Earnings Call Transcript - ALOT Q1 2024

Operator, Operator

Good day and welcome to the AstroNova's First Fiscal Quarter 2024 Financial Results Conference Call. Today's conference call is being recorded. I would now like to hand the conference over to Scott Solomon of the company's Investor Relations firm, Sharon Merrill Associates. Please go ahead, sir.

Scott Solomon, Investor Relations

Thank you, Ellen. Good morning, everyone, and thanks for joining us. Hosting this morning's call are Greg Woods, AstroNova's President and Chief Executive Officer; and David Smith, Vice President and Chief Financial Officer. Greg will discuss the company's operating highlights. David will take you through the financials at a high level. Greg will make some concluding comments, and then management will be happy to take your questions. By now, you should have received a copy of the earnings release that was issued this morning. If you don't have a copy, please go to the Investors page of the AstroNova website, www.astronovainc.com. Please note that statements made on today's call that are not statements of historical fact are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on a number of assumptions that could involve risks and uncertainties. Accordingly, actual results could differ materially, except as required by law. Any forward-looking statements speak only as of today, June 8, 2023. AstroNova undertakes no obligation to update these forward-looking statements. For further information regarding the forward-looking statements and the factors that may cause differences, please see the risk factors in AstroNova's annual report on Form 10-K and other filings the company makes with the Securities and Exchange Commission. On today's call, management will be referring to non-GAAP financial measures. AstroNova believes that the inclusion of these financial measures helps investors gain a meaningful understanding of the changes in the company's core operating results. It also helps investors who wish to make comparisons between AstroNova and other companies on both a GAAP and a non-GAAP basis. A reconciliation of the non-GAAP financial measures to their most directly comparable GAAP measures is available in today's earnings release. And with that, I'll turn the call over to Greg.

Gregory Woods, CEO

Thank you, Scott. Good morning, everyone, and thank you for joining us. Despite a macroeconomic climate that remains volatile, we delivered a solid first quarter performance. Our results highlighted our progress in three key areas: first, integrating the acquisition of Astro Machine; second, maintaining disciplined expense management; and third, capitalizing on the continuing rebound of the commercial aviation market. Through the exceptional work of our team members around the globe, we generated double-digit revenue growth in both our Product Identification and Test & Measurement segments. Our aggressive focus on implementing and maintaining cost-disciplined measures helped drive a 91% increase in operating income. This increase translated to a 150 basis point improvement in operating margin. On the bottom line, net income grew to $800,000 or $0.11 per diluted share compared with $400,000 or $0.06 per diluted share in the same period of fiscal 2023. Now let's look at each of the segments, beginning with Product Identification, which reported first quarter revenue of $25.1 million, nearly 16% higher than the year earlier period. The increase was driven by the addition of Astro Machine, which we acquired in August of last year. The integration of Astro Machine is proceeding on plan with a rapid level of cross-pollination in terms of engineering, manufacturing, and product development between our operations in West Warwick and Elk Grove Village. For example, our first jointly developed printer has already been completed and will be released later this month, and at least one more additional jointly developed printer should be released before the end of the year. First quarter segment operating profit margin improved 350 basis points to 10%, reflecting the higher Product ID revenue from a more favorable mix in the 2024 period. Going forward, we expect revenue mix to also benefit from the retrofitting of printers in the field that were sidelined since last year by a supplier-related ink quality issue as those units are restored and returned to full production. We expect this issue to be fully resolved before the end of the fiscal year. We kicked off our Product ID trade show season last month with great responses at two large European trade shows in Germany: interpack 2023 in Düsseldorf and a couple of weeks later, FESPA Global Print Expo in Munich. The shows featured a number of our latest products and accessories, and we were delighted by the number of high-quality leads we generated and the traction our new products are gaining with customers across an array of applications. Also last month, we had another important milestone with the launch of our e-commerce site, giving customers the ability to research and purchase AstroNova printers and supplies directly over the Internet. It's ideal for new customers searching for a solution as well as existing customers that want to reorder or check their account order status. The site provides a convenient, user-friendly experience. Initial customer response has been very positive, and we will continue to add products and functionality to the site throughout the year. Turning to the Test & Measurement segment. Revenue increased 11% year-over-year to $10.3 million driven by continuing improvement in the commercial aerospace market. Segment operating profit was up modestly, but margin was down 50 basis points to 20.1% of revenue. With the projected global demand for air travel in the coming decades, the outlook for our aerospace printers, supplies, and services is strong. Airbus anticipates 46,930 aircraft in service by 2041, up from 22,800 in 2020. A total of 39,490 of those are expected to be new deliveries with 60% to support growth and 40% to replace aircraft that will be retired from service. Boeing likewise projects a massive jump in airline fleets over the next 18 years. Turning to the data acquisition portion of the Test & Measurement segment. In addition to our core aerospace and defense programs, we have landed several new power generation monitoring projects due to the exceptional accuracy and performance of our data acquisition products. We look forward to growing this new segment in the coming quarters. Finally, we were pleased to see the company-wide bookings in the first quarter were up over 18%, totaling $38.4 million. With further strengthening of our backlog, that totaled $38.7 million at quarter end. Backlog is up more than 32% year-over-year and more than 8% sequentially from the fiscal year-end. Now let me turn the call over to David for additional financial review.

David Smith, CFO

Thanks, Greg, and good morning, everybody. At the top line, we posted revenue of a 13% increase to $35.4 million and solid contributions from both segments. We always highlight the recurring revenue nature of our overall business model. Looking at revenue by type, hardware revenue grew by more than 25% to $11.7 million driven primarily by the addition of Astro Machine in the Product ID segment, segment revenue increased more than 6%, and supplies revenue increased by more than 6% to $19.1 million, reflecting demand growth in both segments. The service and other category was up by more than 24% to $4.7 million. So in total, hardware revenue accounted for 33% of total revenue in the first quarter; supplies 54%; and service and other, the remaining 13%. As a percentage of revenue, both hardware and service were up year-over-year, while supplies revenue was down about 4%. Greg noted the cost control in the quarter. Operating expenses as a percentage of revenue decreased to 30.8% in the first quarter from 32.1% in the same quarter last year, which along with a 40 basis point increase in gross margins led to a 160 basis point increase in operating profit margin. I'll note that the operating expense this quarter was lower than the prior two quarters. That remains a very strict focus for us. From a geographic perspective, domestic revenue accounted for 64.5% of total revenue, up from 63.4% in the same quarter last year. International revenue accounted for 35.5% of total revenue compared with 36.6% a year earlier. In dollars, we saw double-digit growth in Asia and Central and South America in the quarter and a high single percentage growth in Europe. Adjusted EBITDA, which we define as normal EBITDA plus share-based compensation, increased to $3.1 million or 8.6% of revenue compared to 6.2% of revenue last year. Cash was $1.5 million higher at the end of the year. Total debt at quarter end was $29.7 million, slightly lower than year-end. Total debt to trailing 12-month EBITDA is calculated in our bank agreement includes a full year of Astro Machine, and that checks in at 2.2x. On the historical GAAP financials, the debt to adjusted EBITDA would be 2.6x. We're comfortable with this level. We do expect leverage, though, to decline through the year absent any acquisitions. We've got sufficient capacity to support our business, the operating needs primarily. And we will use about $1.7 million of secured financing for some new capital equipment that will upgrade our hardware and supplies manufacturing equipment to improve efficiency and keep up with demand growth. Inventory investment increased in the quarter a little bit primarily to support our Test & Measurement segment. We're still experiencing some supply chain struggles in the Test & Measurement electronic components area and in a few instances in the Product Identification segment as well, where we need to purchase extra buffer stocks. However, there are clear signs that those supply chain issues are abating, and we're confident that our inventory will shrink as we move through the year. We'll use the free cash to reduce debt. With that, I'll turn the call back to Greg.

Gregory Woods, CEO

Thanks, David. In closing, we began fiscal 2024 with improved results that mark an important step towards our larger goal of driving sustained top-line growth and margin enhancement. Barring any downturn in the global economy, fiscal 2024 should see continued momentum in the commercial aerospace business, which we expect to contribute favorably to the performance of our Test & Measurement segment. In Product ID, our focus is on innovation with multiple new products slated for launch this year and other technology initiatives underway across our lines of business. Now David and I will be happy to take your questions. Operator?

Operator, Operator

Our first question comes from Samir Patel.

Samir Patel, Analyst

One question on the Product ID side. So I know this is the first Q1 that you have the Astro Machine business in there, and I noticed that there was a sequential step-down in revenue from kind of the Q3, Q4 levels. Is there some seasonality to that business?

Gregory Woods, CEO

We don't have a good enough read exactly on that, but there does seem to be a favorability of the second half of the year from the numbers that we've looked at. A few of the customers that we've talked to kind of bear that out. Although they don't commit exactly to that kind of cycle, it tends to do kind of Q3, Q4 supplies buildup is what we've seen.

Operator, Operator

Our next question comes from Peter Sidoti from Sidoti & Company.

Peter Sidoti, Analyst

Gentlemen, two quick questions. One, can you give me a capital spending budget for this year?

Gregory Woods, CEO

We can give you approximately. David, do you want to address that?

David Smith, CFO

Yes. We've got about $1.8 million sort of legitimately in the pipeline. So I'm going to estimate that we'll end up at about $2 million.

Peter Sidoti, Analyst

Okay. So the excess cash flow from operations will be used to pay down debt? Is that the assumption, unless an acquisition comes along?

David Smith, CFO

Yes, that's correct.

Gregory Woods, CEO

That makes sense.

Peter Sidoti, Analyst

And inventories, do you think they'll stay flat given the growth? Or do you think you'll be able to bring them down?

David Smith, CFO

We should be able to bring them down. I'm not going to commit to a number. As I said in my comments, I think the supply chain issues are abating. And we're going to concentrate on getting the inventory levels down over the balance of the year. It's a slow process, but we will get them down.

Gregory Woods, CEO

Right.

Peter Sidoti, Analyst

Okay. And one simple question, Greg. What's your economic assumptions for 2023 at this point?

Gregory Woods, CEO

My economic assumptions? Yes. What do you think is going to happen with the economy over the next 12 months? And how do you think it will affect you? There's all different views of what's going on... Yes. I'll have to admit, I'm not an economist. But right now, as I mentioned in my presentation, we do see a very strong demand in aerospace. That's probably the strongest indicator that seems to be solidly up. But as long as the economy works well and it doesn't seem to be affected at all so far. So we see that as a big driver.

Peter Sidoti, Analyst

Okay. So you see no slowing down in any of your sectors at this point?

Gregory Woods, CEO

Well, I said in the aerospace and in our Product ID, it is a very global business and a lot of different market segments. So it's hard to predict exactly what the macro economy may or may not affect that. Obviously, the better the economy, the better we will do.

Operator, Operator

Our next question comes from Tom Spiro from Spiro Capital.

Thomas Spiro, Analyst

Tom Spiro from Spiro Capital mentioned that Astro Machine's annual revenues are approximately in the low to mid-20s, around $5 million to $6 million each quarter. If this is correct and they performed similarly in Q1, it seems that the core Product ID has declined. Is that accurate?

Gregory Woods, CEO

We don't break it out exactly. But yes, I would say the growth in Q1 was driven by the Astro Machine business, correct.

Thomas Spiro, Analyst

No, it's not just about growth. It seems that core Product ID was down.

Gregory Woods, CEO

We don't break out the different segments, Tom.

Thomas Spiro, Analyst

The quality issue first appeared in fiscal '22, based on one of your annual reports. If I understood you correctly, it will be resolved by the end of this fiscal year, but that seems to take a very long time. Why?

Gregory Woods, CEO

We actually are on our third iteration of fix for that, to be honest with you. So what happened is we worked with the supplier, and their first two recommendations, which we implemented, did not prove effective in the long run. So we reverted to a third that we tested very stringently in the last four or five months. And that does seem to be working very well. So now we're rolling that out across the board. Unfortunately, some of the machines we upgraded, we have to upgrade again to this latest fix. But the good news is it does look very sustainable now.

Thomas Spiro, Analyst

Which product lines are affected by the quality issue?

Gregory Woods, CEO

It's mostly the Trojan-label products. There's very little impact on the QuickLabel; it's primarily in the Trojan-label line.

Thomas Spiro, Analyst

And if someone has one of these...

Gregory Woods, CEO

I was going to say, it works for some applications fine, but in certain applications, it didn't perform as well as it needs to, and that's why we're redoing those machines.

Thomas Spiro, Analyst

I see, I see. And if I'm one of the folks who has one of the affected machines, does the problem prevent me from using the machine at all? Or simply do I use it at a lower rate? What do I do?

Gregory Woods, CEO

It depends on the application. There are different types of labels and various uses of our labels across numerous markets. Some applications face no issues at all, while others experience intermittent problems that we can manage by treating the symptoms without addressing the root cause. Additionally, some applications may not work well because they have very specific requirements. It's a combination of factors, with several hundred printers involved.

Thomas Spiro, Analyst

As I recall, we did receive some modest compensation from the vendor a couple of years ago for this problem. Are we expecting further compensation for what we've suffered or no?

Gregory Woods, CEO

We can't disclose that exactly because it has to do with the agreements that we made. But it's a combination of some concessions, and then future concessions and a variety of elements. But there won't be a clear payment like we had at the outset there.

Operator, Operator

Our next question comes from Samir Patel from Askeladden Capital.

Samir Patel, Analyst

David, in relation to the inventory issue, I understand you prefer not to specify a exact number. However, based on the data I've gathered, it seems that from October 2002 until around late 2018, your inventory turns were typically at 5 or higher, with only a brief dip early in that period. Currently, my data indicates that those inventory turns are at 3.3. Do you see any structural factors in your business that might allow for recovery in inventory turns to around 4, 4.5, or 5 as supply chain challenges lessen? Or is there something fundamentally different about the business now?

David Smith, CFO

I love the question. I wish I had been around long enough to have that in my bones. But I'll take your math at good faith. No, there's nothing about the business inherently that should keep us from getting back to those levels. I think the aerospace business will always turn slower than the PI business for a variety of reasons, including the fact that you have to support these printers for a very, very long time. And if you have old technology, you have to do last-time buys to make sure that you have the components to build the printers over that entire period. And I think that's sort of the long-term drag on inventory turns. The PI business turns inventories much more quickly. We did have a slowdown across the board during this most recent struggles with the aerospace business and the pandemic and so forth. But no, I think our turns should improve in the PI business. And I think there are secular reasons why the aerospace business should improve. So no, I think our turns should improve over the next couple of years.

Samir Patel, Analyst

That makes sense. Another way to look at it is that the last time your revenues were at similar levels, your inventories were about $35 million according to this data, compared to $50 million now. I know you aren't ready to provide a number, but it seems like it could be quite significant. What timeframe do you anticipate this happening? Is it around 12 months, 24 months, or somewhere in between?

David Smith, CFO

Yes. The business has grown, and we acquired Astro Machine. As a result, inventory levels will see a slight increase. I mentioned earlier that we expect our cash flow generation to improve over the year, and inventory levels should get better as well. I'm not committing to a specific figure, but I hope we can enhance this further in the coming years. However, that's still uncertain at this time.

Gregory Woods, CEO

Samir, so I could add a little bit of color to that, if you like. And I think we've said this in the past as well is that when we had these supply chain issues going back over a year now, we definitely stocked up above our normal run rates. So that will start to bleed off, actually. It's just orders for those suppliers are typically six to eight months in the future. So some of that is actually going to bleed off this year and will continue into next year.

Samir Patel, Analyst

Okay. Perfect. And then one topic you haven't talked about for a little while is I know you implemented the new ERP system. You were excited about some of the visibility that gave you, I think, when you were integrating Astro Machine. Maybe just talk about some of the benefits there and how you see that helping you run the business going forward.

Gregory Woods, CEO

Yes. One of the biggest benefits is having it integrated amongst our different operations. Here in West Warwick, we're very far through the process. It's now a matter of kind of optimizing processes. We kicked it off very rapidly at Astro Machine because it's here, domestic, it's a smaller operation. So we expect to have that one done probably by the October kind of time frame. That's moving very quickly. Then we'll move directly to the branch locations, Canada, U.K., France, and Germany. Have different instances of NetSuite that they've had over time. We just need to consolidate all of those, which will be the focus after Astro Machine. Getting everyone on the same system clears up a fair amount of inefficiencies that we have to deal with mainly in the financial reporting side of the business. But the CRM systems, having those integrated, because that's also part of NetSuite, that just helps the whole sales and marketing team know globally what's going on instantaneously.

Samir Patel, Analyst

Got you. And I guess I'm excited to hear about e-commerce next time but probably wait for more data. As far as...

Gregory Woods, CEO

If you want to check it out, just go to our AstroNova Product ID site and click on the Shop button to explore it on your own.

Samir Patel, Analyst

I will do that. As far as M&A, I mean, I know timing is kind of not within your control, but do you want to talk about the pipeline? Or are you seeing more opportunities on the Test & Measurement side, the Product ID side, both of them?

Gregory Woods, CEO

Yes, it's quite promising with several factors at play. We usually focus on about four to six serious opportunities in both the Test & Measurement and Product ID segments. A few of them appear intriguing. As is often the case, we remain cautious; if we aren't satisfied with what we find, we will opt out. We tend to take a conservative approach to the deals we pursue. Therefore, if we can align one of these opportunities with what we seek for Astro Machine, we will definitely consider it. With the current state of our balance sheet, we should be well positioned to make a significant deal later in the year if we can identify the right opportunity through our due diligence process.

Samir Patel, Analyst

Okay. And Greg, I actually did what you said. I am on the e-commerce website. I'm only seeing the ability to buy printers and presses. Am I missing sort of the supplies component of that? Or is that a part of the website?

Gregory Woods, CEO

No, you can go in there. You can buy a label, all different labels. You actually can buy them if you were...

Samir Patel, Analyst

Okay. I see it now.

Operator, Operator

Our next question comes from George Melas from MKH Management.

George Melas, Analyst

A follow-up on Thomas Spiro's questions about the quality issue. It clearly affected machines that are in the field. So it impacts supply sales. Did it also impact hardware sales? Was it just hard to sell the Trojan machines given the issues that you were having?

Gregory Woods, CEO

Yes, in certain models, primarily through our channel segment. We understand which indications we can sell the machines to, and moving forward, we can approach this incrementally. Now that we have the fix in place, we can take a more aggressive stance. However, as a channel partner, if you faced several issues, you would be hesitant to proceed until you see the new solution validated and your sales recover. Therefore, a significant part of our efforts involves collaborating with channel partners to get them back on track and detailing what we have done to ensure we have a robust solution. This is progressing well, but they now need to go out and generate their customer sales. Thus, there was a hardware impact for these reasons.

George Melas, Analyst

Okay. And maybe help us understand, like Trojan, what percentage of revenue is direct or how much is through the channel? How important is the channel for Trojan sales?

Gregory Woods, CEO

It's an important piece of it. There's a good amount of direct sales as well. But a lot of the OEMs, some of the larger accounts, happen to be either OEM accounts or channel accounts for Trojan equipment, less so with the QuickLabel.

George Melas, Analyst

Okay. Great. Maybe a question on the bookings. They seem to be really strong. Was there any particular area of strength? Or was it sort of across the board? Was it like a few large deals? Maybe give us just a little bit of color on the bookings.

Gregory Woods, CEO

Yes. There wasn't an outsized deal that was involved there. It's pretty much spread across different products in both the Test & Measurement segment and in the Product ID segment.

David Smith, CFO

Yes. The trend in aerospace products is generally favorable.

George Melas, Analyst

Okay. How do the aerospace guys order? I mean, is it very lumpy? Or is it sort of just a continuous kind of order patterns?

Gregory Woods, CEO

We wish it was the latter, but it's more the former. It depends on the Test & Measurement segment, which I will combine for reporting purposes. The data acquisition aspect is heavily influenced by aerospace and defense government contracts, making it quite variable. In the aerospace product lines, it hinges on new airline purchases, such as 50 Airbus 320s or 50 Boeing 737s. The orders depend on the product category and the airlines then place their orders directly with us or through Boeing or Airbus. These can be significant orders that are distributed over a period of 12 months or longer. Sometimes the orders are just forecasts which we cannot record as actual orders, contributing to that variability. Occasionally, we also receive surge orders, but it's rare to have urgent requests for delivery within three months that weren't anticipated. The aerospace sector tends to be fairly predictable, and we typically ship products six months or more in advance of their final assembly in the airplane. However, there are spare parts and other business areas that may experience fluctuations as well.

George Melas, Analyst

Okay. That's helpful. I have a final quick question for David. David, do you expect some leverage on the G&A line in the future as the business grows? Specifically, do you anticipate that G&A will decrease as a percentage of revenue?

David Smith, CFO

Yes. That's the goal. It makes sense that that will happen. We haven't talked about specific percentages from a guidance standpoint. But certainly, it would make sense that that would happen, and that's our goal. I think that's what will happen.

George Melas, Analyst

Okay. And is there a particular number you can give about the ERP implementation costs in the quarter?

David Smith, CFO

Most of the implementation costs are in the rearview mirror. We are spending some capital on implementation at Astro Machine. We'll spend some more work on capital in the European convergence with the global system. But those numbers are in my overall guidance for capital spending this year. So they're not huge.

Operator, Operator

There are no more questions on the line. So I'll now hand back to Mr. Woods for any closing remarks.

Gregory Woods, CEO

Great. Thanks a lot. So thanks, everyone, for joining us here this morning. We look forward to keeping you updated on our progress in the future. Have a good day.

Operator, Operator

That concludes today's conference call. Thank you, everyone, for joining. You may now disconnect your lines. Have a lovely rest of your day.