Allient Inc. (ALNT) Q3 2022 Earnings Report, Transcript and Summary

Good day, and welcome to the Allied Motion Third Quarter 2022 Conference Call. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Craig Mychajluk of Investor Relations.

Please go ahead. Thank you. And first off, I just want to apologize to everyone for the delay. We had some technical difficulties. We certainly appreciate your time today as well as your interest in Allied Motion. Joining me on the call are Dick Warzala, our Chairman, President and CEO; and Mike Leach, our Chief Financial Officer. Dick and Mike are going to review our third quarter 2022 results and provide an update on the company's strategic progress and outlook, after which we'll open up for Q&A. 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, along with the slides that accompany today's discussion. If you're reviewing those slides, please turn to Slide 2 for the safe harbor statement. As you are aware, we may make forward-looking statements on this call during the formal discussion as well as during the Q&A. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from what is stated on today's call. These risks and uncertainties and other factors are discussed in the earnings release as well as with other documents filed by the company with the Securities and Exchange Commission. You can find these documents on our website or at sec.gov. I want to point out as well that during today's call, we'll discuss some non-GAAP measures, which we believe will be useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We have provided reconciliations of non-GAAP to comparable GAAP measures in the tables accompanying the earnings release and slides. With that, please turn to Slide 3, and I'll turn it over to Dick to begin. Dick?

Thank you, Craig, and welcome, everyone. We delivered strong results during the third quarter, which demonstrated the power of our strategy as our global teams executed very well in a challenging macro environment. We continue to leverage our diversified end market mix benefit from new solution offerings, both organically and inorganically and further developed our One Allied global platform to drive record sales. Third quarter revenue grew 30% to $134.4 million, with strong organic growth of 15% on a constant currency basis. While we have seen broad-based demand across each of our target markets, 2 were the primary drivers of our growth. Aerospace and defense revenue grew 159% due to incremental demand from acquisitions, defense program timing and solid organic growth. Revenue from industrial markets was up 39% in the quarter, benefiting from our acquisitions and strong end market demand with industrial automation, pumps, and oil and gas. We continue to strengthen our margin profile despite ongoing macroeconomic headwinds. We delivered gross margin of 32.2%, which represented a 130 basis point increase from the year ago period. Operating income grew 35% to a record $11.7 million with a margin of 8.7%, and adjusted EBITDA margin expanded 80 basis points to 14.8%. While our recent M&A activity is certainly helping, we also equate this performance to our global teams that continue to manage supply chain issues and inflationary pressures on logistics, energy, material and labor. We achieved adjusted net income per share of $0.60 per share, which was up 22% or $0.49 per share in the prior year period. We continue to have a solid pipeline of opportunities and are encouraged with coating and order levels from each of our target end markets. The integration of our recently acquired businesses has progressed well. Each have enhanced our value proposition, and we are working hard to maximize the opportunities and realize the full potential of these margin-enhancing businesses. And with that, let me turn it over to Mike for a more in-depth review of the financials. Mike?

Thank you, Dick. As a reminder, our results include the acquisitions completed during the fourth quarter of 2021 and the second quarter of 2022. Starting on Slide 4, we provide some detail regarding our top line. Third quarter revenue increased 30% to $134.4 million, a record level, which reflected strong demand in the A&D and industrial markets as Dick discussed and incremental sales from acquisitions. The unfavorable impact of exchange rate fluctuations on revenue was $7.2 million in the quarter. Excluding FX, revenue was up 37% and organic revenue growth was 15%. Revenue in the vehicle and medical markets each grew 4%. Vehicle market sales growth reflected higher demand from the commercial automotive and trucks, while medical markets have now largely lapped pandemic-related sales and are benefiting from the return of elective surgeries and recent acquisitions. The distribution market, while small, a small component of our total revenue increased 25% during the quarter. Sales to U.S. customers were 59% of our total compared with 56% in last year's period and the balance of sales were to customers primarily in Europe, Canada and Asia Pacific. The shift in mix continues to reflect the impact of our recent acquisitions that largely sell to the U.S. market. Slide 5 shows the change in our revenue mix by market on a trailing 12-month basis. Sales to industrial markets were up 39% and driven by the verticals noted on the slide. Industrial has seen nice growth over the last year and now makes up 38% of our total sales. Our second largest market is vehicle, which contracted 4% to strong truck and agricultural vehicle demand was offset by broad supply chain challenges in other market verticals. Medical market revenue was relatively flat on a TTM basis, reflecting similar impacts as the third quarter. And as noted, while acquisitions contributed to the aerospace and defense growth, we are driving solid organic business growth and benefiting from some defense market program timing. As depicted on Slide 6, our gross profit was 32.2%, up 130 basis points from the year ago period and down just 20 basis points from our record high achieved last quarter. Higher volume, pricing and margin accretive acquisitions more than offset continued global supply chain disruptions and rising material and labor costs. Consistent with our stated objectives, you can see the progress we are making in the annualized chart on the right. Moving on to Slide 7. Third quarter operating income reached a record $11.7 million or 8.7% of sales compared with $8.7 million or 8.4% in the year ago period. Operating costs and expenses as a percent of revenues were 23.5%, up 90 basis points, but largely attributable to our M&A activity with step-up amortization expenses as well as added engineering and development costs that we have not yet fully leveraged, helping offset the leverage gain on the SG&A line, which decreased 60 basis points to 13.9% of revenue, our lowest level in more than 3 years. As we have stated, we anticipate growing our margins over the long term with the disciplined execution of our lean toolkit, AST, combined with leveraging higher volume. On Slide 8, we present our bottom line and adjusted EBITDA results. Our GAAP net income and diluted EPS have been adjusted for certain items, including amortization of intangible assets related to acquisitions. We believe that adjusted EPS provides a better understanding of our earnings power, inclusive of adjusting for the noncash amortization of intangible assets, which reflects the company's strategy to grow through acquisitions as well as organically. Third quarter adjusted net income was $9.7 million or $0.60 per diluted share. That was an increase of 22.2% adjusted $0.49 per share in the prior year period. The effective tax rate was 27.5% compared with 24.6% as the prior period included a discrete benefit for an investment tax credit. We expect our income tax for the full year 2022 to be approximately 25% to 27% based on changes to the geographic mix. Adjusted EBITDA increased 37% to nearly $20 million or 14.8% of revenue, which was up 80 basis points. We use adjusted EBITDA as an internal metric and believe it is useful in determining our progress and operating performance. Slide 9 and 10 provide an overview of our balance sheet and cash flow. Total debt was approximately $232 million at quarter end. During the second quarter, we used about $45 million in cash to complete 3 acquisitions net of cash acquired, which was largely funded with debt. The debt increase also reflects the new finance lease that was highlighted during the first quarter of 2022 for a manufacturing facility expansion to support continued growth. At the end of the third quarter, debt net of cash was about $212 million or 51.3% of net debt to capitalization. Our bank leverage ratio was approximately 3.75x. Based on our cash flow projections, we expect to deliver over time in a manner that aligns with and is consistent with our historical performance. So far this year, we've utilized $5.8 million of net cash from operations and invested $11 million in capital investments, which largely focused on growth opportunities and new customer projects. As we round out the end of the year and based on the pace of some projects, we have refined and slightly lowered our 2022 CapEx expectations to range between $14 million and $18 million. Inventory turns were 3.1x in the third quarter, up slightly from our 2021 performance as our teams continue to manage our inventory to meet increasing customer demand, combat sourcing and lead time challenges. Our DSO saw a jump to 55 days in the quarter largely due to timing and mix of customers. With that, I'll now turn the call back over to Dick.

Thank you, Mike. Our backlog and bookings remain solid as highlighted on Slide 11. Orders were more than $126 million in the quarter, representing a book-to-bill ratio of just under 1x. This level also reflects a noted FX headwind of $7.3 million. Our backlog was up 67% over the prior year period, although we saw a 4% decline from the sequential second quarter, which reflected the loosening of some supply chain constraints. The time to convert the majority of backlog to sales is within the next 9 months. While there are still some components with long lead times, generally speaking, we are starting to see some stabilization within our supply chain. Turning to Slide 11 for our outlook. We are a stronger company today and expect to see further benefits as we leverage the full potential of our recent acquisitions. As a reminder, our M&A strategy has delivered approximately $100 million annually of new business to our platform that will be fully realized in 2023 with an incrementally higher margin profile. Equally important, we have created a stronger long-term competitive position across our targeted markets. Specifically, demand is expected to continue at relatively strong current levels across our many industrial end markets. Overall, our vehicle demand has been stable, with the most significant increase in volumes occurring in our automotive market. This is an indicator that the supply chain is improving as demand schedules from our customers continue to firm up for 2023. Medical markets have largely lapped the strong pandemic-related levels and should continue to be solid. And Aerospace and Defense will be bolstered by our recent acquisitions, and we anticipate further organic growth given our exposure and program participation. As a reminder, in the past, we did experience seasonality in demand, reflecting modest reductions in our fourth quarter shipments. This was primarily due to the typical holiday shutdowns and customer inventory adjustments occurring in December. Now that business conditions seem to be normalizing, we may see some minor seasonality creeping back into the business in Q4. We will continue to innovate and invest in each of our target markets and the various end markets when each offer significant opportunities for long-term growth. While the global outlook may have softened, we continue to remain highly confident in our ability to navigate through these unique challenges. We will stay focused on executing our strategy and serving our customers while continuing to capitalize on opportunities to drive growth and improve our operational excellence execution throughout the company. With that, operator, let's open the line for questions.

[Operator Instructions]. Our first question today will come from Greg Palm with Craig-Hallum Capital Group.

Congrats on the good results, especially in light of some pretty severe FX headwinds. Maybe just start with kind of a broad commentary on the demand landscape? I mean, are you seeing anything out there that gives you caution? I mean the bookings were still pretty strong. I guess your initial commentary suggests that things are still holding up. So just wanted to maybe dig into that a little bit further.

No, I would say to you that they are continuing to be fairly strong. We did see, as we mentioned, there's been some reduction sequentially quarter-over-quarter. And I think all along, we've been saying that we would expect that some of that would start to occur as deliveries are getting back to normal, lead times were becoming more predictable and supply chain was improving. So I would suggest to you that all of those are occurring, and in light of all of that, we're still seeing some robust demand going forward here.

And on the supply chain specifically, what pain points are still out there? And I guess, in the past, you've sort of been able to quantify some of that impact to margins. I mean, has that normalized at this point? Or are you still seeing some margin headwinds related to supply chain that could further boost margins from here? Assuming they abate?

Sure. I would tell you that, again, electronic components have been the major challenge throughout the company. and what's happened with electronic components, the shortage in supply as well as the very long lead times as well as everyone attempting to get into the pipeline and scooping up parts that are out there. It caused some very significant PPDs with regard to specific components when you had to go to secondary markets. We're still seeing some of that. But I would say to you, it's the exception now, where floodgates were open and we were battling a significant number now and it's not happening as frequently, but it still happens. I do think that, as I mentioned, we're seeing the supply chains improving. We start to see reliability of delivery, and we're seeing more signs that our customers are experiencing the same thing because they're not getting their components, they're not placing demand for us in the overall assembly. So we're starting to see that stabilize. I would say, overall, it's definitely improving. It's not just electronic components. At times, we're running into specific issues. And I would say to you that COVID hasn't gone away. We have experienced in a couple of instances where there's been an uptick at our suppliers where demand has slowed down. And we've also seen where some value decisions have been made by suppliers, meaning that they're going in to life on certain types of commodities or products and they're giving you notice in long notices, but you're scrambling to find an alternative that could be approved by customers. So it hasn't totally gone away, but it's definitely improved.

Yes. Understood. On the margins, the operating leverage has become really impressive. And I think the EBITDA margin was definitely the highest quarterly amount since we've been following the company. But just broadly speaking, as you look ahead, how sustainable is that? I know that's been a focus point over the years, but it seems like the last couple of quarters, you've really sort of broken out to the upside, partly just due to some internal initiatives, but the acquisitions probably help just given their higher margin in nature, right?

Yes. I'll let Mike speak to that.

Yes, Greg. We definitely have seen that movement. We do think it is sustainable. Obviously, part of that is the gross margin expansion, but we are leveraging more effectively. And I think we've been broadcasting all along, right? But that will be part of the margin expansion that we've been talking about all along. I would tell you that we still have a ways to go. We think in the sense that we do have backlog that's tied up. Some of the acquisitions are not yet being fully leveraged. That, we expect to see at some point in time, just given pushing additional revenue across I would caution you, as Dick noted, we do expect to see some level of seasonality in the business return, that was very common in the past, right? And so that will ultimately affect on a singular quarter basis, or potentially in Q4, our ability to leverage those costs. But generally speaking, yes, we expect to continue to drive leverage in those over time.

Yes. And I think to add on to what Mike said here is that, just to emphasize the fact that we're not where we think we could be. We think there's significant room for continued improvement.

And how much of that is a by-product of just volume continuing to increase revenue versus additional internal initiatives that can help drive further margin improvements on their own?

Certainly, volume is going to help that, but we are utilizing, as we've said in the past, our AST tool set to drive out cost. We've been focused on rationalization activities with our manufacturing footprint and are starting to see some gains there. So we think there's multiple paths there that we'll leverage.

[Operator Instructions]. Our next question today is from Gerry Sweeney of ROTH Capital.

Question around engineering development acquisitions. You're adding a lot of technology around solutions, and I think that's where you want to drive the company longer term. Just wondering if you could give a little bit of details on how these efforts maybe have changed your positioning over the last, I don't know, couple of years. You made some series of acquisitions that I think really position you well. I'm just curious how that's driving revenue, backlog, how the integration of those acquisitions are going and sort of where this could take you, 12, 18, 24 months out.

Sure. Yes. I mean it definitely was a focus and is a focus within the company where we saw 6 acquisitions within the last 12 months. And as we mentioned, some of those acquisitions were more technology-oriented, versus adding a large revenue base. But what's really exciting, Gerry, is that putting together the plans going forward here into next year and beyond is when we look at, let's just call it, a market-specific opportunity, and we look at all of the technology that we can bring to bear in terms of products and our solutions. It just continues to expand, where we would, in the past, look at it, we'd say, 'okay, we can put a motor in there, maybe a motor or a gearbox, and maybe some electronics.' But now the whole solution set has driven much higher, at a much higher level, where we're talking in terms of value per solution in a particular application. And that's the way we're looking at it. So the whole combination, it is very exciting and to see how the One Team strategy is really pulling together across all the TUs and across all technologies and how that commitment that we made and the investment we made and what we call get the global engineering team to pull it all together. First off, the standardized established platforms of building blocks that we could utilize and leverage; secondly, to really come up with leading-edge solutions. So we've identified areas of opportunity that we think we can bring a unique solution to the market that the market may not even see or understand yet. But in addition to that, existing applications where the incremental or increased value of what we could bring to each unit we're selling is significant. And so I would tell you that it's definitely an exciting change in the company. And if you went back 3, 4 years ago, looked at the programs or projects we're working on, very exciting. But you look at them again today and you say, wow, it's really incredible. And I think having, what we do, is our Board does travel to our operations, and we rotate that, and we're very interested in letting our Board meet management to different facilities also to get their inputs, what they're doing and have a one-on-one conversation and get to understand where we're headed. And one of the things I can tell you that the Board had mentioned is that they can see that culture driven throughout the entire company no matter what it is, whether it's a corporate support function, whether it's technology in it itself or whether it's a centralized solution center, it's the same and it's consistent. So that's what's really exciting. We moved, and again, doing 6 acquisitions, the integration piece became very important and had to be handled quite a bit differently. We do 1 or 2 a year. It's quite simple. It just happens naturally. Well, in this case, we had to drive the process. So you've seen a substantial uptick in the training side of it. You're starting to see changes that are going to be made to the website to prepare ourselves and the market for who is Allied today and who will Allied be in the future? And I think it's very exciting. You can think about one of the smaller acquisitions where, let's call it, a technology play, with a lower level of sales and limited resources, to go out there and penetrate the market to generate more opportunities in sales. Well, they get out a training session and there's 150 people sitting on the other end from within Allied. And all of a sudden, you've got tentacles reaching everywhere. The excitement is quite high. And what we have to do is manage that to ensure that we're focused on the right opportunities as a company. So it's moved from acquisition to high focus on integration and high focus on making sure that we're picking the right opportunities to really invest the money from a corporate standpoint. And there's no shortage of those. That's all I can say. So it's really exciting times.

Yes. Does this change how you go to market in terms of sales or is just a gradual process? Or just curious how that kind of fits into...

That's a great question. So it won't change because we're not getting, we're not eliminating. We're not against our custom developments. And most of our work is custom. We actually have standard platforms that we build off of that we can leverage. But it really is tailored to an end user or an end customer. That's not going to change. And the way we go to market with that will not change. We've been successful at it, we'll continue. But what you do see, and I say it's a very good question, because as you get into the higher levels of sophistication in terms of system integration, it's a different skill set necessary. Systems engineering becomes a more important part of that process. Program management becomes a more important part of that project and program. So you do see that we're adding resources in certain places and realignment of technology units and our operations to better support that. So that is actually what we're working on internally as we move into 2023 and later this year, all part of the integration process. So it's a great question. We have the distribution channel that was opened up in between TCI and Spectrum with Rockwell Automation and their automation fair will be there. And I know that there's opportunities for more folks, not just Rockwell, but others that have brought to the systems integrators and the automation companies that we're working with. But also, we have to say it's the higher-level systems integration, system engineering and program management that will change how we go to market for those opportunities. So it's a great question, and that's where you're starting to see as we go through this integration process and everybody getting to become familiar as we're laying out those plans moving into the future, and we're getting really focused on some significant major opportunities that leverages technology from several, many of our technology units.

Not sure how to ask this question, but if we were to sit here and track this evolution, and I'm not sure, again, this is the right way to ask it. If I were to ask you, like, how much component sales were of revenue, we'll say, 2 or 3 years ago versus component sales versus solution sales today. Would that be an adequate or appropriate question to ask to see how you're moving along this transition, knowing that you're not getting rid of some of that component sales, I don't believe, at least.

No, you're absolutely correct. Here's the challenge, and that is what we're seeing internally. What we call the system sale 3 years ago or 4 years ago, is something we would call a component sale today, having a motor and a gearbox. We would have said that was a system sale, motor, gearing and some embedded electronics. We would say there was a system sale. The system sales, we're really talking about today are much more sophisticated. There's software development that goes on. There's multi-access control. There's all kinds of IO support. There's many -- there could be many types of motors. It could be composite materials for light weighting in vehicles. So it's what we call the system before. We kind of look at it at and say, "jeez, that's no longer a system." That became a way of life that where we had to train our sales force to say, "Hey, you're not just selling a motor, you're selling motor and gearing and feedback and control or drive electronics that became a way of life. So I would call, in many cases, what we call the system before perhaps a component today and the real true higher-level system integration that becomes a part of either a machine or a process. It's much more sophisticated and we're much more embedded in the logic and the value of that is much higher. So there's some incredible know-how that goes in their software development and it really does drive the value. So it might have been, let's just say, a $1,000 sale will now be $3,000 sale, a $50,000 sale could be a $100,000 sale and beyond that. That's really what the difference is. So to answer your question, if we go back to our original definition, we would tell you that more than 50% of our sales are solution-oriented, but really, it's approaching more like 60%, 70% in the future as we're looking at these major programs that we're investing in to go after. With much higher value content and much more sophistication and so forth.

Ladies and gentlemen, at this time, showing no further questions. We will conclude the question-and-answer session. I'd like to turn the conference back over to management for any closing remarks.

Yes. Thank you, everyone, for joining us on today's call and for your interest in Allied Motion. I would also like to apologize for the late start as our hosting company did have some technical difficulties in getting the call initiated. Now hopefully, that doesn't happen again. For those of you that are interested, we will be participating in-person at the Barrett Industrial Conference in Chicago next week on Thursday, November 10th. Otherwise, as always, please feel free to reach out to us at any time, and we look forward to talking with you all again after our fourth quarter 2022 results. Thank you for your participation, and have a great day.

The conference has now concluded, and we thank you for attending today's presentation. You may now disconnect your lines.