Allied Motion Technologies, Inc.

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. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, may I press star then one on your telephone keypad? To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Craig Mahalik of Investor Relations. Please go ahead.

Yeah, 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 Wurzela, 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. We 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. On the website, you'll also find slides that accompany today's discussion. If you're reviewing those slides, please turn to slide two for the safe harbor statement. As you are aware, we may make some forward-looking statements on this call during the formal discussion as well as during the Q&A. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from what is stated on today's call. These risks and uncertainties and other factors are discussed in the earnings relief 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 relief and slides. With that, please turn to slide three and I'll turn it over to Dick to begin. Dick?

Thank you, Craig. and welcome, everyone. 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 leveraged the ongoing economic recovery. Total revenue grew 17 percent 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 supply 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 percent. Operating margin was up 10 basis points, and adjusted EBITDA margin improved 40 basis points. As a result, net income increased 60 percent over the prior year to 4.6 million, or 32 cents per diluted share. We continued 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 were 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 or 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, 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.

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 four, we provide some detail regarding our top line. Second quarter revenue increased 17 percent, or 14.9 million, to 101.5 million. Demand was particularly strong in vehicle, improving 82 percent 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 U.S. 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 impact 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 referrals 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 six, 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 seven, 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 percent as higher volume and disciplined cost control offset increased incentive compensation, which was largely in the G&A line. On slide eight, you can see our bottom line and adjusted EBITDA results. Net income increased to $4.6 million, or 32 cents per diluted share, up from 12 cents in the second quarter of 2020. The effective tax rate for the quarter was 21.9 percent compared with 29.9 percent. 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 percent. Adjusted EBITDA for the quarter was 12.4 million or 12.2 percent of sales up from 10.1 million for 11.7 percent 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 percent, 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.

Thank you, Mike. Turning to slide 11, that highlights encouraging trends as customer demand and our strength in 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 percent over the sequential first quarter and was up 33 percent over last year's second quarter to more than 170 million. Approximately 90 percent 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 in 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.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we'll pause momentarily to assemble our roster. Looks like our first question comes from Greg Palm of Craig Hallam Capital Group. Please proceed.

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

Yes, Greg. Thanks, and thanks for the question. Yeah, while it wasn't a material impact, I mean, some items did get pushed. Our systems are integrated systems, which means directly from the order entry to delivery of 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, you know, it certainly did have some impact, but as we said, not material. And certainly nothing, there's no lost business there. It's business that will, that was just delayed into July, but it was not material.

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

Yeah, that makes sense. And I guess on that line of thinking, you know, so I think gross margins were nicely ahead of expectations, even in light of, you know, more supply chain challenges, you got increased input, logistics costs, etc., 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 sort of thinking about maybe further gross margin expansion if we assume that some of these items eventually sort of go away?

Sure. Well, first off, I think we have as we've outlined in the past, is that most of our major contracts have material increase clauses and inflation clauses, and so we are able to look at the core material components that go into our products, and 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 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 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, uh, that, you know, 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, uh, in our operational efficiencies that we're gaining and we will continue to gain that we will see, you know, those improvements as time goes on. So I would say, I would tell you that, uh, our teams have working hard. We're not out of the woods. I mean, it's a, it's a scramble. Uh, and obviously, you know, with the Corona virus 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's going to figure out how to keep going here. If, if this thing does continue to, you know, uh, affect, uh, us in a way with the number of infections increasing over time here. So anyways, I'm encouraged that our team's got it under control to the best of our abilities. And our strategic sourcing activities, you know, while they haven't been as strategic, they've been more reactionary to getting supply. We've been able to do that. And, you know, we'll get back on track here and we'll continue to leverage some of the capabilities that we have, you know, in the long run.

Okay. It's good to hear. And, you know, just kind of looking ahead, I mean, based on your commentary, certain the backlog is indicative of this, but you know, you're clearly on a path to quarterly revenues that, you know, exceed a hundred million. Right. And, 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? Yeah, very good.

Uh, You want to take that, Mike? Go ahead, and then I'll jump in after.

Yeah, Greg, I think we've talked in the past, right, that along with the gross margin improvements that we're going to derive, 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, you know, while we anticipate some significant growth going forward in the future, replicating what we've done in the past, that, you know, I think that foundation is largely there. So the pace at which we're, you know, 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, you know, operating leverage will help magnify the improvement as well in gross margins over the next, even, you know, the next 12 to 18 months.

Okay. Understood.

Thanks a lot.

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 ally 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, you know, we have plenty to invest in internally, I can tell you that. So, you know, 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 that they want to realize the additional value from the combination as well.

Understood. No, that's really helpful, Collier. Thanks, and best of luck going forward. Thanks, Frank.

And our next question comes from Dick Ryan of Collier's. Please proceed.

Thank you. Say, 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?

Right now, the backlog is only $3.5 million of the new vehicle awards. So it's new business. So, yeah, and again, for a reminder, and 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, 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 in the backlog. Okay? And that's when we'll 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. I can tell you that we're on track.

Okay. Looking at your ad 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? Is it picking up or are we still looking at some valuations that are just hard to accept?

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. 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 attained, then we go out and we get it done. And for us, it's very key, 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 slash know-how company that we're acquiring. But that's what we're looking for in the talent. And we acquire, you know, 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 evaluations that just don't make sense long-term for us.

Sure. 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?

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, you know, 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 between You probably see a little bit of elevated inventory, right? We're building strategic inventory to protect our customers. Some of that, you know, comes at a cost, as we've talked about, and it impacts our gross margins to some extent. But, you know, again, I would not describe it as overly material impact. It's just, you know, maybe I'll call it $3 million to $4 million of revenue on a quarterly basis that just becomes directly impacted by, you know, the ability to source on a timely fashion. You know, a lot of the good efforts are put in and you're expecting to receive something and things just get perpetually put out from a timeline perspective. So it's just a tough thing to manage.

Well, it also adds to that is that, you know, as you hear from, let's look at automotive, you know, the supply chain shortages and, you know, 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, 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 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's 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 on board with what we're doing.

And Dick, as I mentioned, I'd we saw a similar level of deferral 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.

Sure. Thank you. And congratulations on the strong execution.

Thank you, Dick.

As a reminder, If you have a question, please press star, then 1. Our next question comes from Brett Kearney of Gabelli Funds. Please go ahead.

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

Morning.

You mentioned some of the new solutions and projects that you have rolling out. Obviously, there's what 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?

Well, there's several of them, and unfortunately, I don't really want to talk about them. I mean, because they are... No, I appreciate that we have to give you some color there, but I can suffice it to say that 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 And 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 an incorporation of a drive and a control and feedback elements and gearing with a motor. It's just more and more of that is happening. And the other thing that's really encouraging, too, is that We can, you know, 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 industrial. It's in, you know, I'll say A and D. It's in medical. It's across the board, you know, where it's just a – 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.

That's a really helpful caller. Thanks so much.

You're welcome. Thank you, Brett.

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.

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'll conclude our call operator the conference is now concluded thank you for attending today's presentation you may now disconnect