of our Lean tool kit AST. While we are not immune to the supply chain and material cost constraints as well as labor inflation, we believe that our team is managing those impacts well. Nonetheless, we expect some headwinds to continue for the near term, though, as we have stated, we anticipate growing our margins over the long term. Moving on to Slide 8. Third quarter operating income was $8.7 million, up $2.2 million from the 2020 third quarter and up $2 million from the sequential second quarter. Operating margin of 8.4% expanded 160 basis points year-over-year and 180 basis points sequentially. We have continued to effectively manage our costs and leverage the higher volume. This more than offset increased incentive compensation, which was aligned with the revenue and net income growth and was largely in the G&A line. On Slide 9, you can see our bottom line and adjusted EBITDA results. Net income increased to $6 million or $0.41 per diluted share, up $0.13 from the third quarter of 2020. The effective tax rate for the quarter was 24.6% compared with 25.4%. We expect the income tax rate for the fourth quarter of 2021 to be approximately 25%. Excluding the discrete tax benefit of $7.4 million recorded in the first quarter of 2021, the full year 2021 income tax rate is expected to be approximately 24%. Also, I'd like to point out that we continue to pursue tax planning strategies to help reduce our effective tax rate. Adjusted EBITDA for the quarter was $14.5 million or 14% of sales, up 190 basis points over the prior year period. Sequentially, adjusted EBITDA was increased $2.1 million and 180 basis points. We use adjusted EBITDA as an internal metric and believe it is useful in determining our progress and operating performance. Slides 10 and 11 provide an overview of our balance sheet and cash flow. We paid down $3 million of debt during the quarter, resulting in $109.3 million of total debt at the end of the period. Debt net of cash was about $90 million, and net debt to net capitalization was 35.7%, down 470 basis points from year-end. At the end of the third quarter, our bank leverage was 2.22x. After quarter end, we did utilize $23 million of our credit facility to fund our recent acquisitions. We paid $9 million for ORMEC, the majority of which was cash, with a $385,000 equity component. We paid $20 million for ALIO composed of $15 million cash and $5 million in equity. There are potential earn-out payments over the next 3 years based on ALIO achieving certain annual EBITDA targets. We've 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 future growth opportunities. We generated solid cash flow from operations of $3.5 million in the third quarter and a total of $19.9 million over the year-to-date period. Continued inventory build to mitigate supply chain issues was the primary reason as to why cash flow from operations was not stronger during the quarter. Third quarter CapEx was $3.9 million and largely focused on new customer projects as well as continued ERV implementations. We expect our fiscal 2021 CapEx to range between $12 million and $15 million. Inventory turns were 3.6x, down from 2020. Our teams have been managing our inventory levels well as we work to meet increasing customer demand and combat sourcing and lead time challenges. Our DSO increased slightly to 49 days in the quarter. With that, I'll now turn the call back over to Dick.

Dick Warzala, Chairman, President & CEO

Thank you, Mike. Slide 12 highlights encouraging trends as customer demand and our strengthened market position, again, has resulted in record orders and backlog. We have now achieved five consecutive quarters of order growth since the low point during the onset of the pandemic last year, reaching $120 million in the third quarter. This represents a 35% increase over last year's third quarter. All of our major market channels are contributing, and our book-to-bill ratio was solid at 1.2. Backlog increased 9% sequentially over the second quarter and was up 50% over last year's third quarter to more than $185 million. Approximately 90% of our backlog is expected to convert to sales over the next 3 to 9 months. We estimate that $3 million to $5 million of our current backlog is a carryover due to the global supply and shipping challenges. Importantly, this level has remained relatively steady from last quarter as our teams have continued to do a great job meeting our customers' demands. As we look out, industrial and vehicle demand remains strong, and while most customers will accept everything we can deliver, shortages from other suppliers can and may impact our shipments as well. In the fourth quarter, we do expect some seasonality given typical holiday shutdowns and inventory adjustments, although we believe that impact could lessen if there is improvement related to the global supply chain challenges. Demand in our medical market is expected to still be solid with the ongoing recovery of elective surgeries and potential demand from the pandemic. While we continue to take a cautious approach with our A&D markets, we are seeing some increased quoting and project activity, and we further expect to benefit from ORMEC in this space in 2022 and beyond. From an inflation and supply chain perspective, we do not foresee any significant improvements in the near term. Nonetheless, we believe we can continue to leverage the strength of our supply chain management capabilities to help navigate this dynamic landscape. We are also focused on retaining our critical talent and keeping our team focused on several new project opportunities as well as ensuring we meet our internal timelines to effectively launch several new growth-oriented product platforms. While we have announced a couple of acquisitions in the last two days, 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. As always, we will be prudent with our capital allocation. Overall, we demonstrated strong execution by generating record levels of revenue, orders and backlog, and we have further developed our One Allied strategy. We have a high level of confidence that we have a platform that can deliver expanding margins over time and will continue to drive growth in the future. Now before we turn it over to the operator for questions, I'm sure some of the questions are going to be around the acquisitions, and Mike has stated giving you some answers as far as the amounts we have paid for the acquisitions. What I will relate to you and we'll do it in a kind of a general format here is that we do expect the combination of the two acquisitions to generate approximately $20 million plus in revenues next year and with gross margins that are well above our current average gross margins. So I think as part of our strategy, we talked about expanding gross margins 1% year-over-year. And these two acquisitions combined certainly bring us close to achieving that goal for the coming year as well as taking some other activities that we will be working on to continue to expand that gross margin. So with that, operator, let's open the line for questions.

Operator, Operator

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

Greg Palm, Analyst

A lot of good stuff to unpack here. So maybe we'll start, and sorry if I missed this, but were you able to fulfill or ship the entirety of demand that you had in the quarter? Was there some impact from, I don't know, supply chains that maybe pushed a certain amount of revenue out to Q4 or beyond?

Dick Warzala, Chairman, President & CEO

Yes. There was definitely some impact, Greg, and I think what we mentioned is it's about $3 million to $5 million in revenue, which was pretty much consistent with what we saw in the previous quarter. So there was some push.

Greg Palm, Analyst

And I mean, what's your view of supply chains going forward? I mean, do we expect that that same sort of amount of revenue will end up getting pushed from Q4 to Q1? I mean, do you see any signs of easing? Or do you think this is going to be with us for some time still?

Dick Warzala, Chairman, President & CEO

Well, unfortunately, I think it's a challenge every single day, and it shows up in different places at different times. So I think we're still going to have these challenges moving forward. And I don't think there's any reason to expect that we're not going to see some delays in our ability to ship. What I mentioned in my script, which may not have been very clear, is that even if we have everything we need to ship product to a customer, many of our customers have taken on a different approach to manufacturing where the single-piece flow, reduced inventory and just-in-time inventory practices mean they're doing partial builds with the components they have and subassemblies that they can put together as other components show up, and then they can complete their assemblies. So we're impacted by that as well, which is very hard for us to predict when and if that's going to happen. But I would say to you that we have the demand there. Our customers will take, almost all of them, anything we can ship them. And we are working very closely with them to ensure we're aligned and shipping the products that they need so they can ultimately get their product out the door. But I think those challenges are still ahead of us. They're not going away.

Greg Palm, Analyst

Yes. Makes sense. And I guess, if I could ask one more and sort of focus on the same subject, but I'm curious how you're viewing your own competitive positioning with everything going on. I mean, lots of talks about whether it's reshoring or secondary sourcing for supply chains. And do you think that this is maybe an event that can drive more business to a company like Allied Motion, given all your capabilities?

Dick Warzala, Chairman, President & CEO

Well, it's happening. We're receiving inquiries for shipping products when customers' current suppliers are having difficulty meeting demand. It depends on the product and the components—whether it's electronic components, magnetic components, or mechanical components. In many cases, we are taking on some new business and satisfying those demands, and hopefully, we can retain that long term. We're doing the best we can to satisfy them. In some cases, customers are locked into their existing backlog and existing customers, and you may not be able to meet their needs. But the challenges are there and the opportunities are there, and we are seeing them. Hopefully, they do convert long-term for some additional business for us.

Mike Leach, Chief Financial Officer

And I think we're well-positioned from a manufacturing footprint standpoint, Greg, to support the movement towards localization of supply that you see happening globally. With our expanded footprint, we have capabilities that allow us to support customers in any geographic locale.

Dick Warzala, Chairman, President & CEO

Yes. And to add further, we talked before the pandemic about strengthening our strategic sourcing team and looking at localization of supply chain, so we were already down that path. We're continuing down that path and will continue to accelerate it. What's happened here is not just supply chain but logistics channels and delays in ports and so forth. I think there's going to be an increased emphasis on localization, and we had already started down that path. We'll continue to accelerate that.

Greg Palm, Analyst

Got it. All right. Best of luck going forward.

Operator, Operator

Our next question is from Dick Ryan with Colliers.

Dick Ryan, Analyst

So Dick, in the quarter, you mentioned the China facility had some shutdown due to their power rationing over there. Can you just refresh us the impact that you—what China contributes from a revenue standpoint and how significant this issue could be going forward if that rationing continues next year?

Dick Warzala, Chairman, President & CEO

Well, there's two plants in China. One came as part of the Dynamic Controls acquisition from Suzhou, and the other plant is in Changzhou. They do different things. Our plant in Changzhou was less impacted from a rationing standpoint than our plant in Suzhou. Suzhou is primarily electronics and drives for the rehab market, and while some of those are delivered directly into the Asian market, most of those are exported out to Europe and North America. As long as we understand when the rationing is going to occur, and they don't hit you last minute, there are workarounds. They may shut certain factories down on certain days, so you may have to reschedule in order to fulfill demand. If they shut you down for a week, that has a much bigger impact. We've dealt with this in the past—for example, during the Olympics they would put factories on schedules to reduce pollution—and our teams have been effective in managing that. From a revenue standpoint, the bulk of our business is in North America and Europe, with a relatively small portion in Asia, though some of Suzhou's output is exported. We haven't seen anything that we're concerned about long term. We'll plan around it once we understand the outlook, and we'll keep supplying our customers.

Dick Ryan, Analyst

Okay. Say, with the strong order flow, are you getting any sense that some of this might be double ordering, or is it just strength across all your end markets?

Dick Warzala, Chairman, President & CEO

If you ask our customers, they'll tell you they need it. Based on my experience and cycle observations, I think there's definitely some double ordering going on. How much is hard to tell, but it's there. When we'll feel the impacts and how it will adjust over time is uncertain. For example, in automotive, the inability to get electronic components has pushed demand into the future. It's not going away, it's just being pushed out. We may see these effects differently across markets and customers, but again, our customers tell us they need it now.

Dick Ryan, Analyst

Okay. One last one, if I can. On your large auto wins, has anything in the supply chain impacted the outlook or the timing, how that will flow over the next several years? And can you refresh us how much revenue have you delivered to date? And how much is in backlog?

Dick Warzala, Chairman, President & CEO

It has impacted the timing because they're not building as many vehicles. We're seeing that being shifted out. It's not changing the overall demand; it's a timing issue. As they start building more vehicles and get the electronic components they need, production will ramp up. We had talked about going into full rate production at $40-plus million per year in revenue from that program. Currently, the ramp-up we've seen has delivered maybe $5 million to $7 million in revenue so far. We expect that to continue to increase and move forward, but we have seen some delays.

Dick Ryan, Analyst

Okay. Great. And congratulations on continued strong execution.

Operator, Operator

Our next question is from Gerry Sweeney with ROTH Capital.

Gerry Sweeney, Analyst

Nice quarter. I wanted to talk about acquisitions and maybe from a higher level. I think over time, Allied Motion's going from maybe components to solutions. I think you're looking at solutions with these recent acquisitions, maybe going to higher technical value-oriented opportunities. Curious, is this part of that strategy you alluded to in your comments, part of the gross margin structure longer term—just getting into some higher value, more technical opportunities as you sort of develop your menu of technologies?

Dick Warzala, Chairman, President & CEO

Sure. You're absolutely correct. As you've looked at the evolution of the company and our previous acquisitions, many were component related, and we then took on the challenge internally of leveraging those components to come up with more complete solutions. These two acquisitions take us to another level. The fundamental elements underneath the solutions—electronics, controls, drives, motors—are the same, but now you add software, customer interface and control solutions from an automation standpoint. From ALIO, for example, their stages incorporate products we make, and they add multi-axis control and very sophisticated nano precision positioning accuracy. The Hybrid Hexapod is compelling technology with repeatability critical in six-axis applications. That's essentially a robotic solution, and as miniaturization progresses in genetic and life sciences applications, nano precision is increasingly required for automation and analysis. With ORMEC, we are doing complete system design—multi-axis controllers, high-speed synchronization up to 72 axes, complete automation systems, software and long-term support—while pulling through Allied-manufactured products. We've stated our goal to improve gross margin by 100 basis points a year, and these acquisitions put us on target for 2022. We said we expect roughly $20 million of revenues from these two businesses combined, and their gross margins are at the high end of where we are today, which supports our margin expansion goals and the systems strategy.

Gerry Sweeney, Analyst

Perfect. That's a lot of great detail. I really appreciate that. Shifting gears, I didn't want to start with an inflation question, but obviously, a topic of the day. There are a lot of levers to deal with inflation—internally and externally, pricing with customers, manage costs over time, etc. It feels like inflation is going to be here for a while and could even increase. When you look at your toolbox of levers, how much opportunity do you still have left to manage some of these headwinds if they accelerate further or go on longer?

Dick Warzala, Chairman, President & CEO

That's a tough question. I'll turn it over to Mike.

Mike Leach, Chief Financial Officer

Certainly the environment has been supportive of adjusting pricing given the current conditions; customers have been more understanding, although it's still a challenge. As far as levers go, we continue to focus on our Lean tools and our AST. We have opportunities we've discussed before around optimizing our manufacturing footprint, driving costs out of the business—whether that's in manufacturing sites or operational expenses or even G&A. Continuing to progress down the solutions or advanced systems sales channel, and moving up the ladder in terms of precision and capabilities, as evidenced by the last two acquisitions, will lead us down that path as well. If inflation and supply chain disruptions get tougher or go on longer, that will be challenging, but we are working aggressively, irrespective of the supply chain environment, to drive these initiatives.

Gerry Sweeney, Analyst

Got it. I guess you could even say your previous work and focus and culture has almost prepared you for some of this as well.

Mike Leach, Chief Financial Officer

Correct. I'd say that over time, that's grown stronger. Our commitment to that, as we've referenced before, includes our investment in our global supply chain group as another lever that moves us down the Lean path.

Dick Warzala, Chairman, President & CEO

One thing to be clear about: Allied does make customized components that are integral parts of our customers' systems, and we will continue on that path. We're not abandoning components. The solution side allows us to leverage those components more extensively and approach the market from a higher-level system perspective—electronics, control, and complete systems. In automation systems, instead of customers assembling all the individual components, we can put them together and commit to a higher-level solution like nano positioning. That opens new channels and opportunities across electronic, control, motor and gearing domains.

Gerry Sweeney, Analyst

Got it. That's very helpful. I do appreciate that.

Operator, Operator

We have reached the end of the question-and-answer session, and I will now turn the call over to management for closing remarks.

Dick Warzala, Chairman, President & CEO

Well, again, thank you, everyone, for attending our shareholder conference call here, and we really appreciate your participation. I think there are exciting times here at Allied. Our team worked extremely hard to get a couple of these acquisitions, which are very strategic to us, and we're looking forward to our new partners coming on board. We think there's a bright future ahead for Allied and our shareholders. So thanks again. We look forward to talking to you soon. Bye now.

Operator, Operator

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