Allied Motion Technologies Inc. (AMOT) Q2 2023 Earnings Conference Call August 3, 2023 10:00 AM ET

Company Participants

Craig Mychajluk - Investor Relations

Richard Warzala - Chairman, President & Chief Executive Officer

Mike Leach - Chief Financial Officer

Conference Call Participants

Greg Palm - Craig-Hallum Capital Group

Ted Jackson - Northland Securities

Brett Kearney - Gabelli Funds

Operator

Good day, and welcome to the Allied Motion Technologies Second Quarter Fiscal Year 2023 Financial Results Conference Call. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Mr. Craig Mychajluk, Investor Relations. Please go ahead, sir.

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 Michael Leach, our Chief Financial Officer.

Dick and Mike are going to review our second quarter 2023 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 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 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, 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 will 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 three, and I will turn it over to Dick to begin. Dick?

Richard Warzala

Thank you, Craig, and welcome, everyone. And I'd like to start the call with some off-script comments, as I have something I would like to relate to everyone. Sadly, Dick Smith, our former CFO, CEO and Chairman of the Board, passed away this past Sunday after a brief illness. Dick was the first one that brought me into Allied at that time halfway 22 years ago and for that, I will forever be grateful.

Dick was a great friend, partner and he exhibited the highest levels of honesty, integrity and willingness to do what was right for the company. Beyond that, Dick was a family man and family always came first. Our thoughts and prayers will go out to Dick and his family. Rest in peace, Dick. We will miss you, and you will not be forgotten.

Now I'll start with the script as we have written here. So first off, we continue to successfully execute our strategy by delivering record sales with double-digit organic growth and strong operating leverage, which translated into a measurably improved bottom line and solid cash generation.

Our 20% top line growth reflected strength in each of our four targeted markets, highlighted by continued strong demand with our industrial markets, which increased 39% over last year's second quarter. What drove our industrial strength with industrial automation projects, power quality solutions for oil and gas and HVAC and continued demand for material and a vehicle handling systems. We also benefited by shifting some of the long lead projects that were in our backlog.

Aerospace and Defense markets grew 11% during the quarter due to incremental contributions from acquisitions and defense program timing. Vehicle market sales increased 7% due to continued ramping of commercial automotive programs, partially offset by lower agricultural vehicle demand in Europe. Lastly, medical markets were up 3% overall.

Driving higher margins continues to be a focus. And while we saw some contraction in gross margin for the quarter, which was largely impacted by mix, we are seeing the leverage play out in our operating performance as we delivered record operating income of $12 million with a margin of 8.2%, which was up 210 basis points.

Given the improved operating performance, net income per share increased 45% to $0.42 per share. On an adjusted basis, net income per share was up to $0.58 per share. We generated significant cash from operations of $13.7 million and reduced our debt balance by $9.4 million during the quarter.

Our orders were up sequentially, further emphasizing demand in the market, while our backlog was down since the first quarter due to continued improvements within the supply chain. I will talk about this performance later in the presentation.

The first half of 2023 has positioned us for a strong year. Our entire team is energized by the continued growth and operational successes throughout the company, and we expect to continue executing our strategy well into the future.

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, our results include the acquisitions completed during the second quarter of 2022. Starting on Slide 4, we provide some details regarding our top line. Second quarter revenue increased 20% or $24 million to a record $146.8 million. The unfavorable impact of exchange rate fluctuations on revenue was $0.4 million in the quarter.

Organic revenue growth was 17%. Dick touched on the quarterly sales highlights for our targeted markets and end market demand. One other sales channel, which is still a small component of our total is distribution, which has continued to see solid growth and was up 17% in the quarter.

Slide five shows the change in our revenue mix by market on a trailing 12-month basis and the drivers behind that change. Industrial continues to be strong and remains our largest market, making up 41% of our total TTM sales. The 40% growth in the industrial space is driven by the specific markets identified. A significant portion of our backlog reduction occurred with customers in our industrial markets as well.

Solid organic growth, defense program timing and contributions from acquisitions contributed to substantial growth and performance in A&D. Medical growth has benefited from the gains in the medical mobility market and vehicle market revenue was up slightly on a trailing 12-month basis as commercial automotive, power sports and truck demand more than offset weaker agricultural demand in Eastern Europe, driven by current geopolitical events.

As highlighted on Slide 6, our second quarter gross margin was 31.3%, down 110 basis points from the prior year period. Higher volume was more than offset by unfavorable mix and remaining global supply chain disruptions. Consistent with our stated objectives, you can see the progress we are making by executing our strategy in the annualized chart on the right of Slide 6.

Moving on to Slide 7, you can see the results of our strong revenue growth and the leverage inherent in our operations as second quarter operating income increased 60% to a record $12 million or 8.2% of sales, which was up 210 basis points. Operating costs and expenses as a percent of revenue were 23.2%, down 310 basis points.

On Slide 8, we present GAAP net income and adjusted net income, along with our adjusted EBITDA results. Our net income and fully diluted EPS have been adjusted for certain items, which we believe 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.

Net income increased 48% to $6.8 million or $0.42 per diluted share. And on an adjusted basis, net income was $9.5 million or $0.58 per diluted share, up 21%. The effective tax rate was 23.9% in the quarter due to discrete tax benefits and geographic mix. We adjusted our expected income tax rate for the full year 2023 down slightly to be approximately 24% to 26%.

Adjusted EBITDA increased 26% to $20.4 million or 13.9% of revenue, which was up 70 basis points from the second quarter of 2022. 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. As a reminder, in the first quarter, we made a $6.25 million deferred cash payment for our prior acquisition, which was reflected in our cash position at the end of the second quarter. Total debt was approximately $228 million, down $8.3 million from year-end 2022. Debt net of cash was about $203 million or 46.2% of net debt to capitalization. Our bank leverage ratio was 3.06 times.

We generated $17.3 million of cash from operations year-to-date, a significant increase from cash usage during the prior year period. The increase reflects higher net income and improved working capital due to stronger inventory turns.

Based on our cash flow projections, we expect to continue to drive strong cash flow this year consistent with historical trends. Year-to-date, capital expenditures were $6.1 million and were largely focused on new customer projects due to project timing, we adjusted our 2023 CapEx expectations to now range between $16 million and $20 million, down from $18 million to $23 million. Inventory turns improved to 3.3 times in the second quarter compared with under three times last year. Our DSO was stable at 55 days, largely reflecting timing and mix of customers.

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

Richard Warzala

Thank you, Mike. Turning to Slide 11 shows that our orders and backlog levels in the second quarter, orders of approximately $137 million resulted in a book-to-bill ratio of 0.9 times and a backlog of nearly $300 million. Although there continues to be some near-term challenges with some pockets of weaknesses in Europe, we still see excellent long-term opportunities for growth and value creation across our global platform.

Our backlog decreased 3% from the sequential first quarter of 2023; reflecting the continued improvements in the supply chain as we reduce our lead times and accelerate shipments of several long lead products. As we mentioned last quarter, we expect our backlog to decline slightly over the coming quarters as our book-to-bill ratio drops below one. The time to convert the majority of backlog to sales is within the next 9 months.

Turning to Slide 12, demand is expected to continue at relatively strong levels within our industrial markets, which should continue to benefit from our increased market presence around industrial automation, material handling and power quality solutions.

On the defence side, we are experiencing a significant increase inquiries with the ability to leverage our comprehensive product portfolio to develop solutions for several new and emerging applications.

Our medical markets have returned to a more normalized sales environment focused on surgical and instrumentation-related end markets. And lastly, we are still anticipating modest growth within our vehicle markets as the supply chain continues to improve and demand schedules from our customers ramp up this year and beyond.

As we demonstrated this quarter, driving cash conversion and paying down debt is the focus. We will continue to focus these efforts as debt reduction will support our planned M&A activities. On that note, we are actively grooming potential opportunities as we build out our M&A pipeline, a key element of our overall growth strategy. While uncertainty remains in the global markets, we have confidence that we can continue to successfully execute our proven strategy well into the future.

Before we open up for Q&A, just a reminder for those of you that are interested, we will be hosting our inaugural Investor and Analyst Day at the NASDAQ on Wednesday, August 23. The event will kick off at 11:00 a.m. Eastern and will accommodate with us ringing the NASDAQ closing bell.

The Investor Day will be a great opportunity for you to hear more about our company and the actions we are taking to: number one, expand our available markets; two, further strengthen and grow our market share; three, leverage our global manufacturing and engineering capabilities to ensure we achieve our goals and objectives.

And last but not least, help you gain a better understanding of how we plan to leverage our success in the past and continue to execute our proven process well into the future. Please visit our Investor Relations website for more details on the event. With that, operator, let's open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And the first question will come from Greg Palm with Craig-Hallum Capital Group. Please go ahead.

Greg Palm

Thanks. Morning everyone. Sorry to hear the news about Dick. So condolence is his family and all of you. So I guess maybe we can just start by kind of just recapping what you're seeing out there. It sounds like maybe a little bit of softening in certain verticals or geographic areas. So maybe just a little bit more color on kind of real time, what you're seeing and then we can go from there?

Richard Warzala

Sure. I would say to you that overall, I mean, we were certainly well prepared that the order intake over the last couple of years here was somewhat inflated and as the supply chain started to normalize that we would expect to see some adjustments of schedules and so forth and that probably incoming orders would decrease.

We have experienced some of that. But on the other hand, I think as noted by our 20% increase in revenues, we seem to be pretty well positioned, and we are really not very concerned going into the future. What we probably will see, Greg, is that there will be some ups and downs in markets.

I think we've covered those markets are where we see -- we have some concerns. And Mike mentioned them and some geopolitical concerns and so forth. But on the other hand, we still see some very strong opportunities here for us to continue at the levels that we've delivered here in the past.

We may see less volatility quarter-to-quarter as we've diversified our portfolio more than what we had experienced in the past. But overall, I think the numbers we put up here for the quarter were quite strong and exhibited very strong growth. And as we said during the conference call, we feel confident that we can continue doing so into the future.

Greg Palm

And I know you've talked about some of that elevated order activity in the past quarters or past few years. Do you have a sense of what kind of inventory levels are? Is that a concern at customers or some customers? Or just you feel like they're in a position where it's just more of a real-time demand thing?

Richard Warzala

It varies by customer. I mean, some customers were more conservative than others and place demand for longer periods of time just to mature they were in the pipeline and we are seeing some adjustments based upon that.

But I would just say to you that we have a really excellent communication with our blanket customers, and there's some reshuffling, but it's something we would have expected, quite frankly.

So I don't -- there's no concern on our part that business is going away or there's a major drop off into the future. We're just not seeing that. And so I would say to you that as expected, when we come out of these things, this is the normal historical trends of supply chain shortages and longer lead times and orders being entered much earlier based upon forecast, we have experienced the same thing, but I would also have to say that it's certainly not as drastic as we had seen in the past adjustments. But it's customer by customer. And really, each of them manages their business a little bit differently, and it really depends on them.

Greg Palm

Yes. Okay. Operationally, another good quarter where you saw solid margins, good operating leverage. I know you've talked about gross margin expansion on an annual basis. I think you've targeted 100 basis points. Are you still comfortable with that in light of some of your comments on a more muted sort of demand volume outlook?

Or do you still think there's ways that you can take some costs out? And I'm just curious, are you still seeing or incurring some of the elevated supply chain cost that we've been talking about over the past year or have those basically ended at this point?

Richard Warzala

No, I think -- okay, a couple of questions here. First off, let's -- we've stated that our goal was to increase gross margin. And I think we've come back and stated as well that you've got to consider as part of the gross margin overall operating margin.

So that's really what we will focus on in the future is that the combination of gross margin and operating margin improvements will give us the 100 basis points per year, okay. So that's I think let's make sure that we take that and we're clear on that going forward.

Operating margin is always a challenge based on mix. And that's what's sometimes difficult from quarter-to-quarter or year-over-year to really look at. So depending on -- and obviously, as you know, the mix of our products, based on certain markets and certain products sold, the margins will be lower and the opposite of that.

We have others that are much higher gross margin based upon, I'll call it, the IP involved in the markets we're serving as well as the content that we have in those in terms of the solution set. So let's -- I think let's level set and say we are going to proceed here with meeting our commitments for 100 basis points improvement, a combination of gross margin and operating margin level, okay.

Greg Palm

Makes sense to me. I think I'll leave it there. Thanks and best of luck.

Operator

The next question will come from Ted Jackson with Northland Securities. Please go ahead.

Ted Jackson

Thanks very much. Congrats on a very solid quarter guys. So a couple of questions. One, just because following up on the prior kind of Q&A commentary. I understand supply chains normalizing out and some, call it, floating around if you would, with regards to orders and shipments.

But you also feel pretty confident that you're going to be able to continue to show growth on an organic basis in the second half of the year. Is that what I picked up from all that dialogue?

Richard Warzala

Yes. I think from an organic growth standpoint, we're certainly confident that we can continue to grow. Okay. What was the comment that I just I think I want to clarify is that in the past, you would see more seasonality in our business quarter-over-quarter.

And based on what we're seeing and based on backlog that had some items that sit in there waiting for supply chain to free up and ship, I think we're saying -- we're seeing more of a normalized quarter-over-quarter shipment rate, and then we see that going forward.

Now fourth quarter, we'll let you know as we get closer because that's always been a crapshoot for us in the past and based upon what happens with our customers. But really, what we're seeing is more stability and less cyclical shipments in quarter-over-quarter. Europe has a tendency to be lower in Q3.

Many countries shut down for multiple weeks in August. So that's July and August, so we do see some weakness there. But I guess I would say to you and to everyone else is that the expectations of the cyclicality that we saw or seasonality we saw in the past is going to be muted.

Ted Jackson

Okay. Just to kind of help clarify a little bit. With regards to backlog, if we were -- if you look in your backlog, how much of your backlog ships in third quarter?

Richard Warzala

Well, I would say to you that the -- here's the -- when we say what's in our backlog and our reported backlog because we only have in our backlog items which have firm release dates or production days. So it varies by customer. We have -- depending on the lead times that we have, so when they release, we'll call it a planned order or forecasted order to a firm production date, that's when it officially goes into our backlog, but you really don't see those.

Those are pretty much book and ship within a very short period of time and pretty much wash out in the quarter. So to answer your question, for third quarter, 95% plus is in our backlog, if you would consider as well the blanket orders that will come and go within the quarter, okay? So it's pretty much locked in the third quarter at this point.

Michael Leach

Yes. The dynamic of our backlog hasn't changed, right? We have stated that it's what's in the backlog, most of it will ship within the next six to nine months.

Ted Jackson

Okay. And then shifting over, just out of curiosity, I know Rockwell is a distribution channel for you and they reported results earlier in the week and honestly, they had some difficult performance in the stock as well.

One of the things that impacted them during that quarter and probably really the only thing was that they put this new distribution center in place and it caused a little bit of a hiccup in terms of timing with regards to some revenues. And I was curious, given your exposure to Rockwell, is there anything within that, that has played out for Allied Motion, and is there anything that we need to think about on that front?

Richard Warzala

Not really.

Ted Jackson

Okay. And then, Dick, the last -- well, probably maybe three press releases. It's been pretty consistent with regards to discussion about Europe and certain kind of softness in pockets of it, if you would.

With regards to this current quarter, is there any kind of relative shift with regard to that weakness relative to, say, first quarter? Or is it just a continuation of kind of the same kind of generalized believe, if you would, that's affected the reason because of the Ukraine war?

Richard Warzala

Yes. What I would say to you is this, is that surprisingly, the booking -- the bookings in the quarters one and two and so forth. And based upon we had expected some in Europe, some impact on it and so forth. And we really weren't seeing that to a great magnitude. We have seen some additional softness in the booking levels, but there's still strong backlogs to work off them.

So energy prices, the Ukraine war, I think, are still impacting and you've got -- but the reality is the bookings have remained strong. Orders were placed. There has been a little bit of softness here in the last few months that we've noticed. But again, too, it's holiday season in Europe. So that's a hard one to predict.

Ted Jackson

Yes. You're not the only one that has that problem. My last question is just on the vehicle business. You commented on the commercial vehicle business and the strength you're seeing within there, and it's offset some of the ag side of things, which clearly is from the small ag equipment market. But in the commercial vehicle side of the equation, there's clearly been some, call it, forward demand pull-through because of emission rule changes and stuff.

Given that market dynamic, how do you see that part of your vehicle business performing as we roll out of '23 and into '24? And maybe you could give a little color with regards to the exposure within that line item that the commercial vehicle market is relative to the aggregate?

Richard Warzala

Sure. Well, we're not going into specifics about what the percentage of sales overall, we talk about overall vehicle market, I would say to you that the impact on us for commercial automotive is not very significant, okay. We have seen increase. We have seen the volume and the demand going up.

Where we talk about the offset, which I'll say it is a much greater magnitude, which will mute some of that growth. It is in the agriculture equipment and programs that we are working on with our OEMs in Eastern Europe, which are essentially shut down.

So until that has a greater impact on us in the reduction on the level of shipments there versus commercial automotive ramp-up. So we would gladly substitute and swap those to and see that demand for the agricultural equipment and construction equipment and so forth, that impact in Eastern Europe go back to what the expected levels were and have a, let's say, a slower growth in automotive, we would be perfectly happy with that. And the impact would be when we talk about mix and so forth in margins, that would definitely have a positive impact favorable to the company.

So I would just say to you that these are the diversification of the company is what's really our strength. And while some markets are experiencing a little softness, our other markets are growing. And that is our intention to continue to do that in the future.

And we've always said that we like the benefits of the commercial automotive market and that the core unit volume, the discipline it teaches you in the zero defect mentality and the positive impacts on overall cost and other areas that, that can bring. We also don't want to be overweighted in that area that it's do enough to realize those benefits, but let's make sure that we don't get over weighted, okay.

So I hope that helps you understand it. It's -- to answer your question, we have seen an increase. And I think we'll continue to see increases. But the offset is more powerful than the increase that we see in that market.

Mike Leach

And the income is coming from the new programs that we have been discussing for the last couple of years.

Richard Warzala

Correct. Yes, they're coming.

Operator

[Operator Instructions] Our next question will come from Brett Kearney with Gabelli Funds. Please go ahead.

Brett Kearney

I was going to follow up on the vehicle, new program awards. You kind of covered it some in your prepared remarks and in the discussion right there. But just on whether those program launches are still kind of on the original timetables. And maybe if you could remind us kind of the ramp schedules there?

And then also, the customers and products you're supporting there on some of the new programs seem to be that product set seems to be growing nicely globally. Maybe opportunities if you guys perform there as you have done historically longer term with some of these customer relationships you've developed?

Richard Warzala

Yes. Those programs are all delayed through COVIS. And so they definitely were pushed. And I would tell you that we look at the original forecast that we were provided for programs and, let's say, without COVID, and without supply chain we're probably two years behind. So nothing has changed in terms of what we expect our annual revenue base to be in that area.

Programs are moving forward. It's just a matter that they were pushed out and the ramp-up was delayed, but it's clearly ramping up, okay. So I would tell you that in next year, we'll be at what we stated for the new program shipment levels will be at full level of what we've stated, okay. So they are moving forward, and they're moving forward nicely.

Brett Kearney

Excellent. Okay. And then I think just last one, we've covered the topic of destocking across the industrial channel. Maybe we've heard from some folks that there's some inventory adjustments taking place on the medical OEM side. It seems like the applications you guys are on their kind of insulate you, but maybe what you're seeing positives and negatives on the medical side of the business?

Richard Warzala

Yes. I would tell you that, that's one that has been -- of course, you go back to the COVID time and you take a look at what the products were shipping during COVID and those that were not shipping. And we've said here, I think within the last -- in the past year or 1.5 years, they kind of normalize back to, we'll call it, a normal period of time, a non-COVID period of time.

So our instrumentation and our surgical equipment and all the other surgical equipment that goes on when I say surgical, including oncology and surgical robotics and other surgical. I mean, they're tracking nicely.

So we're up 3% overall year-over-year. And I would say to you that there may be some correction going on and maybe the growth rate should be higher. It's certainly a drag on our overall growth rate that we've seen for the company than in some other areas. But on the other hand, it's been stable. And I think it's pretty steady. It's probably -- if there's restocking, we're not really seeing it, all right? So I don't know where that's occurring, but we're not seeing it.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks. Please go ahead.

Richard Warzala

Well, 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 at any time, and we look forward to talking with all of you again after our third quarter 2023 results.

In addition to the Investor Day at Nasdaq, please join us at the Northland Capital Markets Conference on September 19 in Minneapolis. Thank you for your participation, and have a great day.

Operator

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