Earnings Call Transcript - ALNT Q4 2020

Operator, Operator

Greetings. Welcome to Allied Motion Technologies Fourth Quarter Fiscal Year 2020 Financial Results. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Operator provides instructions to participants. Please note this conference is being recorded. I would now like to 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 2020 results and provide an update on the company’s strategic progress and outlook, after which we’ll open it up for Q&A. As part of today’s Q&A, we do ask that you limit your questions to two or three in order to allow for all participants and you can certainly go back into the queue for additional follow-up. 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. On the website, you’ll also find 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’ve 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. I guess it goes without saying and all of us would agree that 2020 was an exceptionally unusual year. I am most proud of the resilience and agility demonstrated by our entire Allied team during these challenging times. We responded rapidly to the changing situation and worked tirelessly to create a safe work environment, while at the same time making the necessary adjustments to ensure that the needs of our customers continued to be met. At the onset of the pandemic, we qualified as an essential supplier, because our products are used to support critical industries including medical, defense and agriculture. As a result, we were able to keep all of our manufacturing facilities operational. We adjusted our staffing levels to align with production volumes to meet varying levels of demand for several of our end markets. And we successfully managed inventory levels in our facilities to maintain responsive delivery to our customers. While the pandemic significantly impacted our end markets and operations, we were able to pursue the execution of our strategy due to the flexible and committed efforts of our team to position the company for long-term growth. This included a number of significant achievements. We refinanced our lending agreement and successfully closed and integrated the acquisition of Dynamic Controls. The acquisition significantly increased our available critical engineering resources, further strengthened our medical market position around patient mobility and rehabilitation, and provides a platform to further develop higher level solutions and leverage the electronic products across our other vertical markets. We also realized several wins with new and existing customers by providing innovative solutions, which provide key revenue streams for the next several years. Our focused and disciplined approach allowed us to navigate this environment, while advancing our strategic priorities and ending a challenging year with solid financial results including record levels of orders and backlog. Fourth quarter revenue increased 6% to $93 million even as the pandemic continued to impact several of our served markets. This increase was driven by our Medical markets and exceptional engagement and focus on executing a significant recovery in powersports within our Vehicle market. Driven largely by Dynamic Controls, we saw an increase of 69% in Medical compared with the 2019 fourth quarter and for the year Medical was up 61%. This market performance almost offset the decline in all other markets as revenue was down by only 1% in 2020. For the full year, we achieved a gross margin of 29.6% as our diverse market strategy and disciplined cost management efforts helped mostly offset COVID-related headwinds. Our fourth quarter gross margin in particular had some atypical impacts that Mike will detail. Our effective execution and disciplined cash management drove solid cash generation of $9.8 million during the quarter, which enabled us to reduce total debt by almost $5 million. For the year, we paid down almost $17 million of debt, while generating nearly $25 million of cash flow from operations. At the same time, we’ve been making strategic capital investments to further our momentum and emerge in an even stronger position once the economy returns to a more normalized state. We are confident in our initiatives and the strength of our business model. We will remain vigilant and continue to implement the measures required to ensure the health and safety of all of our employees and their families. Before I turn it over to Mike, yesterday, we announced our standard quarterly dividend and also announced that the Board of Directors approved a 3-for-2 stock split that will take effect on April 30 for stockholders of record at the close of business on April 16. This action reflects our outlook for continued growth and our confidence in driving long-term shareholder value. We also believe this will provide greater liquidity of the company shares and assist in expanding our investor base. 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. We provide an overview of our top line on Slide 4. As a reminder, our results include Dynamic Controls, which we acquired in March, 2020. Fourth quarter revenue was up $5.1 million or 6% to $93 million despite the continued impact of the pandemic on our end markets. Revenue growth was driven by strong demand in Medical, including the incremental benefit of Dynamic, and a 6.5% increase in Vehicle. FX impact for the quarter on revenue was a favorable $2.8 million. Revenue for the full year came in at $366.7 million, down 1%. FX fluctuations on revenue were favorable $1.8 million for the full year. Our Medical market grew 61%, again reflecting the addition of Dynamic and favorable impact due to COVID-19. While Vehicle has rebounded, we’re still down year-over-year given the severe decline when the pandemic first hit earlier in the year, when many of our customers' production facilities were completely shut down. Sales to U.S. customers were 53%, down from 57% in the prior year period with the balance of sales to customers primarily in Europe, Canada, and Asia. The shift in geographic mix reflects the addition of Dynamic Controls. Slide 5 shows the change in our revenue mix by market and the change in revenue by markets for the full year ended December 31. Overall, broadening the scope and diversification of our various end markets has added some resilience to our business. Again, the economic impact as the COVID-19 pandemic was reflected in the reduced demand and order deferrals within Industry, Vehicle and A&D. As depicted on Slide 6, our gross margin was 27.9% for the quarter, compared with 30.1% for the 2019 fourth quarter. The change reflects an unfavorable mix, the under absorption of some fixed costs in certain facilities due to declines in Industrial and A&D, and nearly $800,000 of higher costs as a result of increased tariffs, duties and expedited freight charges. We believe we have managed the impact of tariffs and duties relatively well and have benefited from our efforts to strategically source components as close to our manufacturing footprint as possible. Nonetheless, there were components that began to be impacted in the fourth quarter due to the expiration of certain exemptions. Additional freight reflects the high demand in powersports combined with supply chain constraints, which resulted in some inefficiencies and unintended costs as our teams worked hard to support and meet customer demand and schedules. Gross margin for the full year was 29.6%, compared with 30.3%. Our diverse markets and cost containment efforts helped to partially offset the impact of lower volumes and the higher tariffs, duties and freight. Moving on to Slide 7, our operating income for the fourth quarter was $4.8 million or 5.1% of total sales, compared with $5.7 million or 6.5% in the prior year period. We managed to drive down operating costs as a percent of revenue by 90 basis points to 22.8% and the higher revenue and cost control partially offset incremental expenses related to Dynamic Controls. However, the flow through impact from the gross margin decline more than offset that upside. For the full year, operating margin declined 160 basis points to 6.3%, reflecting a 90 basis point increase of operating costs and expenses as a percent of revenue to 23.3%. This is largely driven again by the addition of Dynamic Controls, higher business development costs and our conscious decision to maintain key engineering capabilities, which we consider vital to drive future growth and continue to gain market share. Turning to Slide 8, you can see our bottom line and adjusted EBITDA results. It is important to note that during the fourth quarter, we incurred a foreign currency loss of $500,000 and the revaluation of short-term assets and liabilities as a result of expanded global production and the weakening of the U.S. dollar. That amount was offset by a return of $400,000 withholding tax that had been charged to Allied in the third quarter of 2019, due to tax assessments in a foreign jurisdiction for our previous acquisition. These two items are netted within our other expense line. Net income for the quarter was $2.7 million or $0.28 per diluted share. The effective tax rate was 26.2% and 27.3% for the fourth quarter and full year 2020 respectively. Net income for the full year was $13.6 million or $1.43 per diluted share. Excluding the tax item and other atypical items, adjusted net income for the year was $14.3 million or $1.50 per diluted share compared with $18 million and $1.90 per diluted share in 2019. Accordingly, I encourage you to review our non-GAAP disclosures and reconciliation tables that are provided in the release and slides. We anticipate the effective tax rates for fiscal 2021 to range between 27% and 29%. Adjusted EBITDA for the quarter was $9.9 million or 10.7% of sales. Full year adjusted EBITDA was $43.1 million and 11.8% of sales. We use adjusted EBITDA as an internal metric and believe it is useful in determining our progress and operating performance. Slides 9 and 10 provide an overview of our balance sheet and cash flow. At year-end, total debt was $120.1 million, up $10.3 million from 2019, reflecting funds used to acquire Dynamic Controls. In the quarter, we paid down $4.6 million of debt, nearly $17 million for the full year period. Debt, net of cash, was approximately $97 million for 40.4% net debt to net capitalization. It is noteworthy that on a net basis, the debt associated with the Dynamic Controls acquisition has essentially been paid off. Our bank leverage ratio was 2.78 times at year-end. While we are comfortable at this level, we continue to focus on paying down debt. As a reminder, in February last year, we expanded our borrowing capacity and reduced our cost of debt with a new $225 million senior revolving credit facility, which also included an accordion feature allowing the expansion up to $300 million. Additionally, we enhanced our flexibility by increasing the leverage coverage ratio of debt to EBITDA to 3.5 times. We generated strong cash flow from operations of $9.8 million in the fourth quarter, bringing the 2020 total to $24.8 million. This was used in part to fund our annual capital expenditures of $9.4 million, which were largely focused on new customer projects, advancing the large previously announced Vehicle market project wins and next-generation off-road vehicle steering capabilities. We expect our fiscal 2021 CapEx to range between $12 million and $15 million, which consists of some capital projects that have been deferred from 2020 as well as investments for new customer projects. Inventory turns were 3.8 times, down from 4.1 times at the end of 2019. As a reminder, there are a number of critical components that had substantial lead times providing sourcing challenges, particularly in the pandemic environment. This combined with the ramp up of new customer programs, is leading to temporarily elevated inventory levels. Our DSO was at 47 days relatively consistent with 2019. Before I turn it back over to Dick, let me reiterate that our primary focus is advancing internal and organic growth initiatives, as well as paying down debt to reload for future acquisitions. Given our demonstrated cash generating capabilities and current liquidity as well as our ability to rapidly adjust to changes in the economy, we believe we have sufficient liquidity and are in a strong financial shape to weather any near-term uncertainties. We’ll be in a position of strength when we emerge from this pandemic. With that, I’ll now turn the call back over to Dick.

Dick Warzala, Chairman, President & CEO

Thank you, Mike. As depicted on Slide 11, fourth quarter orders climbed to a record level of more than $108 million up 26% compared to the fourth quarter of 2019. Full year orders grew 1% to $371 million, a very solid level given the challenging operating environment. Backlog at year-end was approximately $141 million, up 14% sequentially, and also represented a record level. The majority of our backlog is expected to convert to sales over the next three to six months. In the second quarter of 2020, we secured the nomination of another award to provide a customer specific solution for our Vehicle market, raising the total of all awards to $325 million. We began shipments of the first award at approximately $8 million; that initial award is now currently included in our reported backlog numbers. At this time, we are expecting all of the awards to be at full-rate production in 2024. While the economic outlook for 2021 remains uncertain, we believe we are in a strong operational and financial position and the actions we have taken will allow our organization to continue to advance our strategy and drive growth through organic and inorganic opportunities. We’ll continue to focus on the areas of our business that we can control, and that includes utilizing our AST toolkit to drive continuous improvement in all areas of our business, as we work to create the right operational environment through leadership and team building. From a market perspective, we are optimistic that the various vaccines working their way around the world will continue to keep us on a path back to normalcy. While we expect demand from our Medical market to moderate, especially as we now lap the Dynamic Controls acquisition, we will continue to identify long-term market opportunities to leverage our broad base of technologies and develop market-based solutions that drive profitable growth. Within our Vehicle markets, there are a few dynamics at play, as we look to the first quarter. Powersports demand continues to be strong and the automotive markets continue to progress and return to previous levels of demand. As expected, we are seeing the runoff of some legacy programs that may not perfectly line up with the ramp of the new large award programs that we have previously announced. We’re still taking a cautious approach with our Industrial and A&D markets as we are seeing some pockets beginning to perform better, while others are still being impacted by the pandemic and near-term uncertainty. Ultimately, our record level of backlog, diversified end market penetration, thorough understanding of our served markets and demonstrated agility positions us well to perform across varied market trends. This also gives us confidence that we can drive further efficiency, profitable growth and enhanced free cash flow over the long-term. Importantly, given our diversified business model and ability to create more efficient and cost-effective controlled motion solutions for a wide variety of applications, we believe we will deliver expanding margins as the economy recovers. We have established an internal goal to drive an annual gross margin increase of 1 percentage point per year that can only be achieved through the continuing strong commitment and alignment on executing our long-term strategy. With that operator, let’s open the line for questions.

Operator, Operator

Thank you. Operator provides instructions to participants. Our first question is from Dick Ryan with Colliers. Please proceed.

Dick Ryan, Analyst, Colliers

Thank you. Hey, Dick. On the record orders in Q4, were there any specific key wins that you can point to and how does the backlog shape up? I mean, does that mirror the contributions of your various end markets or are there any variances in the strong backlog?

Dick Warzala, Chairman, President & CEO

Sure. I’d say, Dick, it mirrors what I’ll call the normal business mix within our markets. But I would tell you that there is an A&D contract in there that has firm deliveries and lead times, which may skew it a little bit more in that area. I don’t want that to come across as if we see A&D increasing in terms of the relative sales within our markets. I think it just says that we had a firm commitment with firm production dates and when we get those then we do book it into backlog. But for the most part, I’ll just tell you that it’s across the board and it mirrors the mix of our normal business.

Dick Ryan, Analyst, Colliers

Okay. When you look at — we’re coming to the close of the first quarter, any green shoots out there when you look at the various end markets and then looking out for the rest of the year. Which market should we see some growth or hope to see some growth in?

Dick Warzala, Chairman, President & CEO

I think we’re seeing some very encouraging signs across pretty much most markets now. Our European business, obviously, we have concerns as you still hear about lockdowns and the COVID spikes and so forth, especially in Europe. But we’re seeing very positive trends. Of course as the oil prices go up, we’re starting to see improvements there as well. So I think we’re quite optimistic that we’re starting to turn here and things are moving forward.

Dick Ryan, Analyst, Colliers

Okay. One last one on the M&A side, last quarter you talked about turning that activity up and matching, what’s the current environment out there. And have you had any change of thought on kind of your acquisitive efforts here in the near-term?

Dick Warzala, Chairman, President & CEO

No change in thought. And I will say to you that it’s definitely heating up.

Dick Ryan, Analyst, Colliers

Okay, great. Thank you.

Operator, Operator

Our next question is from Greg Palm with Craig-Hallum. Please proceed.

Greg Palm, Analyst, Craig-Hallum

Yes, thanks. Good morning everyone. I guess, just maybe starting going back to the commentary on gross margin. So if we back out that sort of $800,000 that you talked about, I’m still coming to a lower margin than expected. So just kind of curious how much of that was mix versus something else. And you seem pretty confident that at least some of this is kind of transitory and the long-term trend is upward. So maybe just going a little bit more detail on kind of how you’re thinking about the improvement going forward.

Dick Warzala, Chairman, President & CEO

Yes, Greg. I think what I’ll do is, there’s a number of factors at play there. Let’s turn this over to Mike. He’s got a good handle on where the impacts are and what we see that we can mitigate in the future.

Mike Leach, Chief Financial Officer

So it clearly is mix-related, Greg. I think we talked last quarter a little bit about how mix is impacting things. So while Medical is up and Medical typically is strong from a gross margin standpoint, the nature of the products that are being sold, particularly the ones that are pandemic-related, are of a lower gross margin nature than our average. Certainly, the other area we’ve seen surge is in Vehicle. Again, that traditionally has carried lower margins than our general average. And certainly, the absence of A&D, which I would characterize as quite typically higher margin products, certainly impacts us. And then from a volume perspective, while we were close to our volume last year, having an entirely new operation throughout the year means some of our fixed overhead costs are just not being absorbed as strongly as they will when volume returns, and we’ll get a lift out of that as well. And then clearly, the impact of the tariffs and some duties as well. Along with, in certain markets, we’ve seen such a surge that it’s presented supply chain constraints and issues. As I mentioned, things like expedited freight were fairly significant in the quarter as well. Again, that’s expedited freight to get products in from our suppliers. Throughout this pandemic period, there’s been those types of challenges and when the demand ramps up with it, it just made it even tighter and tougher. Our focus has been on meeting the demands of the customer. So certainly, we’ve incurred some costs and there were some inefficiencies.

Greg Palm, Analyst, Craig-Hallum

Got it. So it sounds like a lot of sort of one-timers that as things progress here through this year should start to improve.

Dick Warzala, Chairman, President & CEO

Sure. The tariffs are an unknown in terms of how long and where those are going. We have a large number of mitigation efforts to put those behind us as well. Those things take time to potentially address. That’s the one I would point to that certainly in Q1 we would expect to see some continued impact.

Greg Palm, Analyst, Craig-Hallum

Yes. Makes sense. The $8 million of the Vehicle award that’s now in backlog, I know you said full run rate in 2024. How should we be thinking about the progression of the ramp up of that award from now until then?

Dick Warzala, Chairman, President & CEO

I think what you’re going to see is each of the awards are now coming on starting up as planned, so there are varying timelines. As we mentioned, the first is now moving into ramp up and full-rate production. Each of the programs will ramp up in the next couple of years, and that is why we said full-rate production in 2024. So each will be coming on and ramping in this year and next year and the following year.

Greg Palm, Analyst, Craig-Hallum

Okay, good. And then last one, I know you don’t guide, but looking at seasonality between Q4 and Q1 and given the backlog, any reason why Q1 revenue won’t be higher than what you just saw in Q4? Just kind of curious how activity is trending quarter-to-date, it seems like things are pretty positive overall.

Dick Warzala, Chairman, President & CEO

I’m not going to argue with what you said and I concur to a large extent. I’ve mentioned that things are improving and we were encouraged by what we’re seeing. Last year was obviously a very unusual year; certain markets were performing extremely well at the end of the year. Our fourth quarter and December in particular is always a challenge for us and we don’t know which way it’s going to turn. Given everything else that occurred last year, I think in general your statement is consistent with what we’re seeing.

Greg Palm, Analyst, Craig-Hallum

Okay. All right. Thanks. Best of luck going forward.

Operator, Operator

Our next question is from Gerry Sweeney with ROTH Capital. Please proceed.

Gerry Sweeney, Analyst, ROTH Capital

Hi, good morning. Thanks for taking my questions.

Dick Warzala, Chairman, President & CEO

Good morning.

Mike Leach, Chief Financial Officer

Good morning, Gerry.

Gerry Sweeney, Analyst, ROTH Capital

I wanted to stick on the revenue side a little bit specifically in the Vehicle segment to start off with a little bit of talk about chip shortages, and I think even that may be more auto related, but curious one that can would impact powersports as well. I know there’s been some talk about some supply chain issues in powersports in the short-term. And does that sort of figure into any of your — you’ve mentioned a little bit of mismatch on legacy going down and new products and new business auto once going up.

Dick Warzala, Chairman, President & CEO

Okay. Let me clarify your second statement first about the mismatch. The mismatch is that legacy programs in automotive were ramping down and the timing of the awards meant the ramp ups were delayed. The ramp downs continued while the ramp ups were delayed. So that’s related to those Vehicle new awards. Specific to electronics, we are absolutely feeling the challenges. As electronics have become an important element in many markets for the solutions we provide, it’s a constant battle. As soon as you solve one issue another one pops up, including passives as well as active components. We’re also seeing it in plastics. Plastics has been a fairly significant challenge. Today, we’ve been able to work through many of these issues and we hope to continue, but there’s been a tremendous amount of requalification, new suppliers and new components. It’s obviously been quite a challenge that I think will continue to be for the short-term, especially as lead times extend. One of the things we have to watch for, having gone through cycles before, is when lead times start to extend, you start to see some double ordering just to make sure people are in the queues. We’re working to make sure that we’re getting commitments back from our customers and if they’re accelerating demand or increasing demand to ensure that we don’t get stuck with parts that we can’t use for a longer period of time. So there are clearly challenges, because of electronics and plastics and also magnets and bearings; lead times are extending and it’s causing us to react and to work very hard on alternative supply and also to ensure we can continue to supply even in the short-term.

Gerry Sweeney, Analyst, ROTH Capital

Are any of those costs — are you able to pass any of those costs through if they stay elevated for an extended period of time or is that just something…

Dick Warzala, Chairman, President & CEO

Certainly, when there’s increased demands and extended lead times, we work toward getting reimbursed. I’m not going to say we get reimbursed for everything, but we do have contracts that provide protection on cost increases in our longer-term, larger contracts; they have protection for commodity price increases. It’s the short-term bursts where a supplier notifies you that lead times are being pushed from 12 to 30 weeks and you may have to expedite materials — that’s where it’s not always possible to pass the cost on. Many times we incur the cost now to keep the supply chain going and keep the customer satisfied, and then we go back later and work on getting reimbursed.

Gerry Sweeney, Analyst, ROTH Capital

Yes, got it. So it’s a little bit of a delay there, got it. Okay. That’s it for me. I appreciate it. Thank you.

Dick Warzala, Chairman, President & CEO

Thank you, Gerry.

Operator, Operator

Our next question is from Brett Kearney with Gabelli Funds. Please proceed.

Brett Kearney, Analyst, Gabelli Funds

Hi guys, good morning.

Dick Warzala, Chairman, President & CEO

Good morning.

Mike Leach, Chief Financial Officer

Good morning, Brett.

Brett Kearney, Analyst, Gabelli Funds

Good morning. So Dick, you guys obviously took really good care of your team last year, not all companies undertook as thoughtful comprehensive approach as you did, but we’re hearing from some folks out there not just on the supply side, which we covered, but labor and staffing challenges and as you think about some of your markets coming back, as well as the new wins you have ramping up just generally curious how you’re thinking about the workforce side of meeting some of the production ramp up going forward.

Dick Warzala, Chairman, President & CEO

Sure. Regarding the production ramp up for the large Vehicle awards, a couple of things we’ve done: we’ve improved the level of automation so that as we move forward with new contracts and product launches, the automation we’re implementing decreases the need for additional labor. Having protected the workforce, we do feel there’s a level of loyalty and we haven’t seen high turnover, which may be due to our approach and the job market conditions. I do think we will, as production ramps in certain areas and pockets, have challenges and that’s something we’ve been actively working on for a while now — anticipating recruiting needs as demand increases. We’ve also been doing selective recruiting in key areas, primarily engineering and material supply, to ensure we’re positioned as we come out of this to grow and be in a stronger long-term position.

Brett Kearney, Analyst, Gabelli Funds

Terrific. Thank you so much.

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 remarks.

Dick Warzala, Chairman, President & CEO

Thank you, everyone for joining us on today’s call and for your interest in Allied Motion. As always, please feel free to reach out to us at any time. And we look forward to talking with all of you again after our first quarter 2021 results. Thank you for your participation. Stay safe and have a great day. Now conclude the call operator.

Operator, Operator

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