Allied Motion Technologies Inc. (AMOT) Q2 2021 Earnings Conference Call August 5, 2021 10:00 AM ET

Company Participants

Craig Mychajluk - Investor Relations
Dick Warzala - Chairman, President & Chief Executive Officer
Mike Leach - Chief Financial Officer

Conference Call Participants

Greg Palm - Craig-Hallum Capital Group
Dick Ryan - Colliers
Brett Kearney - Gabelli Funds

Operator

Good day, and welcome to the Allied Motion Technologies Second Quarter Fiscal Year 2021 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [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.

Craig Mychajluk

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 2021 results and provide an update on the company's strategic progress and outlook after which we'll open it up for Q&A.

As part of today's Q&A, we do ask that you try to limit your questions to two or three in order to allow enough time for all participants. You can certainly go back into the queue for additional follow-ups. You should have a copy of the financial results that were released yesterday after the market close. If not, you can find it on our website at alliedmotion.com.

On the website, you can also find 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 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 other documents filed by the company with the Securities and Exchange Commission. You can find these documents on our website or at sec.gov.

I want to point out as well that during today's call, we'll discuss some non-GAAP measures which we believe will be useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We've provided reconciliations of non-GAAP to comparable GAAP measures in the tables accompanying the earnings release and slides.

With that, please turn to slide 3 and I'll turn it over to Dick to begin. Dick?

Dick Warzala

Thank you, Craig, and welcome everyone. Strong execution of our One Allied strategy continued to drive solid operating performance around the rollout and ramping of new projects and solutions, while we also leverage the ongoing economic recovery. Total revenue grew 17% over last year's second quarter to $102 million, reflecting the recovery in our vehicle and industrial markets. Notably, we achieved double-digit organic growth of 12.4%. Our vehicle markets were up 82% year-over-year which was largely driven by power sports as well as growth in other end markets such as commercial automotive and construction vehicles.

The resurgence of our industrial market which was up 20% over the prior year has been broad-based with gains in material handling, automation, HVAC, electronics and oil and gas projects as well. Revenue for medical has normalized as residual demand from the pandemic has mostly ended. Our A&D markets continue to be impacted by the pandemic, although on a sequential basis, we saw 15% growth. Overall, we are encouraged by improvements and increasing demand as demonstrated by our record level of orders and backlog in the quarter.

Like many others, we have faced significant material and supplies chain constraints resulting in extended lead times and higher material cost. For example, sourcing components for electronics has been very tight and we are strategically building inventory if possible given anticipated future demand. We believe our teams have done an excellent job managing demand and fulfilling orders to satisfy customer requirements to date. However, we expect these adverse market conditions to continue for the foreseeable future.

The result of these efforts was reflected in our margin performance. On a sequential basis gross margin was up 110 basis points to 30.7%. Operating margin was up 10 basis points and adjusted EBITDA margin improved 40 basis points. As a result, net income increased 60% over the prior year to $4.6 million or $0.32 per diluted share. We continue to generate strong cash from operations of $10.9 million during the quarter. This enabled us to reduce total debt by $7.6 million and further improve our bank leverage ratio to 2.44 times.

During the quarter, we were among those that were the subject of a cybersecurity breach. We discovered the issue fairly early and we're able to immediately implement our risk management playbook which entails bringing in forensic experts in the field. We were able to contain the issue and we were able to get operations back up and running without a material impact on our results for the quarter. We have also since implemented additional security measures thus further safeguarding our systems. Unfortunately, we believe cybersecurity is a national issue and all are at risk. We were pleased with our ability to act quickly and decisively to contain the breach and move forward.

Moving on, we are excited about the progress we are making and are increasingly encouraged by our potential over the longer term with record backlog and increasing order trends. And we are confident in our initiatives and the strength of our business model. Importantly, we are making the investments necessary to execute on our One Allied strategy and strategic areas of excellence to drive further growth, enable scalability and improve our earnings power. Our advanced engineering skills that create integrated solutions for our customers continue to be a key differentiator for us. The breadth of our product offering and our ability to provide an optimized and complete controlled motion solution sets us apart from our competition, enabling us to take market share and gain more business from current customers.

With that let me turn it over to Mike for a more in-depth review of the financials.

Mike Leach

Thank you, Dick. As a reminder, all share and per share information in our earnings release and slides reflect the three-for-two stock split completed in April.

Starting on slide 4, we provide some detail regarding our top line. Second quarter revenue increased 17% or $14.9 million to $101.5 million. Demand was particularly strong in vehicle, improving 82% year-over-year. Our industrial markets grew 20% year-over-year and 8% on a sequential basis. Both verticals are benefiting from the continued economic recovery.

The favorable impact of exchange rate fluctuations on revenue was $4.1 million in the quarter. Excluding FX, revenue was up 12.4%. Sales to US customers were 55%, up from 50% in the prior year period with the balance of sales to customers, primarily in Europe, Canada and Asia Pacific. The change in geographic mix reflects the strong vehicle market demand.

Slide 5 shows the change in our revenue mix by market for the trailing 12-month period. Total TTM revenue was up 8% and reflects the impacts of our diversified business model including the addition of Dynamic Controls to our medical market, which continued to perform well.

The economic impact of COVID-19 pandemic was reflected in the reduced demand or order deferrals within A&D. And while industrial has seen improving demand that market was still down on a trailing 12-month basis, given the significant headwinds from the impact of the pandemic over the last year.

As depicted on Slide 6, our gross profit was up $4.8 million or 18% to $31.2 million reflecting higher volume compared with the prior year period. Our second quarter gross margin increased 110 basis points sequentially to 30.7%, reflecting strong volume levels, favorable mix and the disciplined execution of our Lean toolkit AST.

We continue to believe that our team is managing the impact of the supply chain and material cost constraints well and we are constantly working hard to offset those impacts. Ultimately, we expect some lingering headwinds to continue for the near-term. But as we have stated, we do anticipate seeing margins grow over the long term.

Moving on to Slide 7. Second quarter operating income was $6.7 million, up $1.7 million from the 2020 second quarter and slightly up from the first quarter of 2021. Operating margin of 6.6% increased 80 basis points year-over-year and 10 basis points sequentially. Operating costs as a percent of revenue improved 60 basis points year-over-year to 24.1%, as higher volume and disciplined cost control offset increased incentive compensation which was largely in the G&A line

On Slide 8, you can see our bottom line and adjusted EBITDA results. Net income increased to $4.6 million or $0.32 per diluted share up from $0.12 from the second quarter of 2020. The effective tax rate for the quarter was 21.9% compared with 29.9%. The lower rate was largely driven by higher discrete income tax benefits, primarily related to share-based awards. We expect our income tax rate for the remaining quarters of 2021 to range between 26% to 28%.

Adjusted EBITDA for the quarter was $12.4 million or 12.2% of sales, up from $10.1 million or 11.7% of sales in the prior year period. Sequentially, adjusted EBITDA increased $0.4 million and 40 basis points. 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 paid down $7.6 million of debt during the quarter resulting in a $112.4 million of debt – total debt at the end of the period. Debt net of cash was $89 million and net debt to net capitalization was 36%, down 440 basis points from year-end. Our bank leverage ratio was 2.44 times at quarter end. And while we are comfortable at this level, we will continue to focus on paying down debt to reload for future acquisitions.

We generated strong cash flow from operations of $10.9 million in the second quarter and a total of $16.5 million for the year-to-date period. Second quarter CapEx was $2.8 million and largely focused on new customer projects as well as ERP implementations. We expect our fiscal 2021 CapEx to range between $12 million and $15 million.

Inventory turns were 3.7 times, down slightly from 2020. Our teams have been managing our inventory levels well as we work to meet increasing customer demand and combat sourcing and lead time challenges. Our DSO was consistent at 47 days in the quarter. Given the strength of our balance sheet, demonstrated agility and diversified end markets we are confident and well positioned to continue driving further efficiency, profitable growth and enhanced free cash flow over the long term.

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

Dick Warzala

Thank you, Mike. Turning to Slide 11, that highlights encouraging trends as customer demand and our strengthened market position has resulted in record orders and backlog. Since the low point during the onset of the pandemic, we have achieved one full year of consistent order growth, reaching $119 million in the second quarter. This represents a 48% increase over the second quarter of 2020, and up 4% sequentially. All of our major market channels are contributing and our book-to-bill ratio was solid at 1.17 for the quarter.

Backlog increased 12%, over the sequential first quarter and was up 33% over last year's second quarter to more than $170 million. Approximately, 90% of our backlog is expected to convert to sales over the next three to six months. From a market perspective, we expect demand within our vehicle and industrial markets to remain strong in the third quarter, as we are seeing increasing order activity reflecting continued improving economic conditions.

Demand in our medical market is expected to still be solid with the ongoing recovery in elective surgeries. We continue to take a cautious approach with our A&D markets, though we are encouraged to see increased quoting and orders, which we expect will have a positive impact in fiscal 2022 and beyond.

We do not anticipate any meaningful improvement to inflation and supply chain constraints in the near-term. We believe we can continue to leverage the strength of our supply chain management capabilities to help navigate this dynamic landscape. Additionally improved volume leverage and productivity gains are in place to help offset the operational challenges of the tight supply chain.

Our strong cash generation will enable us to continue to pay down debt and at the same time execute acquisitions, which remains an important element of our overall strategy. Our acquisition pipeline has been building but we are continuing to see very high valuations. As our history has demonstrated, we will be prudent with our M&A strategy as we look to enhance the long-term growth and profitability profile of Allied Motion. As we look forward, we believe we have a platform that can deliver expanding margins. And given the emergence of a more stable environment, we are optimistic that we will continue to drive growth in the future.

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

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] It looks like our first question comes from Greg Palm of Craig-Hallum Capital Group. Please proceed.

Greg Palm

Yeah, thanks. Good morning everyone. Congrats on the good results here. I guess, just starting off with revenue and orders. So orders significantly outpaced revenue. So I'm curious if there was a chunk that maybe wasn't fulfilled, maybe you got pushed into this quarter. It doesn't sound like the cybersecurity impact was material, but did that inhibit your ability to ship anything at all?

Dick Warzala

Yes Greg. Thanks and thanks for the question. While it wasn't a material impact, I mean, some items did get pushed. Our systems are integrated systems, which means directly from order entry to deliver your product to our customers. So there was definitely some impact on it. And not every system was impacted, okay? So we do have multiple systems in the company. But I would tell you that it certainly did have some impact, but as we said not material. And certainly nothing -- there's no lost business there. It's a business that was just delayed into July but it was not material.

Mike Leach

And Greg, I would just add that I think it was probably -- supply chain issues probably impacted us more so than the breach did.

Greg Palm

Yeah. Makes sense. And I guess on that line of thinking. So I think gross margins were nicely ahead of expectations even in light of more supply chain challenges. You got to increase import logistics costs et cetera. Are you able to quantify maybe what the headwind is right now? And I think you said that you're not expecting really much in terms of free up in the near-term, but how are you thinking about maybe further gross margin expansion if we assume that some of these items eventually go away?

Dick Warzala

Sure. Well, first off, I think as we've outlined in the past is that most of our major contracts are -- have material increase clauses and inflation clauses or -- and so we are able to look at the core material components that go into our products and if the indexes show that they're increasing we're able to pass that increase on. So we're fortunate there. When it comes to some discrete components, which we need to go out and secure maybe in a secondary market in order to keep product -- production moving our customers are totally engaged with us on the process.

So during that process if we have to incur additional costs, we engage our customers to notify them of that and to get authorization to go out and do these spot buys especially in electronic components to ensure that we can keep the pipeline going.

From a margin increase standpoint, we're going to continue to see -- and as we've gone and made the statement in the past that our goal here is to improve our margins by 1% per year for the next 10 years. And we do believe with our solution offerings, our integrated solution offerings and our operational efficiencies that we're gaining and we'll continue to gain that we will see those improvements as time goes on.

So I would tell you that our teams are working hard. We're not out of the woods. I mean it's a scramble. And obviously with the coronavirus and this delta variant I mean who knows what that impact will be. But from -- right now we see everybody continuing to forge ahead. And we don't see any signs of shutting down. We see signs of everybody is going to figure out how to keep going here if this thing does continue to affect us in a way with the number of infections increasing over time here.

So anyways I'm encouraged that our teams got it under control to the best of our abilities and our strategic sourcing activities while they haven't been as strategic they've been more reactionary to getting supply. We've been able to do that and we'll get back on track here and we'll continue to leverage some of the capabilities that we have in the long run.

Greg Palm

Okay. That's good to hear. And just looking ahead, I mean, based on your commentary certainly the backlog is indicative of this but you're clearly on a path to quarterly revenues that exceed $100 million right? And so I'm curious as you see those top line improvements, how are you thinking about further investments in the business and balancing those versus operating leverage?

Dick Warzala

Yeah, very good. Do you want to take that Mike, or you want -- you just go ahead and then I'll jump in after.

Mike Leach

Yeah. Greg I think we've talked in the past right that along with the gross margin improvements that we're going to drive, we expect foundationally operating leverage to occur as well. We've been investing heavily in the One Allied structure and building the platform for growth here for a few years. And certainly I think, while we anticipate some significant growth, going forward in the future replicating what we've done in the past that I think that foundation is largely there.

So the pace at which we're building that organization will not have to be as rapid as it has been in the past with the investments that we've made. So certainly I think operating leverage will help magnify the improvement as well in gross margins, over the next -- even the next 12 months to 18 months.

Greg Palm

Okay, understood. Thanks a lot and …

Dick Warzala

And I would add to that -- yeah I'm sorry, I was going to add to that and just say, that we have a strong focus on major programs, and major projects, and platform development product, platform development and that's going to continue.

And the leveraging of the core technology underneath it, is very encouraging is that our -- as Mike mentioned One Allied, to really talk about what that means is that, we have a strong engineering capability within the company.

We have over 300 engineers in the company. And the ability to leverage that capability, and get them working together, and making sure that we've got a strong focus on, the key activities that are going to drive substantial growth in the future that's really where we are.

So it's very encouraging. Our model-based design, simulation capabilities, continue to improve meaning, we can react much faster, get designed in quicker and get the right solution out there.

So, integrated solutions, is again, a continued emphasis within the company and we have plenty to invest in, internally, I can tell you that. So acquisitions are out there and we're going to continue.

But as we said, we're going to stay disciplined. We're going to find the right companies that -- where the combination of Allied and the acquired company really bring additional value. And we're looking for partners in that and that they want to realize the additional value from the combination as well.

Greg Palm

Understood. No. Actually really helpful color. Thanks and best of luck going forward.

Dick Warzala

Thanks Greg. Thank you.

Operator

And our next question comes from Dick Ryan of Colliers. Please proceed.

Dick Ryan

Thank you. So Dick, when you look at the backlog, how much of the new vehicle awards that you've announced previously have now worked their way into backlog?

Dick Warzala

Right now, the backlog is only $3.5 million of the new vehicle awards. So it's …

Dick Ryan

Okay.

Dick Warzala

… new business. So yeah -- and again for a reminder, I know you know how this works Dick is that, we don't put something in the backlog. That's why when we had these large orders, that were coming from vehicles and the awards that we had. We talk about what the value of that is.

But when we get releases to production, firm production releases, that's when they move into backlog, okay? And that's when we actually book the order. So of that there's only $3.5 million there that we show. But it is ramping up. And it's moving forward. And I can tell you that, we're on track.

Dick Ryan

Okay. Looking at your add-backs, I see you had a little bit of an uptick in business development costs from Q1. I'm sure that's tied to M&A.

But do you think the cadence of things you're looking at, or things that are kind of moving through the funnel, where are we? Are we -- is it picking up, or are we still looking at some valuations that are just hard to accept?

Dick Warzala

Well, I would tell you with a high level of confidence that we'll be able to execute a deal or two, before the end of the year, maybe more. And as I mentioned in the earlier commentary was that, we're going to stay disciplined.

So we're engaging in deal activity, where there truly is value that can be added from both sides. So -- and also looking for partners in that regard. And that's where we've had the greatest success in the past, where we groom these we work them for a long period of time.

And when we absolutely -- when both parties see that there's value that can be obtained, then we go out .And we get it done. And for us, it's very critical, that when we acquire a company, we acquire it to expand our capabilities, whether it's technology, whether it's products, geographic market or vertical markets it’s complementary.

There's -- of course, there's always an overlap, because it's a fundamental technology/know-how company that we're acquiring. But that's what we're looking for and the talent. And we acquire -- if it's good talent, it's a good company.

And we intend to ensure that we keep the talent on board when we acquire a company. So I will tell you that, we're encouraged. Activity is moving fast and moving hard. We've stayed away from the valuations that just don't make sense long-term for us.

Dick Ryan

Sure. And Mike, you mentioned, supply chain having a greater impact on revenue than the cybersecurity issue. Can you quantify what the revenue impact has been from the supply chain issues?

Mike Leach

Yeah. Again, I think, I'd classify them as low seven-figure impacts. Again, nothing that I would describe ultimately as material in the sense that it's really deferred orders. Nothing that would cause a cancellation or anything like that, and frankly, it's no different than the pace and tempo of impact if you will over the last couple of quarters.

We've described it as a constant battle. You probably see a little bit of elevated inventory, right? We're building strategic inventory to protect our customers. Some of that comes at a cost as we've talked about. It impacts our gross margins to some extent.

But again, I would not describe it as overly material impact. It's just maybe I'll call it $3 million to $4 million of revenue on a quarterly basis that just becomes directly impacted by the ability to source on a timely fashion.

A lot of the good efforts are put in. And you're expecting to receive something and things just get perpetually putout from a timeline perspective. So it's just a tough thing to manage.

Dick Warzala

Well. And also add to that, is that, as you hear from, let's look at automotive the supply chain shortages and chips and electronics. They're building vehicles and they're waiting to put them back through the line when they receive a component that may be missing or assembly that may be missing. So we're impacted by some of that as well.

If our customer can't get everything they need to build their product, there's a tendency to push everyone out. But I think we're seeing -- some companies are saying, they have to change the model.

You're looking at one piece flow and lean manufacturing, but we are seeing certain customers saying, hey, we can't do that and we'll never meet market demand in the future. So they are continuing to build, but some of them will push that out. If there's significant enough -- if there's enough components missing where they really can't build their product, they'll push it out.

So there's a little bit of the impact as well. I'll tell you our team has done a really good job of going into the secondary market and sourcing components and working closely with our customers to ensure that they're onboard with what we're doing.

Mike Leach

And, Dick, as I mentioned, that we saw a similar level of deferral, right, coming out of Q1. So you had a flow-through coming into the quarter from it. And, obviously, we had the impact at the back end of the quarter. So it's kind of normalized itself over the last couple of quarters, but it still exists.

Dick Ryan

Sure. Thank you and congratulations on the strong execution.

Dick Warzala

Thank you, Dick.

Operator

[Operator Instructions] Our next question comes from Brett Kearney of Gabelli Funds. Please go ahead.

Brett Kearney

Hi, guys. Good morning. Thanks for taking my question.

Dick Warzala

Good morning, Brett.

Mike Leach

Good morning.

Brett Kearney

You mentioned some of the new solutions and projects that you have rolling out. Obviously, there's much you've been able to win on the vehicle side that's going to be ramping up. But just curious whether there's anything else on kind of new solution offerings that you are particularly excited about?

Dick Warzala

Well, there's several of them. And unfortunately, I don't really want to talk about them. I mean, they are -- no, I appreciate that we have to give you some color there. But I can suffice it to say, we're seeing good -- actually, it's in every market and that's what's exciting about it, is that we're expanding our reach into our existing customer base in all of our markets.

Our focus is really on the integration of our components into a more complete solution, whether it's active and passive components in our filters, or if it's a incorporation of a drive and a control and feedback elements and gearing with a motor in there, we're -- it's just, more and more of that is happening.

And the other thing that's really encouraging too is that, we can -- we're keeping ahead of -- I can't say ahead of competition, but I can say ahead of the product next-generation designs or redesigns by our customers and we're delivering better value to them through the integration. So it is in industrial, it's in, I'll say, A&D, it's in medical. It's across the board, where it's just -- the direction of the company and the success that we've had is continuing to expand and grow from there. So plenty, just plenty of them.

Brett Kearney

That’s really helpful color. Thanks so much.

Dick Warzala

You’re welcome. Thank you, Brett.

Operator

At this time, we have no further questions. This concludes the question-and-answer session. I would now like to turn the conference back over to management for any closing remarks.

Dick Warzala

Thank you. Thank you everyone for joining us on today's call and 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 2021 results. Thank you for your participation. Stay safe and have a great day. That will conclude our call, operator.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.