Allient Inc. (ALNT) Q2 2020 Earnings Report, Transcript and Summary

Greetings, and welcome to the Allied Motion Technologies Second Quarter Fiscal Year 2020 Financial Results. [Operator Instructions] A brief question-and-answer session will follow the formal presentation. [Operator Instructions] It is now my pleasure to introduce your host, Craig Mychajluk, Investor Relations. Thank you, Craig. You may begin.

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 second quarter 2020 results and provide an update on the Company's strategic progress and outlook, after which we'll open it up for Q&A. You should have a copy of the financial results that were released yesterday after 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 two 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 the 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 three, and I'll turn it over to Dick to begin. Dick?

Thank you, Craig, and welcome, everyone. Allied has continued to steer a steady course through these challenging conditions of the COVID-19 pandemic. I would like to acknowledge the incredible efforts, dedication and resilience of our employees who have done an excellent job helping us respond to the ever-changing environment and unique opportunities that have presented themselves. Our second quarter performance was relatively solid and demonstrated the success of our One Allied strategy. The diversification of our revenue base, the execution of our lean toolkit, Allied Systematic Tools, or AST for short, and the integration of Dynamic Controls all played a role in driving our results. Despite second quarter organic sales decline, our gross margin held up well, we achieved solid profitability and we continued to generate significant cash from operations. From a market perspective, we successfully navigated what we believe was the low point for us during the COVID-19 pandemic. All our facilities continued to operate, and our team was able to effectively mobilize and engage with customers. I was particularly impressed with our ability to flex up and support the increased demand that came in from various medical market customers, many of which are at the forefront of combating this pandemic. In fact, sales in the medical market, which includes contributions from our Dynamic Controls, nearly doubled on a year-over-year basis. Outside the medical market gains, we experienced broad end market declines as industrial activity slowed due to shutdowns and demand deferrals. In particular, our vehicle market was hit the hardest. There are some encouraging trends that give us optimism as activity has since increased and demand has picked up. We have also kept our team focused on several new project opportunities, which included the recently announced fourth major award since 2017 to provide solutions for our vehicle market in Europe and Asia. This additional award further validates our strategy to be a leading global provider of controlled motion solutions and demonstrates the market's recognition of our ability to develop highly reliable solutions for the vehicle market. Adjusted to reflect current exchange rates, the total value of these awards for vehicle market solutions is approximately $325 million. I will remind you that the value of these awards is not reflected in our backlog, and we only recognize them in the backlog when they are released to production. We have been focused on cash conservation, and we quickly adjusted our variable cost structure to align with market changes, while also maintaining strong discipline over fixed cost. As a result of these efforts, we managed to generate almost $10 million in cash from operations, and that enabled us to reduce total debt by nearly $8 million during the quarter. Given our prudent actions, we remain confident that we have the liquidity to address the current situation and the financial flexibility to be on the offensive as the economy recovers. I would also like to touch on our recent announcement to realign and expand our leadership and organization structure. We have grown to a size where a broader leadership base will improve our capabilities and ensure we meet the growth and profitability objectives of the Company in the future. This initiative and new structure is consistent with and in support of our long-term strategy as it leverages and crosses geographic and technology boundaries and creates greater cohesion across the entire organization. On the operations side of the business, we have created three new business groups and promoted three individuals who have proven themselves as strategic leaders. Each will look to drive growth opportunities and improve profitability as we further leverage the wide breadth of technologies and our geographic reach. In addition, we expanded the breadth of our global engineering team to improve system solution capabilities and drive organic growth through innovation with the goal of continuing to exceed normal industry growth levels. We also further elevated our AST focus to accelerate implementation and ensure we continue to improve efficiencies and drive growth and innovation across the entire organization. And finally, as acquisitions have been a key element of our growth strategy and our past success, we have formerly added a business development role to ensure we continue to drive and consummate strategic M&A opportunities in the future. Lastly, this realignment allows me to focus more intently on strategic initiatives to drive increased shareholder value, while also providing me greater bandwidth to ensure we meet the long-term goals and objectives of the Company. Despite the COVID-induced recession, these are exciting times for Allied. We are confident in our initiatives and the strength of our business model, and 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. With that, let me turn it over to Mike for a more in-depth review of the financials.

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. Revenue in the second quarter was $86.7 million, down $6 million or 6% and included an FX headwind of $1.4 million. The impact of the COVID-19 pandemic created extended shutdowns from many customers in our vehicle and industrial markets for much of the quarter. However, sales to our medical markets, which included $9.9 million from Dynamic Controls almost doubled, helping to partially offset those declines. Sales to U.S. customers were 50% in the second quarter, down from 58% 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 growth of each market for the trailing 12 months ended June 30. The Dynamic Controls business can be found within Medical and accounts for a significant piece of the 35% growth in this market. As we've discussed and demonstrated, growing our Medical and A&D markets are an important element of our strategy to broaden the scope and diversification of the business and to enhance our margin profile. While we have high single to double-digit trailing 12-month growth in most verticals, the drop-off in demand within vehicle due to COVID-19 is reflected in the 13% TTM sales decline. As highlighted on Slide 6, our gross margin for the quarter was 30.5%, down just 20 basis points from the prior year period. Our cost management efforts and improved mix, given the greater percentage of medical market sales including the favorable impact of Dynamic mostly offset the volume impact from the decline in Vehicle. Our operating performance is on Slide 7. While we continued to be prudent on the expense side, our operating performance for the quarter still reflected some negative leverage given the reduction of sales. Operating expenses as a percent of revenue were up 220 basis points, largely due to overall revenue with incremental expenses related to Dynamic, higher business development costs and incremental COVID-19-related costs associated with the ensuring employee health and safety. It's important to note that we are maintaining 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. Net income for the quarter was $2.9 million or $0.30 per diluted share compared with $4.4 million or $0.47 per diluted share in the prior year period. Excluding business development costs, adjusted net income was $3 million or $0.32 per diluted share. The second quarter effective tax rate was 29.9%, and we anticipate the effective tax rate for the full fiscal 2020 to range between 27% to 29%. Despite current headwinds, we continue to demonstrate our cash-generating capabilities. Adjusted EBITDA was $10 million and as a percent of sales was 11.6%. 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. We ended the quarter with sufficient liquidity as we generated a considerable amount of free cash flow, which was used to pay -- in part to pay down debt. Cash and cash equivalents at quarter end were $19 million, up $5.6 million from the end of 2019. We reduced debt by $7.9 million in the quarter, resulting in total debt of $128.5 million. Compared with year-end 2019, total debt was up primarily due to the Dynamic Controls acquisition. Debt net of cash was $109.4 million or 46.4% of net debt to capitalization. Our bank leverage ratio was 2.64 times at quarter end. While we are comfortable at this level, given near-term uncertainty, we continue to focus on paying down debt. Recall that our maximum leverage coverage ratio covenant debt-to-EBITDA is 3.5 times, reflecting solid financial flexibility. Year-to-date capital expenditures were $3.6 million. We continue to expect our fiscal 2020 CapEx to range between $10 million and $12 million, which will enable key projects to move forward, while deferring lower-priority activities. Second quarter inventory turns were 3.5 times, down from 4.1 times at year-end. At this time, we continue to face an uncertain supply chain environment with extended lead times and customer pushouts leading to higher inventory levels to support our broader customer base. Our DSO was also elevated at 53 days due to the timing of collections of receipts and was not due to deterioration in credit quality. In fact, credit quality metrics actually improved since the sequential first quarter with lower levels of past due accounts. Let me reiterate that we are very pleased with our ability to generate cash and reduce debt during this downturn. We expect continued strong cash flow generation and believe our capital allocation strategy positions us well to successfully navigate the conditions ahead. With that, I'll now turn the call back over to Dick.

Thank you, Mike. As depicted on slide 11, orders were more than $80 million in the quarter and reflected $1.8 million of unfavorable FX. Backlog at quarter end was approximately $128 million, down 4% sequentially. As I mentioned earlier, we secured a nomination of another award to provide a customer-specific solution for our Vehicle market, and just a nominal amount of these awards is currently included in our reported backlog numbers. While we have begun shipments at very low levels for the first of the four awards, the COVID-19 pandemic has slowed the production ramp-up for these projects through the remainder of the year. As we look to the near term, we remain cautious given the uncertainty of the current COVID-19 environment as demand signals continue to be mixed and highly dependent on the vitality of the end markets we serve. Some markets provide limited visibility and may be impacted by ongoing macro uncertainties due to different recovery rates from the pandemic, while there are other verticals that are stabilizing or showing encouraging trends. Ultimately, for us, we are focused on the elements that we can control. In particular, that is reflected in our new product development efforts, which continue to be a high priority. We are on track to create several exciting new products and solutions to ensure that we stay at the forefront and continue to meet the emerging needs of our served target markets. Our business has demonstrated outstanding resilience, and we are firmly committed to retaining our critical talent. As a technology/know-how-driven company, it is essential that we continue to enhance our engineering capabilities to supplement and support our customers through these very difficult and unprecedented times. Overall, I'm confident that the measures we have taken will allow our organization to continue to operate safely. We will adjust and prioritize our customers' needs as required, and through the disciplined execution of our long-term strategy and the guiding principles of our One Allied culture, deliver superior results over the long term. With that, operator, let's open the line for questions.

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Greg Palm with Craig-Hallum. Please proceed with your question.

Great. Thanks. Good morning, everyone. Nice results, especially with everything going on here. Wanted to maybe start with, square some comments that you made, Dick. You said I think that it was pretty clear that you hit the low point in Q2. You're seeing some encouraging trends in Vehicle, which is your largest market. Yet at the same point, it sounded like there was a little bit of, sort of, cautiousness in there. So, I don't know, maybe a little bit more detail on what you're seeing in July and how you're sort of looking or viewing the second half here?

With the Vehicle market, we did see some delays, and I'll talk the on-road vehicle-type market delays in getting updated schedules and people, and companies coming back to work and so forth. So yes, it did have an impact on second quarter. With regard to off-road vehicles, we saw a very strong pickup in the second quarter, and we clearly expect that to continue through the remainder of the year, and it's very strong. And then on the on-road side, we see it now coming back, and I would say we're at the point here where we have visibility where it's 80% to 85% of what our original demand expectations were and improving beyond that. So while we're cautious here, we do see some very positive signs in those, in the vehicle, in our vehicle markets.

And what about medical? I mean, that was clearly a standout. And I know you talked about Dynamic a little bit as a main contributor. But even if you back it out, segment revenue was still up quite a bit on a year-over-year basis. So maybe just talk about what some of the largest contributors were in there?

Sure. Yes. The ventilation, the ventilator, respirator, that market, dialysis machines, all which we serve, we saw very strong tick-up in demand, and also some other auxiliary equipment that goes into the hospital environments for staffing as they were expanding the number of hospital rooms and facilities and so forth. So we saw a very strong demand there, and that's continuing. We think that there was a catch-up that had to occur. There's also modernization of equipment that's in facilities. And I, we think that we'll see some continued demand there into the future. In addition to that, I think there are some very encouraging opportunities for us that have come out of this with regard to sourcing product from, for North America in North America, and I think we're well positioned to be able to capitalize on some of those opportunities in the future. We have products that are fairly high performance, and we're a certified medical applications in a number of our facilities. So we do see some strong opportunities for the future. We see some demand continuing through the third quarter, and I think the future for us in that area is quite bright.

It sounded like you were maybe alluding to some new customer opportunities. I mean, how much of the Q2 strength was driven by overall market growth versus maybe some share gains? And is that the right way to think about it where there could be some new customer opportunities going forward?

Yes. Let me clarify that a little bit, too, because typically, as you know, and the types of products that we're being used. I mean, they go through an approval process. And while the approval process can be -- is accelerated in these times, the demand that we saw was based upon existing customers that we already had -- we already designed in and approved on. So in addition to that, we are working on new opportunities for share gain, and I think we're going to certainly take the opportunity to leverage the fact that we design and produce significant number of our medical products in North America. So the second quarter reflected existing customer base with increased demand beyond out into the future. We have opened up new opportunities that we feel very confident that we're going to secure some share gain and new customers along the way.

Okay. Good. And then I appreciate the color on the organizational changes, the leadership structure. I think it'd be helpful to get some, maybe, additional color on the, I don't know, why now as it relates to the timing of the moves. I mean, if you could provide a little bit of detail around some of your long-term goals and objectives of the Company. And what makes you optimistic that some of these leadership changes gets you there, maybe, faster or better than what you were thinking before?

Sure. Well, first off, I have to tell you that these were planned in the first and second quarter, and we delayed them because we did not want the -- a perception to be out there that we're making changes on a defensive basis. These are offensive moves. So we delayed until the timing was -- we get -- I'm not saying we've got this behind us, of course. As we mentioned, there's going to be -- still be some instability in some of the markets. But the structural changes were discussed in great detail. I think our team has really developed nicely and stronger than it's ever been. And I think our goals are going to be to continue the growth and success of this company, and it's going to take additional resources and horsepower to do it. So if you notice every aspect we hit on there, we hit on the operational side. We hit on creating these groups, which would allow us further leverage from an operating standpoint and an efficiency standpoint. We leverage our technology across all these -- all the platforms. We strengthened -- we've made, what we used to call global electronics team, subtle change to that. It's called global engineering team, which means that we now are doing a much better job of modeling and simulating complete solution capabilities, and it's very exciting stuff. So that is the reason for the global engineering team and the excitement that I have around our capabilities there and our speed to market, our speed, play to market because of what we've been able to do internally here, and now pull that together in a way that gives the major strategic offensive objectives a greater focus. So that's been coming, and it's been building nicely. And I think we're at the point where we keep making these positive steps forward. We talked about AST. And as Rob Maida has picked up additional responsibilities in, from an operating standpoint, and we merged what we used to call North American motors and mechatronics together. Geoff Rondeau, who had mechatronics is very strong in AST, both in the growth and innovation side as well as the operating efficiency. And as a partner to Rob, we think that there's some significant opportunities for us to leverage AST throughout the Company. So there's, that's one of the things we've done there. In regard to Europe, we've had, we have one of our general manager who has been with us for quite a while. He is retiring at the end of the year. And we have recruited and have another individual in place. He's been onboard. And what we did is we, again, looked toward developing the synergies, okay, that we can within channels, the supplier base, et cetera, and now began to align the operations in Europe. So I think you get the theme here, I won't have to go into every single one. But you get the theme. It's that we feel from an operating standpoint, there's lots of opportunities for us to leverage the foundation we have, but also create future synergies down the road. And with acquisitions, they've clearly been part of our success in the past, and we think we have a good formula for the acquisitions. And we just, we're going to make sure that we keep the pipeline full. And as you know, Greg and everyone else out there knows, sometimes these take years to develop. So we're planting the seeds, and we have to have the ability to continue to reap the rewards from those, who knows down the road, two, three, four, five years down the road. Okay? So that's, it's all positive. It's all good stuff. And the leadership team has really excelled, and I can't compliment them enough on how well they've worked together here and help each other out through certainly this, the pandemic as well as now getting us positioned for further growth in the future. Does that help? Or do you have more specific questions? We're trying to hit all the growth drivers here.

Our next question comes from the line of Gerry Sweeney with ROTH Capital.

Thanks for taking my call. I'm still playing a little catch-up on some of your answers on the last question there. But can I just dig in a little bit on the Medical and Vehicle side. And this is more anecdotal on the Medical side. Obviously, Dynamic Controls, and then you talked about ventilators, dialysis, just a lot of demand. Obviously, especially the ventilators, lots of press about that, lots of efforts to ramp up production. How much of that could be transitory? And then I think juxtaposed to that, also, some checks indicated, maybe some slowdown on elective surgery and maybe some slowdown on equipment on that side. Looking at both those puts-and-takes, could you give us a little bit more insight as to what you're seeing going on in the medical market and how we look at it from that perspective?

Sure. I think, you're correct. There is, some of it's transitory. And what I was, there was obviously an increased demand for equipment. And our take on it right now is based upon talking to our customers that demand, there was that spike in big peak of demand that occurred to get products into the marketplace, but there's also a recognition that there's a need to get modern equipment into hospitals, and that's not going to go away. So I think you're going to see an investment in and a continued investment in. So that people are going to get caught short in the future. So yes, there was a spike. There was product put into the market. But we think there's going to be a continued demand as people are going to upgrade their equipment and make sure that they're positioned to better combat anything like this in the future. So it's not going to go away immediately, but we would expect going into next year, unless another crisis hits of some sort that the demand should soften going into next year. You're at, the other point you brought up was an excellent point here on the elective surgeries. And obviously, knowing that we're a supplier to that marketplace. We did see some push-outs and drop in demand, but that's come right back. And so, and that market is really at the beginning stages, if you read all the studies on it. So we think there's some strong opportunities for growth in that market, and we are well positioned for that in the future.

So not only since COVID, but, the COVID, you can almost say, was a catalyst for an upgrade cycle with medical equipment, and you're seeing that as well, essentially, what you are saying there, too.

Correct.

Yes. And then switching gears, vehicles. The shutdowns in 2Q, on-road, off-road, channel checks, I mean you look at the dealers are out right now. So, and inventory is low. So we would expect the restocking efforts, maybe, what are you seeing from your customers? Are they ramping up production again? Or are they going back to normal level on-road, off-road? As an ancillary point, I bought a car this weekend because I needed one. And apparently, 300 cars have been sold at the dealership. So there's crazy demand out there right now. So, but curious.

Well, we see it. Yes, Gerry, I think, again, excellent points. We see it. I mean if we look at what happened to us in April and demand coming from those markets, I mean they were devastated. And it bounced back fairly quickly. So I would tell you that, as I mentioned earlier, that we're 80%, 85%, going to 90% of previous demand in the on-road market. We, I think the off-road market, we're exceeding that. So I think, clearly, there is definitely some increased demand. And I also have to tell you, say to you that through this process here, we had installed another production line to build products for the off-road market, and it was implemented in Mexico. And our team down there was able to get it up and running and delivering products. So again, kudos to our team. Through all of this. They still kept these projects going forward. And we're able to make thing, make it happen and for us to meet the delivery demands and the accelerated delivery demands. So I think, again, I think your perception of what's occurring in that market is, and what we're seeing, they align.

Okay. Switching gears a little bit to some costs, like OpEx headwinds. How much of that was, we'll say, maybe unabsorbed overhead? And then how much of it was, maybe, some excess COVID costs, which could go way or transitory as well. How do we look at that when we're looking at the model? Do we potentially see a rebound in revenue?

So certainly, from a gross margin standpoint, right, there was with the lower volume, some unabsorbed costs and certainly not leveraging our fixed manufacturing costs as well as if we'd had that volume, and, right, there'll be some tailwinds there as that comes back. From an operating expense standpoint, again, I think that is relatively stable. Again, it's reflective of adding the incremental costs associated with Dynamic Controls and just flexing that as a percentage of total sales. And with sales being down, I think you saw that basis point increase really is reflective of just the lower revenues, more than it is an imbalance with expenditures. So that should come back. And then as it relates to COVID-related costs, I would tell you that the COVID costs were moderate from an actual expenditure standpoint, whether that's supplies or cleanings or things like that. Where you feel it really, though, is in productivity, right? Having to adjust shifts to accommodate social distancing, lunch breaks, arrival times of employees and the like, right? It's a matter of lost efficiency, if you will. And so certainly, that'll help with margins as well when we become more accustomed and practiced to add those things. And two, if those things get relaxed over time, obviously, we are maintaining that and being diligent in our safety processes. So that may continue for some time.

Thank you. [Operator Instructions] Our next question comes from the line of Dick Ryan with Colliers. Please proceed with your question.

Thank you. So Dick, a question on Dynamic, specifically. It looks like, obviously, this thing has checked all the boxes from a good acquisition for you guys. But if I recall, there were some competitive issues that the previous owner of Dynamic was running into to kind of limit some growth? I'm not sure if that's accurate summary there. But since you've had this now for 5 months, can you talk about if that issue has gone away? And what you're just seeing in the general market demand for Dynamic now that you own it?

Sure. You're correct, Dick, and thanks for the question here. Dynamic was owned by a major player in the patient mobility and rehabilitation marketplace. So obviously, being owned by the parent company, it limited their ability to provide solutions or sell product to the competitors. So one of the reasons that we felt that Dynamic will be a great acquisition is that if we -- they're now allowed to go and they're not tied to one particular -- to a parent company who has ownership over make an established direction. And while they were allowed to go, compete and sell to other companies before, I think, certainly, just given the relationship, that was restricted or restrictive in some manners. And so that's gone. And now the process is to approach the other players in the marketplace and start bringing our solution forward and which we are doing. In addition to that, the Dynamic had the electronic and the control side of it, and Allied brings the motors and the gearing. So it's a perfect solution. And it just continues to build on the successes we've had in the past of being a very, and leverage the technologies to come up with a solution for our customers. And that's really what we're working on. So that for the medical markets, but in addition to that, because Dynamic has significant core unit volume and mass in the electronic control area, they're dealing with safety issues. They're dealing with traction. They're dealing with interface that's common in all of our vehicle-type applications, whether it's automated material handling or it's additional patient mobility and so forth. So I think we're looking at expanding that capability into markets that we are already serving and some new market opportunities for us. So we're quite excited about it. We mentioned, and unfortunately, they kind of got lost here in the process of COVID hitting. But we're really excited about the capabilities, the talent that's come on board and our ability to leverage a solution sell into not only the medical but other markets.

So when you look at the backlog, has there been any cancellations or deferrals of deliveries. You indicated it's probably a three to six month flow-through, but has there been anything below the surface, cancellation or deferrals?

We haven't seen cancellations, but we definitely have seen deferrals. And I think if you look at total demand in the market, now that could change fairly quickly. So, but yes, to answer your question, we have seen deferrals. I will, normally, we don't give much color about what's happened. But since July is completed, we've had, we saw a nice tick up in bookings, in our order intake. So we hope that continues to accelerate, but it was at a very nice level with some wins here, things that we had been working on that now have come through. People are back to work, and these things are getting released. But yes, to answer your question, we did see some demand push-outs. And I would tell you that industrial is an area that we saw some of that and also a little bit in the, in defense sector.

Thank you. We have no further questions at this time. I'd like to turn the floor back over to management for closing comments.

Thank you, operator. And 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 third quarter results. Thank you for your participation. Stay safe, and have a great day. And that'll conclude the call, operator.

This does conclude today's teleconference. You may disconnect your lines now. Thank you for your participations and have a wonderful day.