Allied Motion Technologies, Inc. (AMOT) Q1 2022 Results Earnings Conference Call May 5, 2022 10:00 AM ET

Company Participants

Craig Mychajluk - Kei Advisors
Richard Warzala - Chairman, CEO & President
Michael Leach - CFO

Conference Call Participants

Gregory Palm - Craig-Hallum Capital Group
Brett Kearney - GAMCO Investors
Gerard Sweeney - ROTH Capital Partners

Operator

Greetings, and welcome to the Allied Motion Technologies Inc. First Quarter Fiscal Year 2022 Financial Results. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Craig Mychajluk of Investor Relations. Please go ahead.

Craig Mychajluk

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 first quarter 2022 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 the market closed. If not, you can find it on our website at alliedmotion.com, along with the slides that will 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 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 and 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.

So with that, please turn to Slide 3, and I'll turn it over to Dick to begin. Dick?

Richard Warzala

Thank you, Craig, and welcome, everyone. Our results continue to demonstrate the successful execution of our strategic growth initiatives. First quarter revenue grew 13% to nearly $115 million with organic growth representing 5.3%. Our industrial market saw strong demand, resulting in market growth of 46% over last year. We are benefiting from continued economic recovery in a number of submarkets, including material handling, pumps, oil and gas, industrial automation and instrumentation. Recent acquisitions also contributed to the growth in our Industrial and A&D markets. While we are doing relatively well on the top line, the challenge, like many others, is on margins as supply chain issues and inflationary pressures on logistics, energy, materials, and labor continue to persist.

We are actively managing these challenges and believe our operating performance will reflect our efforts over the long term. This includes being proactive on pricing and realizing the full potential of our margin-enhancing acquisitions. Excluding nonrecurring items, we achieved adjusted net income of $3.8 million or $0.24 per share for the quarter versus a reported net income of $2.5 million or $0.16 per diluted share. Order levels continue to be strong, and we ended the first quarter with a record backlog of $289 million. I will talk to this performance later in the presentation.

And with that, let me turn it over to Mike for a more in-depth review of the financials. Mike?

Michael Leach

Thank you, Dick. As a reminder, our results include the acquisitions of ORMEC Systems on November 2, 2021, ALIO Industries on November 4, 2021, and Spectrum Controls on December 30, 2021. Starting on Slide 4, we provide some detail regarding our top line. First quarter revenue increased 13% to $114.8 million and reflected the higher demand in the industrial markets, as Dick discussed, and approximately $11 million of incremental revenue from acquisitions. The unfavorable impact of exchange rate fluctuations on revenue was $3.2 million in the quarter. Excluding FX, revenue was up 16% and organic revenue growth was 5.3%. It is also worth noting that we estimate the impact of supply chain constraints on the revenue was approximately $6 million to $7 million in the first quarter.

The recent acquisitions contributed to the A&D group growth of 27% in the quarter. Partially offsetting were lower sales in the vehicle markets of 5%, largely due to broad supply chain challenges within commercial, automotive. Medical markets declined 8% due to the lapping of a strong prior year period that was still benefiting from pandemic-related sales. Sales to U.S. customers were 56% of our total compared to 51% in last year's period, and the balance of sales were to customers primarily in Europe, Canada and Asia Pacific. The mix shift reflects the impact of our fourth quarter 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 34%, benefiting from new solution offerings and continued economic recovery in a number of verticals as well as contributions from our recent acquisitions. Vehicle markets were up 10% on strong truck, agricultural and construction demand. While acquisitions contributed to the year for space and defense growth in the recent quarter, that market is still down due to the defense program timing. The change in medical markets reflected similar pandemic-related impacts in the first quarter.

As depicted on Slide 6, our gross profit was down 40 basis points from the year ago period. Higher volume, improved mix and accretive acquisitions were offset by continued global supply chain challenges with rising materials, transportation and labor costs. Despite these challenges, gross margins improved 50 basis points from the sequential 2021 fourth quarter.

Moving on to Slide 7. First quarter operating income was $4.3 million or 3.7% of sales compared with $6.6 million or 6.5% in the year ago period. Operating costs and expense as a percent of revenue were 25.4%, up 230 basis points, of which 140 basis points was attributable to higher engineering and development costs largely attributable to the 3 acquisitions completed in the fourth quarter of 2021. Also contributing to the operating expense increase was higher business development costs of $0.8 million or 70 basis points as a percent of revenue, which reflects our M&A activity as well as activities in optimizing our global manufacturing footprint. These investments and activities reflect our continued commitment to execute on our strategy. As we have stated, we anticipate growing our margins over the long term with a disciplined execution of our lean toolkit AST, combined with leveraging higher volume.

On Slide 8, we present GAAP net income and adjusted net income, along with our adjusted EBITDA results. First quarter adjusted net income, which excludes business development costs and other nonrecurring items, was $3.8 million or $0.24 per diluted share compared with $4.6 million or $0.32 per diluted share in the first quarter of 2021. The effective tax rate was 21.3% in the first quarter of 2022 due to discrete tax benefits in the period. We expect our income tax rate for full year 2022 to be approximately 24% to 26%. Adjusted EBITDA was $12.9 million or 11.2%, which was down 60 basis points in the quarter. 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. Total debt was $178.6 million, up $19.7 million from year-end 2021. Approximately half of the debt increase was attributable to a new finance lease for a manufacturing facility expansion in Germantown, Wisconsin to support continued growth. At the end of the first quarter, debt net of cash was $161.7 million or 45.5% of net debt to capitalization, and our bank leverage ratio was 3.49x. We've consistently demonstrated our ability to delever our balance sheet following acquisitions, and is our expectation that we will continue the strategy to relook for future growth opportunities.

We used $13.4 million in net cash from operations, reflecting higher levels of inventory to deal with supply chain challenges and payment of incentive compensation earned in 2021. CapEx for the quarter was $2.5 million and largely focused on new customer projects. We expect our 2022 CapEx to range between $15 million and $20 million and to be focused on growth opportunities. Inventory turns were 3.1x compared with 3.0 at December 2021. Our teams continue to manage our inventory to meet increasing customer demand, combat sourcing and lead time challenges. Our DSO increased to 55 days in the quarter, largely due to timing.

With that, I'll now turn the call back over to Dick.

Richard Warzala

Thank you, Mike. Our backlog and bookings remain robust as highlighted on Slide 11. Orders are more than $155 million in the quarter, up 35% sequentially and year-over-year with strength across most end markets. This represented a solid book-to-bill ratio of 1.4x. Customers continue to place orders with additional lead time to ensure they are in the pipeline given the current supply chain challenges. As a result, we are seeing some buildup in the backlog numbers, which hit another record, increasing 16% over the sequential fourth quarter and up 90% over the prior year period to $289 million. Just under half of the increase in the quarter was from our acquired companies. And the time to convert the majority of backlog to sales is within the next 9 months.

As we look forward, we expect demand within our industrial markets to remain strong. Vehicle demand will be muted by supply chain disruptions in the short term, although we are seeing some encouraging signs with production demands being increased for late this year and early into 2023. Demand in our medical markets has been solid as we lap prior year pandemic-related sales, which reflects the continued return of more elective surgeries. We are also expecting to see stronger A&D performance, and we see a lift from our recent acquisitions. On the M&A front, our pipeline is still very active as we continue to pursue opportunities to complement our organic growth efforts. 2022 has started on a solid path, although we do expect that in the near term, we will continue to battle supply chain and inflationary challenges.

The Russia-Ukraine conflict and COVID lockdowns in China will provide additional uncertainty on a macro level, and we'll be monitoring these events closely to anticipate and implement the necessary corrective actions to mitigate the impacts. We believe our long-term success is within our control. And to ensure that, we will continue to be driven by our discipline and focus on the execution of our strategy. Through acquisitions and organic investments, we have strengthened our competitive position in several target markets, and we're working hard to leverage these investments as quickly as possible. Each of our recent acquisitions is accretive to our gross margin profile, has expanded our technology base and capabilities and further enhanced our system selling opportunities to create additional value for our customers.

Similar to our base business, our acquisitions are not immune from the daily supply chain disruptions and inflationary pressures that impact the efficiency of all businesses. As we work through these challenges, we remain highly confident in our ability to enhance both our top and bottom line performance in the future. The profile of Allied Motion is rapidly evolving in a very positive manner. We remain committed to executing our strategy and fully realizing our potential to emerge as an even larger and stronger enterprise in the future.

With that, operator, let's open the line for questions.

Question-and-Answer Session

Operator

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

Gregory Palm

Here, I guess -- just starting with supply chain, which unfortunately, has only gotten worse since our last update a few months ago. Are you taking any new steps to address all these challenges? I don't know if that's signing on new suppliers, whether that's shifting some of your own manufacturing elsewhere? What are you seeing? Any new thoughts there?

Richard Warzala

Yes. Sure, Greg. I mean, it is -- every day, without fail, it seems like somewhere in the company, there's a new challenge that's popping up. And our team has been very effective in being able to address those. And one of the things, I mean, a recent one was impacting our welding capabilities was the ability to leverage our corporate buying power in order to ensure a steady supply of product that we needed to produce and to be able to weld. So I think you just continue to see that. And what that does is it causes you to look at your process. And I think longer term, you'll make some significant improvements, but it causes you to take a look at process and make changes in process that eliminate, let's call it, certain commodities or certain components that are in short supply. So we look at as much as we can, localization of supply chain. We look at second sourcing.

Our customers are working very closely with us to help us secure materials that are required for their products. And I think it's not going to go away in the short term. And as we said, though, that will make us stronger and better when we come out of this because there are procedures and processes we put in place to make sure that we don't run into similar problems in the future. So I think to answer your question, yes, we are seeing them. And yes, we are doing whatever we can do to effectively deal with them. And I would state that, especially with electronic components, typically, our demands are much lower than what you would see in consumer electronics or automotive. So secondary market is available in many cases, although at a much higher price. So that helps.

Gregory Palm

Makes sense. Yes. And have you -- just to dig in just one step further. Have you taken any significant pricing actions? Or are you planning to in order to offset these additional input cost inflation that we've seen? And I guess, how should we think about the trajectory for gross margins as we sort of go through the year knowing everything that we know today?

Richard Warzala

Yes, great question. I think as we've mentioned before, price increases do lag. By the time you're getting supply cost increases and by the time you turn around and pass them on, unless they're part of a blanket agreement where commodity pricing is already addressed in there, you have to deal with them on a one-on-one basis. So we have very actively been looking at that. And I would say to you that we did see some improvement at the end of Q1 that should find its way into Q2 and forward. But this is not something -- I look at it and say how far can this go?

You're going to get pushed back, and the market is going to push back. So I think we'll start seeing some resistance overall, not everybody pushing back and saying, how much more can be tolerated here before everyone prices themselves out of the market. So -- but I do think you will see some -- we had some momentum late in the first quarter that will carry in the second quarter.

Gregory Palm

Okay. Good.

Michael Leach

It's also that you're largely passing through those increases without additional margin, right? So it counteracts margin growth a little bit, too, just passing through those costs.

Gregory Palm

Yes, makes sense. And then lastly, as it relates to the book-to-bill, that really jumped up versus prior quarters. I mean do you get the sense that those are all real orders? Or could some of them just be kind of inventory builds that potentially could get canceled? Any thoughts there?

Richard Warzala

Well, I'll answer the first part, and I'll let Mike talk about and add some color to it. I would say to you this. There's no question that customers are getting into the -- they're getting in the pipeline sooner given extended lead times and longer lead times. They're real orders. They have scheduled delivery dates. We wouldn't book them unless they have scheduled delivery days because just to remind everyone, our policy is that if we don't have a production date, it does not go into our backlog.

So we have that unbooked backlog number that we don't report on, that's where the large automotive contracts went. Until we get a firm production release date, it does not go into that backlog. So they're real orders. Now is there a potential down the road when the supply chain issues are being met, and we're starting to see some good flow and increased supply that things will get rescheduled? I think there is a good chance of that. But what we do have will ship eventually.

Michael Leach

And just two comments to add to that. I think we saw some really nice performance out of our newly acquired businesses in the quarter relative to the bookings. Some nice wins that were much talked about in due diligence and came to fruition here in Q1. So we're very excited to see that as well. And then going back to the comments about partnering with your customers to secure supply chain. I think there's evidence of that as well in the sense of proactively working with the customers to lock up materials. And in turn, right, you're getting the customer orders increasing just to provide that again with a longer runway. But as Dick mentioned, with defined production date so that we feel good and confident about it.

Operator

[Operator Instructions] Our next question comes from Brett Kearney with Gabelli Funds.

Brett Kearney

You guys obviously continue to execute very well through a very dynamic, challenging operating environment. Curious on one of those kind of unknowns you had mentioned, Dick, the China lockdown situation. Just how you are viewing that at this stage, both in terms of potential demand from some of your customers, what you're hearing and seeing? And then any potential ripple through impacts on the broader industry from a supply standpoint, just kind of your broad latest thinking there?

Richard Warzala

Sure. I would say to you this is that our team in China, we have two locations there in Changzhou and Suzhou. I think, given the circumstances, they continue to execute very effectively. Obviously, with total lockdowns, that puts them out of work and doesn't allow them to build product. But I would say to you that our customers, if you look at it on a global basis, we're starting to see reality setting in, and that our customers, we'll call it, North America and/or Europe, are looking for localization of supply chain. So I would say we're going to see more and more of that. And so we had -- obviously, that's our approach and our strategy is to be -- look at a local supply chain to reduce the total cost of acquiring products.

And again, trying to minimize the impacts of the increased logistics cost and fuel costs and so forth, so that was underway. And we have now -- and as I said, we're starting to see not just inquiries, but we have received orders now that are looking for to change the supply chain over to us based upon domestic supply, which is a great sign. Our products that are being built and shipped, let's call it, within China, up to this point, we have seen very little impact on those. So for whatever reason, logistics, components, et cetera, have been available to build product and ship product domestically within China. And I think more and more of our business is -- if we're in China and doing business in China is about shipping product directly into China, and I think less and less of it is becoming export based. And I think we'll see that trend continuing.

So with the electronic components, there's -- you can't just make design changes and there's other -- obviously, other materials that the supply chain is coming from China. But I do think over the long haul that the resourcing and localization will take effect, and we'll have an overall positive impact on the business for Allied.

Brett Kearney

Terrific. That was actually going to be my follow-up question was kind of on reshoring and given the solutions you provide really into many kind of automation applications, whether you're hearing and seeing that from customers, and it sounds like that's certainly the case with North America and Europe?

Richard Warzala

Yes. And just to add a little bit more color, too. I mean, we made a significant commitment to our Mexican facility a couple of years ago, and they have done a great job of receiving products that were built, we'll call it offshore, not in North America, that are actually primarily being used in North America. We've got investments that we've made in capital equipment that are in Mexico, ramped up very nicely. And the cost situation or competitive situation in Mexico is very favorable.

So we see that as a bright spot for us. And we just actually approved a -- I'll call it a highly automated or fully automated motor production line that has been in development for 2 years, that's now on its way to Mexico and will be ramping up in mid-second quarter and resourcing product that was not being built in North America, but it's primarily for North American usage. So we're continuing in that vein. And in the same token, I mean, we're looking at, as we said, in Europe, our supply chains, and we're tapping into those and doing the best we can to localize supply chains and minimize all those other costs. But we've made investments, and we're taking actions to do that.

Operator

Our next question is from Gerry Sweeney with ROTH Capital.

Gerard Sweeney

Just a question on Spectrum Controls. I think with the fourth quarter results, you mentioned that Spectrum was having some challenges with supply chain. And obviously, you're going to go in there and I think use some of your corporate buying powers. How much of an impact did Spectrum have on the margins this quarter? Hello? Did I lose you?

Unidentified Company Representative

Hello? Operator, did we lose their line?

Operator

No. Dick, Mike, are you still with us?

Richard Warzala

We're here now. We can hear you. Did we lose Gerry or...?

Operator

No. He's still here.

Gerard Sweeney

No, I'm here. Quite a little bit of a case of COVID, but I thought I asked a bad question. You went quiet, so...

Richard Warzala

You started asking you about Spectrum and then we didn't hear anything after that.

Gerard Sweeney

I was -- obviously, you had mentioned you purchased Spectrum and they were having some supply chain constraints, and it was going to impact the quarter on margins. So I was curious as to if you could give us an idea of how much of an impact it had in the quarter? And if that's -- you see that improving going forward?

Richard Warzala

Sure. We set the expectations for Spectrum coming out of the...

Operator

Mike, Dick, you got -- I think we lost you guys again. Ladies gentlemen, please hold. We are experiencing technical difficulties.

Okay. Mike and Dick, you're back in the conference.

Richard Warzala

Okay. Great. Thank you. Gerry, are you still there?

Gerard Sweeney

I am here, yes. Did you...

Richard Warzala

Sorry about that.

Gerard Sweeney

No worries. You heard my question, correct? That's all.

Richard Warzala

We did. We heard the question. I started to answer it -- we started to answer it, and then again, we notified that we were out. So anyway, what I said was that I started to say, after the Spectrum acquisition, we did state that Spectrum would start slow out of the gates. We knew we had some supply chain challenges going in and that they would ramp during the year. We did experience a slower-than-expected ramp in Q1. There were the supply chain challenges that were even more significant. And they are working through them.

But we do think that as we progress through the year, we will start to see improvement. We'll see improvement, and we will start to realize our ability to ship a very strong backlog that we have there. So it was a negative. It was definitely a drain on our operating results in Q1, and we expected it to be neutral. And our expectation right now is if it's neutral in Q2, the results for Allied will be much better than they were in Q1, let's put it that way.

Gerard Sweeney

Okay. That was sort of my expectation. Actually, I thought it was going to be a little bit more negative in 1Q. But suffice to say, they're being rectified and -- as it fixes itself or you fix it, I should say. That will be -- that headwind should turn to a tailwind, just in terms of aggregate numbers and margins.

Michael Leach

Yes. And again, we're seeing great order wins in the business as we're talking really purely a supply chain constraint here with electronics that's driving the disruption.

Gerard Sweeney

And that's -- I mean that business opens up a lot of opportunities, especially on the industrial side, correct?

Richard Warzala

Sure. All right. Thanks, Gerry. Thanks, everyone, for your patience here. Is there any -- operator, any more questions?

Operator

There are no more questions.

Richard Warzala

Okay. I'll just conclude here though. For those of you that are interested, we will be participating in the Barrington Spring Virtual Investor Conference on Thursday, May 9 -- 19, sorry, May 19. Also Allied will be exhibiting next week at the Healthcare Robotics Summit in Boston, and in an Automate in Detroit in the week of June 6. So if you're in those areas and you have a chance, it would be a great opportunity for you to see how the system configurations are coming together, the new acquisitions and get a good look at how -- what Allied is beginning to look like. And I mentioned profile change, you'll be able to see that very readily if you attend that shows.

Otherwise, 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 second quarter 2022 results. Thank you for your participation, and have a great day.

Operator

Thank you. This concludes today's conference. You may now disconnect.