AMOT (2019 - Q2)

Greetings, and welcome to the Allied Motion Technologies Second Quarter 2019 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.It is now my pleasure to introduce your host, Craig Mychajluk, Investor Relations. Thank you, sir. You may begin. Craig My

Yes. Thank you, and good morning, everyone. 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 2019 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 we released yesterday after the market close. 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 2 for the safe harbor.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 provided 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'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?

Thank you, Craig, and welcome, everyone.Our One Allied approach continues to gain traction as customers are responding well to our engineer solutions as evidenced by our double digit growth in all of our key served markets.We had solid revenue growth and record orders and backlog. Overall, revenue grew 16% with organic revenue up over 3% while FX headwinds reduced our reported revenue by 2.5%. Of note, operating margins expanded immeasurable 22% reflecting the effectiveness of our Allied Systematic Tools to improve performance in all areas of our business. Solid execution led to a 5% increase in our bottom line and we had generated strong cash from operations.Our TCI acquisition is performing well as strategically expanded our addressable market and was a strong contributor to improvement in sales and earnings. We believe we can deliver above market growth through the execution of our strategy and while our overall organic growth rate was impacted by softness in Europe, we made excellent headway in the U.S.In particular for the trailing 12 months, our Aerospace & Defense market is up 35% and our medical market was up almost 20% as we continue to make progress towards further diversification of our business.Executing our business operating system, Allied Systematic Tools or AST is key to margin enhancement as we drive a higher level of continuous improvement in all areas of the company around quality, delivery, cost and innovation.We have a strong AST team and have enhanced those capabilities over the past year as demonstrated by our recent improved margin performance. Importantly, these control improvements help offset the price increases we received from one of our electronic assembly suppliers as we noted in the first quarter.While we are working diligently to lessen this impact, given our current level of inventory in the long lead times we have experienced for certain key components the headwind is expected to persist through the end of 2019.We've also continued to invest in our strategic areas of excellence especially around electronics and software. Those areas have been struck with the addition of multiple new engineers to increase innovation, accelerate new product introduction and drive further integration of solutions for our served markets.Each day, we make progress organizationally as we align ourselves to better support our target markets and customers with more effective utilization of our sales, solution centers, technology unit and our production centers.With that, let me turn it over to Mike for more in-depth review of the financial.

Thank you, Dick.We'll provide an overview of our topline on Slide 4. As a reminder, our results include TCI which we acquired in December 2018. As Dick noted, despite an FX headwind of $2 million revenue increased 16% or $12.6 million to $92.6 million. Demand was broad-based with growth in all of our major served markets.We had particularly strong growth in A&D and Medical. We saw double-digit domestic organic growth, but that was largely offset by softness in Europe. As a result, sales to U.S. customers increased to 58% of total sales with the balance of sales to customers primarily in Europe and Asia.Slide 5 shows the change in our revenue mix by market and the growth of each market for the trailing 12 months ended June 30. The TCI acquisition can be found in industrial and distribution and accounts for the 123% growth within distribution. Over the last 12 months, our A&D and Medical markets have experienced considerable growth as we continue to gain market share with our engineered precision solutions. As we've talked about in the past, growing these markets are important element of our strategy to broaden the scope and diversification of the business.Our margin expansion was certainly a highlight of the quarter. As depicted on Slide 6, our gross margin improved 130 basis points to 30.7%. This significant increase over the prior year period reflects higher volume, favorable mix across a number of served markets, as well as the recent acquisition of TCI. As Dick mentioned, the supplier issue remains a headwind that will likely impact us through the end of 2019.Moving on to Slide 7, operating profit expenses for the quarter increased 90 basis points to 22.5% of sales largely due to higher selling costs related to additional personnel and incremental and intangible asset amortization related to the TCI acquisition. While selling expense of 4.5% of sales were up 90 basis, G&A expense decreased 10 basis points to 10.3% and E&D also decreased 10 basis points to 6.1% despite significant additions to the engineering group to support the company's growth.Solid gross margin and cost management led to the 22% increase in operating income to $7.6 million with operating margin expanding 40 basis points to 8.2%. We plan to continue investments in our growth however, at a level that continues to provide for improving operating leverage. Interest expense increased to $1.4 million on higher debt balances that funded the TCI acquisition.Turning to Slide 8, you can see our bottom line results. Net income increased to $4.4 million or $0.47 per diluted share up $0.02 from the second quarter of 2018. The effective tax rate for the quarter was 28% compared with 27.4%. We've adjusted our fiscal 2019 tax rate expectations up to a range between 28% and 30%. Adjusted EBITDA for the quarter was $12.1 million up 21% and as a percent of sales increased 60 basis points to 13.1%.We use adjusted EBITDA as an internal metric and believe it is useful in determining our progress and operating performance. This is a non-GAAP measure so please be advised to review our reconciliation and the related disclosures in our release and at the end of our slides.Slide 9, provides an overview of our balance sheet and cash flow, reflected in the numbers on this slide are the two acquisitions made in 2018 as both were funded with a combination of cash and debt. As a result, at quarter debt net of cash was approximately $113 million or 50.4% net debt to capitalization. We generated strong cash from operations of $11.3 million in the second quarter resulting in the year-to-date amount of $8.9 million.Our capital allocation strategy has not changed as our primary focus is advancing internal and organic growth initiatives and debt paydown as we reload for future acquisitions. Year-to-date capital expenditures were $6.4 million and were primarily investments for productivity improvement and growth initiatives.We expect our fiscal 2019 CapEx to range between $15 million and $18 million which reflects additional support for the significant project wins that will slowly begin shipping by year-end. The next generation of off-road vehicle steering capabilities and incremental investments related to the addition of TCI.Second quarter inventory turns were 4.5 times the improvement from last year as we've done a better job balancing our strong sales pipeline with a tight supply chain. Our DSO was at 51 days down from the sequential first quarter and a heightened 2018 number.Now I’ll turn the call back over to Dick.

Thank you, Mike.We'll now turn to Slide 10. Our strong order flow in the U.S. offset the softness that has emerged in Europe. As a result, second quarter orders grew 11% year-over-year and 2% sequentially to a record $95 million. Absent unfavorable FX orders would have been nearly $98 million.Backlog at quarter end was at a record level of $133.5 million up 20% year-over-year more than 80% of our backlog is expected to convert in the next six months and approximately 97% over the next 12 months. As a reminder, a nominal amount of the $225 million in the several vehicle market awards we previously announced are included in our reported backlog numbers.We have currently invested in these programs and expect to begin shipments at very low levels towards the end of this year. We will begin ramping shipments in 2020 to full rate production by the end of 2021 which would continue for the following six to seven years. While we remain cautious and flexible around the global economic environment particularly in Europe, we have strong confidence in our future and believe we are well positioned for continued growth in revenue and profitability.As we move forward we will continue to focus on improving internal operational efficiencies through the utilization of AST and we'll strive to enhance our growth opportunities through strategic acquisitions. We’ll also be working to maximize TCI's long-standing distributor relationships and to expand their geographic reach by utilizing our global footprint.We believe the long-term success of our company will be further enhanced by executing our strategy and leveraging our full capabilities to design innovative motion solutions that change the game and meet the current and emerging needs of our customers and our served markets.With that Operator, let’s open the line for questions.

[Operator Instructions] Our first question comes from the line of Greg Palm with Craig-Hallum. Please proceed with your question.

I would say nice job navigating through what appears to be an increasingly challenging environment out there.

Thank you, Greg. Good morning. Thank you.

So I mean just starting on the macro and I guess, specifically Europe since that appears to be kind of the soft spot curious what your visibility is maybe what end markets are you seeing the most softness over there?

The reality is it really is across all the end markets that we’re seeing it in Europe. So it's not one, it's a general, it’s across the board, reduction and level the business for its existing customers. Some of that offset by new business gains that we've had, so overall if we hadn’t achieve some new business, we probably would have seen a bigger drop.

And in terms of visibility I know most of what you do is, is direct, but do you feel like it's sort of a real demand drop-off, is it more sort of destocking from the end customer standpoint or what’s your thought there?

We think it's real demand drop-off.

Moving on to what appears to be a nice bright spot Aerospace, Defense, `were look to be kind of standouts in the quarter from a growth standpoint. Is that driven by new customers, ramp up of the existing programs what's driving the strong growth there?

Again both I would say to you that, what’s happened is that we've taken market share, we’ve won new contracts and we’re - as we have mentioned in the past, we’re – our key to success is that their engineered solutions that were there in the early phases of product development and we get designed in and what that whole design in cycle time takes anywhere from two to three to four years, and as products gets launched and get through the appropriate approval processes then we will see business pick up, so I think here that it's both. There is increased demand in those markets. We've taken market share and we’ve won new projects.

So to say you remained pretty bullish kind on near-term in terms of the opportunities there?

Yes, we do.

And then on the supplier issue, I think last quarter you had alluded to kind of the expectation of some partial release, and in Q3, I don't know the language may be changed a little bit this quarter but is that still the case or we now maybe just expecting that the impact to drag on through the remainder of the year?

Yes, it’s a good pick up. As we look at the lead times on certain key components, we had to protect ourselves and get no components on order and in the pipeline. So what is caused is this going to push things to the end of the year in order for us to we had to protect our - again protect our customers and protect our ability to ship product, so it will push it through the end of the year. I don't think we're going to see relief here now until first quarter next year.

But clarification of the new supplier and new parts are on track as expected?

Correct.

Good. Okay. Make sense. And then just lastly on TCI, I don't know if you mentioned what the actual revenue impact was in the quarter, I don’t know if you're willing to disclose that but just kind of broadly is kind of hinted at potentially over time taking that product to internationally, so just kind of curious if you could update us on these strategy and opportunity with TCI?

There is definitely some international opportunity there. As we mentioned before, the bulk of their business is domestic and as you start launching into the international markets, you run into different electrical frequencies, so you have some development work to do, testing to do and you have to have a footprint.And especially in today's volatile markets not knowing what's going to happen with tariffs from day-to-day, I think it’s become an even more critical for us to be able to produce product locally. So it's not an overnight success where you can sit there and say, okay, now we have footprint in these international markets that we can immediately start selling, we are already testing products that can be shipped into these international markets but it's going to take a little bit of time.We are also - we are looking at acquisitions in that space. So I would say to you that we’re going to work for both paths here. The long-term future we believe in very strongly. It’s performed extremely well. We had an excellent team and I think we’re certainly encouraged about what it can bring to the company long-term.

Our next question is from the line of Dick Ryan with Dougherty & Company. Please proceed with your question.

Mike as you later quantify the supplier issue on margins for Q2,how much of a drag that was?

Yes, I don’t know that I've specifically calculated the drag but it is very similar to Q1,so Q1 we described it is a 60 basis point drag. So…

60?

I know the dollar –60. Yes, the dollar impact was similar and obviously our revenue is similar as well. So it's right in that range.

Dick, you mentioned AST, have enough investments, people, software, the platform been made so that you're kind of rolling that out across all of your end markets or is it more kind of a rifle shot approach, where you're hitting from key markets first and if you can just maybe describe a little bit of that process?

Sure, Dick. Well AST its really our leading toolkit and in addition to that so as I talked about here it’s quality, delivery, cost and innovation. So over time here it’s been a part of our toolkit since Allied Motion was I’ll call it advantage back in 2002 and its that expanded since then.We had other elements to AST as we gone along, and particularly in the growth and innovation area. What we've done internally is we've added additional resources to help drive the process both in Europe and in North America, so our team has been expanded. The participation in a number of events that we hold every year continues to increase and as we move forward, there's always new elements that are coming in into the toolkit that focus on areas of the business that we think will drive some continuous and sustainable improvements both in speed of play, which is one area that we’re really focused on now and improving margins and eliminating waste throughout the entire company.So it's more about rather than say in particular markets and so forth, it is a process, a set of tools that can better utilize in the company. It’s in our culture. We train a large group of people every year and parts of these events and they get certified as they get qualified to participate and/or to potentially train.And it's something just won’t stop. It won’t end. It’s going to continue and we’ll focus on those key areas going forward. But I'll say speed of play and innovation are two key areas that we’re really ratcheting up here this year.

So how is the vehicle market in the quarter? I know you’ve focus - you had mentioned A&E and Medical, but how was vehicle?

The vehicle market for the quarter was essentially - it was up slightly, okay 2.6% for the quarter trailing 12 month, it’s up 14.8%.

[Operator Instructions] Our next question comes from the line of Brett Kearney with GAMCO Investors. Please proceed with your question?

Another solid quarter. Just - as one follow-up you provided a lot of great color on the supply transactions you’ve been some of the dynamics there. Could you provide I guess any additional color more broadly on how we can think about maybe your exposures regionally, your major supply chain exposures. It sounds like the one issue that came up earlier this year is isolated but I guess, where you're sourcing a bulk of your compelling from and how that ties into current I guess, trade dynamics in this environment?

If you got back and you look at the acquisitions that we've done over the last several years, we've been pretty fortunate to acquire companies that were located in different geographic regions. And I will say to you that while if you made a-- if you looked at them on a short-term basis because the profit and loss situation you might have made cusps to that but our strategy all along, and are thinking all along has been that the customers that were dealing with first-off, they like your support locally and secondly, as the economics of the logistics change, the cost, the delays, the speed of play and the ability to source key components for our products in multiple geographic regions has led us down the path that wherever we can regionalized, wherever we can source locally we will do that.So what we see is we have built up some actual production centers that continue to improve in both - and actually North America, Asia and Europe are excellent facilities. Their performance is top-notch in terms of quality delivery and cost and we are going to continue to do that and we look at that very closely when we’re entering certain new key markets as to where is the best place to produce to drive down the total cost of acquisition of the product for the customers.So it's an active project. We've again - we've added some key resources in that area as well for strategic sourcing. We believe it will have some extra benefits in the future. It is moving and we continue to drive towards localization and regionalization that we believe that’s going to be key to our success.

If I could ask just one more. It's clear, obviously continued market share wins including in the vehicle market. I guess, I just want to ask underlying market wise, anything you can share kind of what you're seeing, hearing from customers in terms of activity levels in the overall vehicle space?

Sure. We have - as you know that's our largest market, our largest German market. So we clearly are investing money back into new products for the future to not only secure the business we have and keep it secure but also to generate new business. So when you’re seeing a transition in the company in the last several years moving away from let’s say one customer solution to a market-based solution and while I don't want to share with you the particular applications necessarily that we are focused on.I can tell you there is definitely significant investment being made in engineering, in developing the future products to address those markets and the emerging needs of the markets and I think we are in some exciting areas, where we still see the vehicle market as a definite growth driver for the future and we’re investing heavily there as well as in the other markets we talked about. So I hope you bear with me and I am not going to sit here and tell you exactly what they are because there is competition out there.

[Operator Instructions] The next question comes from the line of Mike Morales with Walthausen & Co. Please proceed with your question.

I am curious on if some of the weakness that you guys talked about Europe changes the way to think about the timing of the ramp of some of the large vehicle contracts over the next couple of years?

Not at all. The ramp-up of those - those are three to five-year process to ramp-up, okay. By the time you begin getting designed into a platform and when you think about vehicles think of our platforms. So what will drive the level of business will be the market demand and whether the market demand is higher or lower in future years here will determine whether we ship the full value a little less or a little more.So the $225 million we talk about, that's kind of the expected value of the business that we will see in that six to seven year period, but it can fluctuate plus or minus 10%, 15%. So we are still full bore, our launch dates are affirmed and the only thing will happen is whether or not the volume will be, again, slightly lower, same or slightly higher.

And then last from me is just a modeling question. I know that year-to-date the stock-based compensation expense is running at a pretty much higher cliff from last year. Can you just help us understand what's driving that? Maybe how you're thinking about that in the back half of the year?

Yes, it is elevated this year. The way some awards were issued were changed to a more current and quarterly basis versus on an annual basis, which is why you're seeing some of it quarter-by-quarter. And also just some of the KPIs, the metrics for which, those incentive compensation are paid out on are elevated this year as well. So I would expect it to be at a similar run rate throughout the year.

Yes, I'll add a little bit to that. Some of that, Mike is mentioning here to, is based on driving topline growth. And as you see topline growth occurring, you will see increased stock-based compensation.

Thank you. Our next question comes from the line Scott Blumenthal with Emerald Advisers. Please proceed with your question.

I apologize, because I got on the call a little bit late. I understand that there is very little of the $225 million vehicle order in backlog; Dick, did you talk about how much of the backlog or can you talk about how much of the backlog you expect to be delivered in 2019 and how much thereafter?

Are you talking about the $225 million or are you talking about the regular backlog?

Talking about the regular backlog.

Yes, we did mention that. We said that in the next six months we expect to deliver 80% of the backlog.

And could you characterize how much, if any, is in backlog from the acquisition of TCI?

We really don't split it up. But I can tell you what TCI … The model for their businesses is usually very quick delivery. So TCI has minimal impact on our backlog. When I say that, I'll get an order and deliver it very quickly. So it's not like some of our other businesses where there is longer lead times and we get orders that could be six months or nine months or 12 months with firm deliveries. TCI is really a book-to-bill business primarily. So very little.

That's helpful, indicating that the backlog is almost completely organic here. And my last one would be; to what do you attribute the really nice strength in A&D and Medical during the quarter?

Both of them we've experienced market share gains as well as wins and new projects. So we some increased spending certainly in A&D for projects that we have already - programs that we're already on. We saw some increased demand. We have taken some market share and we're winning new programs.As far as Medical, I would say to you it's more about winning new programs. And our continued investment in engineering that we work on longer-term solution. So when we're – for us to be successful, it's really engineer-to-engineer, and it really is working on next-generation or future generations of projects or products. And it takes several years for those to come to fruition, but that's our success, that's our strength.And one thing I did mention is that we continue to invest in our engineering resources and we’ve invested heavily in the electronics and software side. And we will continue to do that in the future. You're not seeing that impact in terms of the cost increase because we were utilizing consultants, we were utilizing subcontractors and we've been phasing the subcontractors out and bringing people in internally.So we're getting, let's just say, more bank from our buck there. So we're going to continue to ramp up our engineering resources and we see the electronics and software as an integral part in becoming a larger part of all of our sales.And that's been our strategy from beginning, and that's why the solution centers got started and we're going to continue to focus on that for driving growth in the future. So Medical has been project wins, increased demand; Aerospace and Defense has been market share, new project wins and increased demand.

In Aerospace and Defense, Dick, do you require certification?

Sure, and Medical too. And we have certifications, and really across the Board, whether it's - there is specific certification that you have for whether it's Aerospace and Defense as specific, Medical and/or Vehicle. So, yes. Now we're driving all of our facilities towards, what we'll call, the highest level of quality requirements. But, yes, we do have specific certifications for each of those industries.

Thank you. It appears we have no additional questions at this time. So I would like to pass the floor back over to Management for any additional concluding comments.

Well, thank you everyone for joining us on today's call. And we certainly are pleased with your interest and the level of questions and types of questions that you brought. For those of you interested, we will be attending the Dougherty Conference in Minneapolis on September 5.As always, please feel free to reach out to us at anytime and we look forward to talking with all of you again after our third quarter results. Thank you for your participation and have a great day.

Once again ladies and gentlemen, this does conclude today's teleconference. Again, we thank you for your participation. And you may disconnect your lines at this time.