Earnings Call Transcript - ALNT Q4 2023

Operator, Operator

Good day, and welcome to the Allient Inc. Corporated Fourth Quarter Fiscal Year 2023 Financial Results Conference Call. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Craig Mychajluk of Investor Relations. Please go ahead, sir.

Craig Mychajluk, Investor Relations

Good morning, everyone. Here on the call are Dick Warzala, our Chairman, President and CEO; Michael Leach, our Chief Financial Officer. Mike and I are going to review our fourth quarter and full-year 2023 results and provide an update on the company's strategic progress and outlook. We'll open up for Q&A. The financial results 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. 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 may 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. Uncertainties and other factors are discussed in the earnings release as well as other documents filed by the company with the Securities and Exchange Commission. We may also discuss some non-GAAP measures, which we believe will be useful in evaluating our performance. We have provided reconciliations of non-GAAP to GAAP measures in the tables accompanying the earnings release and slides. Please turn to slide three, and I'll turn it over to Dick to begin.

Richard Warzala, CEO

Thank you, Craig, and welcome everyone. With a backdrop of macro uncertainty and other challenges, the Allient team once again delivered on a number of successes during the past year. This included the kick-off of our next stage of growth with a refined strategy that brought on a new corporate name and ticker and included the publishing of our inaugural sustainability report, which highlights our vision for an approach to corporate sustainability. We continue to execute our financial strategy with the support of 13% organic growth for the year, which is more than double the industry average, and key acquisitions, which I will discuss in a moment. Our top line reached nearly $580 million, reflecting strong demand in industrial markets, largely driven by industrial automation projects and power quality solutions, focused on the HVAC and oil and gas end markets. Additionally, higher sales were recorded within aerospace and defense and the vehicle markets. Regarding margins, we delivered on our expectations with a record annual gross margin of 31.7%, an operating margin of 7.3%, which was up 100 basis points for the year. This translated into stronger earnings that led to a record level of cash generation of $45 million, enabling us to reduce our debt while still investing in organic and inorganic initiatives. Overall, annual net income per diluted share increased 36% to $1.48, and on an adjusted basis, net income per share was $2.30, up 22% for the year. On slide four, we highlighted our recent acquisitions. We reviewed Sierramotion on our last earnings call as we completed the transaction in September. While it is a relatively small acquisition, it was very strategic from an engineering perspective as it enhances both our application design and development efforts in support of our integrated motion solution strategy and advances our customer-facing market strategy as we further expand our reach into our targeted market sectors. In early January, after the year closed, we brought on SNC Manufacturing, which was our first tuck-in acquisition in support of our power technology pillar. They are a well-established company with locations in the U.S., Mexico, and China. Their offerings are complementary to our current power quality capabilities as they design and manufacture electromagnetic products for blue-chip customers in defense, industrial automation, alternative power generation, and energy, including electric utilities and renewable energy. In addition to extending our capabilities in the clean power industry, SNC brings much-needed incremental low-cost manufacturing capacity and expertise to further grow our power quality business. SNC adds about $40 million in annual revenue and is expected to be accretive to earnings in year one. While their current margins are less than our stated goals, we are confident that we are well-positioned to improve them over time. We see several opportunities to leverage the resources within the power pillar and Allient as a whole, which will positively impact sales and profits. We welcome all employees of SNC to Allient, and we look forward to continued growth and success in the future. With that, let me turn it over to Mike for a more in-depth review of the financials.

Michael Leach, CFO

Thank you, Dick. Starting on slide five, we highlight our top lines for the quarter and full year periods. Fourth quarter revenue increased 8%, or nearly $10 million to $141 million, excluding the favorable impact of foreign currency exchange rate fluctuations on revenue of $1.6 million. Organic growth was approximately 6%. Industrial markets were up 23% in the quarter, benefiting from strong end market demand within industrial automation, vehicle handling, and power quality solutions focused on the oil and gas and HVAC markets. Our automotive customers began to ramp up their programs as expected this past year, alongside nice demand for power storage, which helped drive the overall vertical up 17% in the quarter. Offsetting some of that growth was lower demand within agricultural vehicles, given the softness in Europe, which was largely influenced by the Ukrainian conflict. A&D sales were down due to timing and resulting lumpiness around certain defense and space projects, along with customer-driven supply chain challenges within the vertical. Medical market sales declined due to softness in medical mobility products driven by a specific customer. Slide six provides details regarding our full year performance and shows the change in our revenue mix and the drivers behind each change. Industrial continues to lead the way and remains our largest market, making up 44% of total 2023 sales, an increase of 600 basis points since 2022. The 33% growth in the industrial space was driven primarily by the same market as the fourth quarter and reflected continued improvements in the supply chain environment, supporting the shipping of some long-lead projects. The A&D vertical is better evaluated annually given program timing, and we grew to low double digits for the year due to winning new defense projects and ramping other programs. We also benefited from positive commercial aircraft demand. Vehicle market revenue was up 2% reflecting the same demand drivers as the fourth quarter. Medical sales were nearly flat as we continue to see a return to a more normalized sales environment focused on surgical and instrumentation-related end markets. Lastly, sales for the distribution channel, a small component of total sales, were up 6% for the year. As highlighted on slide seven, gross margin expanded 40 basis points for the quarter and full year period on higher volume and favorable mix, along with the continued emphasis and usage of our lean toolkit throughout the organization. These impacts offset elevated raw material costs and remaining supply chain inefficiencies. Moving to slide eight for our operating performance, you will notice a sizable increase in business development costs for the quarter and full year period, in support of recent acquisitions, an increase for our prior acquisition, and some rationalization efforts around our manufacturing footprint to drive stronger operating leverage in the future. On an annual basis, we did gain some operating leverage resulting in operating income growth of 34% to $42.3 million, or 7.3% of sales, an increase of 100 basis points. On slide nine, we present GAAP net income and adjusted net income, which we believe provides a better understanding of our earnings power. Fourth quarter net income increased 18% to $4.3 million, or $0.26 per diluted share, and on an adjusted basis was up 31% to $9.1 million, or $0.55 per diluted share. Included in the fourth quarter results was a tax benefit of $0.4 million, reflecting realization of certain NOLs and R&D credits and incentives. For the full year, net income increased 39% to $24.1 million, or $1.48 for diluted share. On an adjusted basis, annual net income increased 25% to $37.5 million, or $2.30 for diluted share. The effective tax rate was 18.9% in 2023, compared with 26.6% during 2022. We expect our income tax rates for the full year 2024 to be approximately 21% to 23%. We use adjusted EBITDA as an internal metric, which increased 2% to $16.9 million, or 12% of revenue. For the year, adjusted EBITDA increased 18% to $77.2 million, or 13.3% of revenue, which was up 30 basis points. Slides 10 and 11 provide an overview of our cash flow and balance sheet. We generated $45 million of cash from operations for the year, which represented a record level for the company and a significant increase from the $5.6 million generated during the prior year. The increase reflected higher net income and improved working capital management. Based on our projections, we expect to continue to drive strong cash flows consistent with historical trends. Annual capital expenditures were $11.6 million, largely focused on new customer projects. We expect 2024 capital expenditures to increase from this level to a range of $16 million to $20 million. Inventory turns improved to 3.0 times compared with under three times last year. Our DSO was slightly elevated at 56 days for the year, largely reflecting timing and mix of customers. Total debt was approximately $218 million, down $17.1 million from year-end 2022. Debt net of cash was about $187 million, or 42.6% of net debt to capitalization. Our bank leverage ratio was 2.8 times. Lastly, we recently extended the maturity of our existing $280 million revolving credit facility for 2029. Borrowings for the revolving facility will bear interest on a sliding scale based on leverage of 1.25% to 2.5% over SOFR. In addition, we entered into a $100 million fixed-rate private shelf facility with Prudential. The notes will have a maturity date of no more than 10.5 years after the date of original issuance and may be issued through March 2027. Currently, there are no borrowings under this agreement. With that, I'll now turn the call back over to Dick.

Richard Warzala, CEO

Thank you, Mike. Slide 12 shows our orders and backlog levels. As we discussed throughout the year, the change in backlog reflects the continued improvements within the supply chain environment, enabling the shipping of long-lead industrial market projects and customer order patterns beginning to return to a pre-COVID-19 environment. There are exciting programs that will play out as we move through 2024, and we are well-situated as we realign the organization to support significant opportunities we are pursuing across our target verticals. The upcoming year will have its challenges given the changing dynamics of our backlog, which is expected to continue to readjust over the next few quarters. This presents an opportunity to reduce working capital requirements and strengthen cash flow. Turning to slide 13, we are intent on creating stronger earnings power with our simplify to accelerate strategy. 2024 is the year to eliminate redundant costs, realign the organization to improve focus and efficiencies, rationalize our footprint, and ultimately simplify our operating structure. By rethinking how we operate, we believe we can accelerate our efforts to achieve top-tier financial performance. While some of the actions will take time to execute fully, there is a strong sense of urgency throughout the organization to deliver on our goals. Our simplify to accelerate strategy is moving forward with a focus on immediate execution, centered on three high-level strategic initiatives: first, realigning and rightsizing our footprint to better align with our markets and customers; second, reinforcing lean principles throughout the company to accelerate margin expansion; and third, employing working capital initiatives and strong financial discipline to drive additional cash generation and de-lever the balance sheet in 2024. Overall, we are excited and confident in our future as we believe we are well positioned to drive our earnings power with our simplify to accelerate now strategy and create additional value for all of our stakeholders. With that, operator, let's open the line for questions.

Operator, Operator

Thank you. The first question will come from Greg Palm with Craig-Hallum Capital Group. Please go ahead.

Danny Eggerich, Analyst

Thanks. This is Danny Eggerich on for Greg today. Congratulations on the good results, guys.

Richard Warzala, CEO

Thank you, Danny.

Danny Eggerich, Analyst

I'd like to start out by asking what you're seeing out there right now. Any quarter-to-date trends? Bookings dropped off a little bit in Q4, and you noted some inventory drawdowns. What kind of visibility do you have into this? Have trends continued off those Q4 levels? How long do you think these trends should last? Thanks.

Richard Warzala, CEO

I would say this: as we mentioned, we expect that over the next few quarters, we're going to continue to see some adjustments. It's a mixed bag. While we've seen a hold on shipments or delays in shipments so inventories can be balanced properly at our customer level, we're also starting to see demand increasing in the near term. Overall, lead time adjustments, lead time reductions, and better management of inventories throughout the whole supply chain, including our own, are actions that are our top priority, as well as those of our customers. We expect to see continued adjustments in the coming quarters.

Danny Eggerich, Analyst

That's helpful. Can you provide more details on the simplify to accelerate initiative? What are you doing? Are there headcount reductions as part of that? Why now? Will we see this reflected in gross margin or operating expenses? Can you quantify those impacts to the P&L as we move throughout the year?

Richard Warzala, CEO

Yes, sure. The simplify to accelerate strategy, which started last year, is now gaining momentum. I can't stress enough that we need to get back onto initiatives to reduce costs in our operations. We did eight acquisitions in a short period of time, and we know we can leverage the capabilities and footprint of these acquisitions and bring teams together. As we move forward to a unified company image, we can leverage our technology and products into target verticals. It really is an opportunity for us to analyze how we're doing business, use our lean toolkit to drive continuous improvement. The goal here is to improve margins, and this will help us achieve those objectives.

Danny Eggerich, Analyst

That 100 basis points of annual gross margin improvement target you mentioned, does this initiative work toward that, or do you think you can achieve incremental expansion on top of that?

Richard Warzala, CEO

Yes, it's hard to adjust expectations for statements made in the past. Our goal is to exceed the public goals we set. While we see opportunities to do better, we will stick to our stated objectives for the 100-basis points improvement in operating margin, which includes reductions in both gross and operating expenses.

Michael Leach, CFO

One of the things to note is that as we did all the acquisitions, while revenue increased, so did the SG&A expenses. At some point, we need to leverage those increased costs either to grow revenues and earnings or find ways to realize synergies.

Danny Eggerich, Analyst

That's helpful. I'll leave it there, thanks.

Michael Leach, CFO

Thank you.

Operator, Operator

The next question will come from Gerry Sweeney with ROTH Capital. Please go ahead.

Gerry Sweeney, Analyst

Dick, Mike, thanks for taking my call. Mike, I think this is your last call, so congratulations.

Richard Warzala, CEO

It's his last call? Oh, come on, Gerry.

Gerry Sweeney, Analyst

Anyhow, I know we covered the simplified to accelerate, so I'll let that be for now. A&D is obviously lumpy. I'm curious how confident you are for 2024, given there are programs out there, and you feel relatively well-positioned.

Richard Warzala, CEO

Absolutely. Our quoting activity has been extremely high. We’ve seen orders coming in, aligned with our expectations for the replenishment of certain materials needed by the defense markets. We do have visibility on programs beginning to accelerate mid-year and some significant programs expected in the future. We're also focusing on how we handle orders to improve efficiency with our acquisitions. Our goal is to simplify the process and align revenues and profits correctly.

Michael Leach, CFO

As I mentioned previously, we do face supply chain inefficiencies within A&D. Suppliers who are also customers are holding up the release of products because they can't produce at full capacity, which is impacting delivery of our products.

Gerry Sweeney, Analyst

Got you. Taking a step back, it sounds like there's an opportunity not just for cost savings but for a larger solution to customers, getting some of your businesses to interact. Is that accurate?

Richard Warzala, CEO

Absolutely. To win in this business, being first to market with a solution is key. A complex system only delays the process of getting solutions to customers. Our goal is to increase efficiencies, add value in sales, and provide more efficient solutions on a larger scale, which will improve our top line.

Gerry Sweeney, Analyst

Do you plan to slow down acquisitions at this point? Seems like you've made eight acquisitions recently?

Richard Warzala, CEO

Yes, we need to focus on making sure that everything we have acquired is functioning as expected. The emphasis will be on optimizing what we've acquired, particularly SNC, where we see great synergies and opportunities to leverage our combined resources. While we're open to new opportunities, our priority is currently on making the existing acquisitions work better.

Gerry Sweeney, Analyst

So essentially, make some acquisitions, take a step back, optimize, drive cash flow, and then reassess for more acquisitions?

Richard Warzala, CEO

Exactly. Thank you, everyone, for joining us on today's call and your continued interest in Allient. We will be participating in the ROTH Conference on March 18th in Dana Point, California. Please feel free to reach out to us at any time, and we look forward to talking with all of you again after our first quarter 2024 results. Thank you for your participation and have a great day.

Operator, Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.