Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Amounts presented in Item 7 are in thousands, except per share data.
Overview
We are a global company that designs, manufactures and sells precision and specialty controlled motion components and systems used in a broad range of industries. Our target markets include Vehicle, Medical, Aerospace & Defense, and Industrial. We are headquartered in Amherst, NY, and have operations in the United States, Canada, Mexico, Europe and Asia-Pacific. We are known worldwide for our expertise in electro-magnetic, mechanical and electronic motion technology. We sell component and integrated controlled motion solutions to end customers and OEMs through our own direct sales force and authorized manufacturers’ representatives and distributors. Our products include brush and brushless DC motors, brushless servo and torque motors, coreless DC motors, integrated brushless motor-drives, gearmotors, gearing, modular digital servo drives, motion controllers, incremental and absolute optical encoders, active and passive filters for power quality and harmonic issues, and other controlled motion-related products.
Financial Overview
Highlights for our fiscal year ended December 31, 2020, include:
● Revenue was $366,694 for 2020 compared with $371,084 in 2019. Our Medical market experienced strong growth of more than 61%, which included the contribution from Dynamic Controls, however all other market verticals experienced reduced demand as a result of the global economic impact of the COVID-19 pandemic. Sales to U.S. customers were 53% of total sales for 2020 and 57% of total sales for 2019, with the balance of sales to customers primarily in Europe, Canada and Asia-Pacific.
● Gross profit was $108,575 for 2020, a 4% decrease from $112,584 in 2019. As a percentage of revenue, gross margin decreased 70 basis points to 29.6% as productivity and cost containment efforts helped to mostly offset the impact of lower revenue and higher tariffs, freight and duties.
● Operating income was $22,994, or 6% of revenue, for 2020 compared with $29,443, or 8% of revenue, for 2019.
● Net income was $13,643, or $1.43 per diluted share, compared with $17,022, or $1.80 per diluted share, for 2019.
● Bookings were $370,712 for 2020 compared with $366,103 for 2019, an increase of 1%. Backlog as of December 31, 2020 was $141,344, an increase of 13% from $124,950 at year end 2019.
● Debt of $120,079, net of cash of $23,131, increased by $599 to $96,948 at December 31, 2020 from debt of $109,765, net of cash of $13,416 of $96,349 at December 31, 2019.
● We declared and paid a dividend of $0.03 per share for each quarter of 2020 and 2019 pursuant to our quarterly dividend program. Dividends to shareholders for 2020 and 2019 were $0.12 per diluted share. The dividend payout ratio was 8% and 7% for 2020 and 2019, respectively when compared with the diluted earnings per share of $1.43 and $1.80, respectively.
The Company’s 2020 sales were 1% lower than in the prior year. Our market position in the Medical market, combined with the acquisition of Dynamic Controls, nearly offset reductions in our other served markets, many of which were negatively impacted by the COVID-19 pandemic.
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Net income was 19.9% lower in 2020 compared to 2019, and earnings per diluted share decreased by 20.6%. These decreases reflect the impact of declines in the markets we serve and the supply chains we utilize due to market conditions impacted by the COVID-19 pandemic, along with incremental expenses from Dynamic Controls .
We remain focused on executing our strategy for growth while streamlining the organization and emphasizing continuous improvement in quality, delivery, cost and innovation as we drive the One Allied approach and expand our value proposition for our customers. Solid strides continue to be made with our multi-product, fully integrated solutions that are leading to increased business. Also, we continue to build a pipeline of exciting market-based application opportunities. Sales cycles are long and the time from being selected for the solution development to full rate production can be longer, yet we believe we continue to build a scalable foundation which can deliver strong returns on those investments.
Our Strategy
Our growth strategy is focused on becoming the controlled motion solution leader in our selected target markets by further developing our products and services platform to utilize multiple Allied Motion technologies to create increased value solutions for our customers. Our strategy further defines Allied Motion as being a “technology/know-how” driven company and to be successful, we continue to invest in our areas of excellence.
We have set growth targets for our Company and we will align and focus our resources to meet those targets. First and foremost, we invest in our people as we believe that attracting and retaining the right people is the most important element in our strategy. We will continue to invest in applied and design engineering resources.
Our strategic focus is addressing the critical issues that we believe are necessary to meet the stated long-term goals and objectives of the Company. The majority of the critical issues are focused on growth initiatives for the Company.
One of these growth initiatives includes product line platform development to meet the emerging needs of our selected target markets. Our platform development emphasizes a combination of our technologies to create increased value solutions for our customers. The emphasis with new opportunities has evolved from being an individual component provider to becoming a solutions provider whereby the new opportunities utilize multiple Allied Motion technologies in a system solution approach. We believe this approach will allow us to provide increased value to our customers and improved margins for our Company. Our strong financial condition, along with AST continuous improvement initiatives in quality, delivery, and cost allow us to have a positive outlook for the continued long-term growth of our Company.
Outlook for 2021
During 2020, we were able to navigate a difficult environment related to the COVID-19 pandemic, while advancing our strategic priorities and delivering solid results. Our fourth quarter 2020 performance was supported by record orders driven by favorable trends within our Medical markets, and exceptional engagement and focus on executing a significant recovery in our Vehicle market. This demand, combined with supply chain constraints, resulted in some inefficiencies and unintended costs as our teams worked hard to support and meet customer demand and schedules. We also felt the impact of tariffs given the expiration of certain exemptions during the fourth quarter. Ultimately, we believe we can mitigate these costs over time, though their impact is expected to continue over the coming quarters of 2021.
While the economic outlook for 2021 remains uncertain, we believe we are in a strong operational, financial and reputational position. Our record level of backlog, diversified end market penetration and demonstrated agility position us well to perform across varied market trends and give us confidence that we can drive further efficiency, profitable growth and enhanced free cash flow while delivering long-term value for our shareholders.
In 2021, we will continue to focus on leveraging our resources to expand our business in our served markets. In addition, we will continue to execute the ongoing critical issues as defined by our strategy, developed in 2017 and regularly updated since then.
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The critical issues from that strategy include:
1) Execute acquisition strategy to consolidate a fragmented market.
2) Pursue target (niche) markets where we can gain a leadership market position.
3) Develop leading edge products to meet the emerging needs of our target markets.
4) Utilize lean tools to enhance company performance.
5) Execute our long-term strategy and set aggressive growth and profitability goals to measure our success.
Allied Motion is an applied technology/know-how motion company, and to grow, we will continue to invest in the technical resources to ensure we can move forward with our mantra to “ create controlled motion solutions that change the game ” and to meet the emerging needs of our customers in our served market segments. We anticipate that our investment in these key resources will continue to drive our growth now and in the future. We expect to continue the shift from being a component supplier to a more complete solutions provider, along with the application of AST, to drive cost reduction.
Our global production footprint provides us with the opportunity to be a value added supplier for global companies who require support around the world. We will continue to evaluate and find areas to leverage our current manufacturing and sales footprint to drive sales and improve efficiencies.
In addition to our strategy described above, time and resources will be spent to further understand the ESG ecosystem and developments impacting stakeholder expectations. While the Company has a number of initiatives focused on individual components of ESG, we will begin to integrate ESG with our broader strategy and Enterprise Risk Management (ERM). The strategy will include looking to further enhance the Company’s ability to meet ongoing and emerging challenges, including the impacts of the COVID-19 pandemic.
Critical Accounting Estimates
Management’s discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements which have been prepared in accordance with Generally Accepted Accounting Principles (“GAAP”). We make estimates and assumptions in the preparation of our consolidated financial statements that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. We base our estimates and judgments upon historical experience and other factors that are believed to be reasonable under the circumstances. Changes in estimates or assumptions could result in a material adjustment to the consolidated financial statements.
We have identified several critical accounting estimates. An accounting estimate is considered critical if both: (a) the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment involved, and (b) the impact of changes in the estimates and assumptions would have a material effect on the consolidated financial statements. This listing is not a comprehensive list of all of our accounting policies. For further information regarding the application of these and other accounting policies, See Note 1, Business and Summary of Significant Accounting Policies of the notes to consolidated financial statements contained in Item 8 of this report for additional information.
The Company’s critical accounting estimates include:
Revenue Recognition
The Company considers control of most products to transfer at a single point in time when control is transferred to the customer, generally when the products are shipped in accordance with an agreement and/or purchase order. Control is defined as the ability to direct the use of and obtain substantially all of the remaining benefits of the product. The Company satisfies its performance obligations under a contract with a customer by transferring goods and services generally in exchange for monetary consideration from the customer. The Company considers the customer’s purchase order, and the Company’s corresponding sales order acknowledgment as the contract with the customer. In the normal course of business, the Company does not accept product returns unless the item is defective as manufactured. The
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Company establishes provisions for estimated returns and warranties. All contracts include a standard warranty clause to guarantee that the product complies with agreed specifications.
At December 31, 2020 and 2019, the accrual for future warranty obligations was $1,571 and $1,075, respectively. The Company’s expense (income) for warranty obligations was $34 in 2020, $210 in 2019, and ($13) in 2018, respectively. The length of the warranty period for the Company’s products is generally three months to two years and varies significantly based on the product sold. The Company calculates its warranty expense provision based on its historical warranty experience and adjustments are made periodically to reflect actual warranty expenses. If actual future sales returns and allowances are higher than the Company’s historical experience, additional accruals may be required.
Inventories
Inventories are measured on a first-in, first-out basis at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Inventory costing requires complex calculations that include assumptions for overhead absorption, scrap, sample calculations, manufacturing yield estimates, costs to sell, and the determination of which costs may be capitalized. The valuation of inventory requires us to estimate obsolete or excess inventory, as well as inventory that is not of saleable quality.
Historically, our inventory adjustment has been adequate to cover our losses. However, variations in methods or assumptions could have a material impact on our results. If our demand forecast for specific products is greater than actual demand and we fail to reduce manufacturing output accordingly, we could be required to record additional inventory write-down or expense a greater amount of overhead costs, which would negatively impact our net income. As of December 31, 2020, we have $62,978 of inventory recorded on our consolidated balance sheet, representing approximately 18% of total assets. A 1% write-down of our inventory would decrease our 2020 net income by approximately $458, or $0.05 per diluted share.
Valuation of Goodwill and Other Long-Lived Assets
We make assumptions in establishing the carrying value, fair value and, if applicable, the estimated lives of our goodwill, intangible and other long-lived assets. Goodwill and intangible assets determined to have an indefinite useful life are not amortized. Instead, these assets are evaluated for impairment on an annual basis and whenever events or business conditions change that could indicate that the asset is impaired. Definite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset (asset group) may not be recoverable.
Evaluation of goodwill for impairment
We test the reporting unit’s goodwill for impairment as of October 31 st of each fiscal year and between annual tests if an event occurs or circumstances change that may indicate that the fair value of the reporting unit is below its carrying value. In conducting this annual impairment testing, we may first perform a qualitative assessment of whether it is more-likely-than-not that a reporting unit’s fair value is less than its carrying value. If not, no further goodwill impairment testing is required. If it is more-likely-than-not that the reporting unit’s fair value is less than its carrying value, or if we elect not to perform a qualitative assessment of a reporting unit, a quantitative analysis is performed, in which the fair value of the reporting unit is compared to its net book value. If the net book value of the reporting unit exceeds its fair value, an impairment loss is recognized equal to the excess, limited to the amount of goodwill allocated to that reporting unit.
We performed a qualitative assessment of our single reporting unit as of October 31, 2020. As part of this analysis, we evaluated factors including, but not limited to, our market capitalization and stock price performance, macro-economic conditions, market and industry conditions, cost factors, the competitive environment, and the operational stability and overall financial performance of our reporting unit. The assessment indicated that it was more likely than not that the fair value of our reporting unit exceeded its respective carrying value, and as such, a quantitative assessment was not required.
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We do not believe that our reporting unit is at risk for impairment. However, changes to the factors considered above could affect the estimated fair value of our reporting unit and could result in a goodwill impairment charge in a future period. As of December 31, 2020, we have $61,860 of goodwill recorded on our consolidated balance sheet, representing approximately 18% of total assets. A 1% write-down of our goodwill would decrease our 2020 net income approximately $450, or $0.05 per diluted share.
Business Combinations
The Company allocates the purchase price of an acquired company, including when applicable, the acquisition date fair value of contingent consideration between tangible and intangible assets acquired and liabilities assumed from the acquired business based on their estimated fair values, with the residual of the purchase price recorded as goodwill. Third party appraisal firms and other consultants are engaged to assist management in determining the fair values of certain assets acquired and liabilities assumed. Estimating fair values requires significant judgments, estimates and assumptions, including but not limited to: discount rates, future cash flows and the economic lives of trade names, technology, customer relationships, and property, plant and equipment. These estimates are based on historical experience and information obtained from the management of the acquired companies and are inherently uncertain.
Stock-based Compensation
Compensation expense for time-based restricted stock units is measured at the grant date and recognized ratably over the vesting period. We determine the fair value of time-based and performance-based restricted stock units based on the closing market price of our common stock on the grant date. The recognition of compensation expense associated with performance-based restricted stock units requires judgment in assessing the probability of meeting the performance goals, as well as defined criteria for assessing achievement of the performance-related goals. For purposes of measuring compensation expense, the number of shares ultimately expected to vest is estimated at each reporting date based on management’s expectations regarding the relevant performance criteria. The performance shares begin vesting only upon the achievement of the performance criteria. The achievement of the performance goals can impact the valuation and associated expense of the restricted stock units.
The assumptions used in accounting for the share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if circumstances change and we use different assumptions, our stock-based compensation expense could be materially different in the future.
Impact of Recently Issued Accounting Pronouncements
In the normal course of business, we evaluate all new accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”), Securities and Exchange Commission (“SEC”), Emerging Issues Task Force (“EITF”) or other authoritative accounting bodies to determine the potential impact they may have on our consolidated financial statements. See Note 1, Business and Summary of Significant Accounting Policies of the notes to consolidated financial statements contained in Item 8 of this report for additional information about these recently issued accounting standards and their potential impact on our financial condition or results of operations.
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Operating Results
The following discussion is a comparison between fiscal year 2020 and fiscal year 2019 results. For a discussion of our results of operations for the year ended December 31, 2019 compared to the year ended December 31, 2018, please refer to Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, which was filed with the SEC on March 11, 2020.
Year 2020 compared to 2019
For the year ended
2020 vs. 2019
December 31,
Variance
(Dollars in thousands, except per share data)
2020
2019
$
%
Revenues
$
366,694
$
371,084
$
(4,390)
(1)
%
Cost of goods sold
258,119
258,500
(381)
(0)
%
Gross profit
108,575
112,584
(4,009)
(4)
%
Gross margin percentage
29.6
%
30.3
%
Operating costs and expenses:
Selling
15,392
16,536
(1,144)
(7)
%
General and administrative
38,301
37,688
613
2
%
Engineering and development
25,487
23,086
2,401
10
%
Business development
473
113
360
319
%
Amortization of intangible assets
5,928
5,718
210
4
%
Total operating costs and expenses
85,581
83,141
2,440
3
%
Operating income
22,994
29,443
(6,449)
(22)
%
Interest expense
3,716
5,134
(1,418)
(28)
%
Other expense, net
502
468
34
7
%
Total other expense
4,218
5,602
(1,384)
(25)
%
Income before income taxes
18,776
23,841
(5,065)
(21)
%
Provision for income taxes
(5,133)
(6,819)
1,686
(25)
%
Net income
$
13,643
$
17,022
$
(3,379)
(20)
%
Effective tax rate
27.3
%
28.6
%
(1.3)
(5)
%
Diluted earnings per share
$
1.43
$
1.80
$
(0.37)
(21)
%
Bookings
$
370,712
$
366,103
$
4,609
1
%
Backlog
$
141,344
$
124,950
$
16,394
13
%
REVENUES: During 2020, the decrease in revenues reflects growth in the Medical market, including the contribution from Dynamic Controls, offset by declines in all other markets we serve due to reduced demand as a result of the global economic impact of the COVID-19 pandemic. Our sales for 2020 were comprised of 53% to US customers and 47% to customers primarily in Europe, Canada and Asia. The overall decrease in revenue was due to a 1.7% volume decrease partially offset with a 0.5% favorable currency impact. See information included in “Non – GAAP Measures” below for a discussion of the non-GAAP measure and reconciliation of revenue to revenue excluding foreign currency impacts.
ORDER BOOKINGS AND BACKLOG: The increase in orders in 2020 compared to 2019 is due to a 0.8% increase in volume and a 0.5% favorable currency impact. The order volume increases are primarily due to increases in the Medical market, offset by reduced demand in all other markets. The increase in backlog is largely attributable to the Medical market. Included in the current backlog is approximately $8 million of the previously announced $325 million of Vehicle market awards. The Company has begun shipments for the first of four, seven-year awards, and all four awards are expected to concurrently be at full rate production in 2024.
GROSS PROFIT AND GROSS MARGIN: The 4% decrease in gross profit was largely driven by reduced volume in our served markets and additional fixed costs associated with Dynamic Controls. The 70 basis point decline in gross margin
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was due to the impact of lower revenue and higher tariffs, freight, and duties related primarily to the COVID-19 pandemic, offset partially by c ost containment efforts also related to the COVID-19 pandemic .
SELLING EXPENSES: Selling expenses declined 7% during 2020 compared to last year. The addition of expenses from Dynamic Controls was offset by cost control efforts related to the COVID-19 pandemic, specifically travel restrictions . Selling expenses as a percentage of revenues were 4% for both 2020 and 2019.
GENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses increased by 2% during 2020 compared to 2019 due to the incremental expenses from Dynamic Controls and costs associated with ensuring employee safety and making other adjustments for the COVID-19 pandemic, partially offset by reduced incentive compensation and travel costs . As a percentage of revenues, general and administrative expenses were 10% for both 2020 and 2019.
ENGINEERING AND DEVELOPMENT EXPENSES: Engineering and development expenses increased by 10% in 2020 compared to 2019. The increase is partially due to the addition of Dynamic Controls, whose focus is electronics and software engineering, and partially due to the continued ramp up of development projects to meet the future needs of target markets, as well as supporting growing customer application development needs. As a percentage of revenues, engineering and development expenses increased to 7% for 2020 from 6% for 2019.
BUSINESS DEVELOPMENT COSTS: The Company incurred $473 of business development costs during 2020 related to the acquisition of Dynamic Controls. The Company incurred $113 of business development costs during 2019.
AMORTIZATION OF INTANGIBLE ASSETS: Amortization of intangible assets increased 4% in 2020 compared to 2019, from $5,718 to $5,928 due to the addition of Dynamic Controls.
INTEREST EXPENSE: Interest expense decreased by 28% in 2020 compared to 2019 as the increase in our outstanding debt was offset by lower interest rates .
INCOME TAXES: The effective income tax rate as a percentage of income before income taxes was 27.3% and 28.6% for the year ended December 31, 2020 and 2019, respectively. For the year ended December 31, 2019, the effective tax rate included a discrete tax provision of 1.8% related to settlement of a tax audit in a foreign jurisdiction. The effective rate before discrete items varies from the statutory rate primarily due to differences in state taxes, the impact of international tax provisions in the US, the difference in US and foreign tax rates and the mix of foreign and domestic income, section 162(m) compensation limits, and the benefit from the R&D tax credit. Refer to Note 9, Income Taxes, of the notes to consolidated financial statements for a reconciliation of statutory rates to tax provision rates.
NET INCOME AND ADJUSTED NET INCOME: Net income decreased during 2020 compared to the same period in 2019 reflecting lower revenue resulting from the COVID-19 pandemic’s impact on volume and the resulting impact to margins along with increased operating expenses resulting from the Dynamic Controls acquisition .
Adjusted net income for the years ended December 31, 2020, and 2019 was $14,315 and $17,999, respectively. Adjusted diluted earnings per share for 2020 and 2019 were $1.50 and $1.90, respectively. Adjusted net income and adjusted diluted earnings per share are non-GAAP measures. Adjusted net income for 2020 excludes $1,035 ($752 net of tax) and for 2019 excludes $111 ($79 net of tax) of foreign currency losses. Adjusted net income for 2020 excludes a non-income based tax assessment gain of $424. Adjusted net income for 2019 excludes the non-income based tax assessment of $384 and the income tax charge of $433 related to a tax assessment in a foreign jurisdiction. Adjusted net income for 2020 excludes $473 ($344 net of tax) and for 2019 excludes $113 ($81 net of tax) of business development costs. See information included in “Non–GAAP Measures” below for a discussion of the non-GAAP measure and reconciliation of net income to Adjusted net income and diluted earnings per share to Adjusted diluted earnings per share.
EBITDA AND ADJUSTED EBITDA: EBITDA was $38,477 for 2020 compared to $43,832 for 2019. Adjusted EBITDA was $43,111 and $47,643 for 2020 and 2019, respectively. EBITDA and Adjusted EBITDA are non-GAAP measures. EBITDA consists of income before interest expense, provision for income taxes, and depreciation and amortization. Adjusted EBITDA also excludes stock compensation expense, foreign currency gain/loss and certain other items. Refer to information included in “Non-GAAP Measures” below for a discussion of the non-GAAP measure and a reconciliation of net income to EBITDA and Adjusted EBITDA.
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Non-GAAP Measures
Revenue excluding foreign currency exchange impacts, EBITDA and Adjusted EBITDA are provided for information purposes only and are not measures of financial performance under GAAP.
Management believes the presentation of these financial measures reflecting non-GAAP adjustments provides important supplemental information in evaluating the operating results of the Company as distinct from results that include items that are not indicative of ongoing operating results; in particular, those charges and credits that are not directly related to operating unit performance, and that are not a helpful measure of the performance of our underlying business particularly in light of their unpredictable nature. These non-GAAP disclosures have limitations as analytical tools, should not be viewed as a substitute for revenue and net income determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of the Company’s results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies. In addition, supplemental presentation should not be construed as an inference that the Company’s future results will be unaffected by similar adjustments to net income determined in accordance with GAAP.
The Company believes that revenue excluding foreign currency exchange impacts is a useful measure in analyzing organic sales results. The Company excludes the effect of currency translation from revenue for this measure because currency translation is not under management’s control, is subject to volatility and can obscure underlying business trends. The portion of revenue attributable to currency translation is calculated as the difference between the current period revenue and the current period revenue after applying foreign exchange rates from the prior period.
The Company believes EBITDA is often a useful measure of the Company’s operating performance and is a significant basis used by the Company’s management to measure the operating performance of the Company’s business because EBITDA excludes charges for depreciation, amortization and interest expense that have resulted from our debt financings, as well as our provision for income tax expense. EBITDA is frequently used as one of the bases for comparing businesses in the Company’s industry.
The Company also believes that Adjusted EBITDA provides helpful information about the operating performance of its business. Adjusted EBITDA excludes stock compensation expense, foreign currency gain/loss as well as certain income or expenses which are not indicative of the ongoing performance of the Company. EBITDA and Adjusted EBITDA do not represent and should not be considered as an alternative to net income, operating income, net cash provided by operating activities or any other measure for determining operating performance or liquidity that is calculated in accordance with GAAP.
The Company’s calculation of revenues excluding foreign currency exchange impacts for 2020 and 2019 is as follows (in thousands):
For the year ended December 31,
2020
2019
Revenue as reported
$
366,694
$
371,084
Currency impact (favorable) unfavorable
(1,811)
7,845
Revenue excluding foreign currency exchange impacts
$
364,883
$
378,929
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The Company’s calculation of EBITDA and Adjusted EBITDA for 2020 and 2019 is as follows:
Year ended
December 31,
2020
2019
Net income as reported
$
13,643
$
17,022
Interest expense
3,716
5,134
Provision for income tax
5,133
6,819
Depreciation and amortization
15,985
14,857
EBITDA
38,477
43,832
Stock compensation expense
3,550
3,203
Business development costs
473
113
Foreign currency loss
1,035
111
Non income-based tax (refund) assessment
(424)
384
Adjusted EBITDA
$
43,111
$
47,643
Allied Motion’s management uses Adjusted net income and Adjusted diluted earnings per share to assess the Company’s consolidated financial and operating performance. Adjusted net income and Adjusted diluted earnings per share are provided for informational purposes only and are not a measure of financial performance under GAAP. These measures help management make decisions that are expected to facilitate meeting current financial goals as well as achieving optimal financial performance. Adjusted net income provides management with a measure of financial performance of the Company based on operational factors as it removes the impact of certain non-routine items from the Company’s operating results. Adjusted diluted earnings per share provides management with an indication of how Adjusted net income would be reflected on a per share basis for comparison to the GAAP diluted earnings per share measure. Adjusted net income is a key metric used by senior management and the Company’s board of directors to review the consolidated financial performance of the business. This measure adjusts net income determined in accordance with GAAP to reflect changes in financial results associated with the highlighted charges and income items.
The Company’s calculation of Adjusted net income and Adjusted diluted earnings per share for years ended December 31, 2020 and 2019 is as follows:
For the year ended
December 31,
Per diluted
Per diluted
2020
share
2019
share
Net income as reported
$
13,643
1.43
$
17,022
$
1.80
Non-GAAP adjustments, net of tax
Non-income based tax assessment
(424)
(0.04)
384
0.04
Income tax provision charge
—
—
433
0.05
Foreign currency loss - net
752
0.08
79
0.01
Business development costs - net
344
0.04
81
0.01
Non-GAAP adjusted net income
$
14,315
$
1.50
$
17,999
$
1.90
Liquidity and Capital Resources
The Company’s liquidity position as measured by cash and cash equivalents increased by $9,715 to a balance of $23,131 at December 31, 2020 from 2019.
Year Ended December 31,
2020 vs. 2019
2020
2019
$
Net cash provided by operating activities
$
24,838
$
34,530
$
(9,692)
Net cash used in investing activities
(24,099)
(14,882)
(9,217)
Net cash provided by (used in) financing activities
7,489
(14,777)
22,266
Effect of foreign exchange rates on cash
1,487
(128)
1,615
Net increase in cash and cash equivalents
$
9,715
$
4,743
$
4,972
Of the $23,131 cash and cash equivalents on hand at December 31, 2020, $21,371 was located at our foreign entities and may be subject to withholding tax if repatriated back to the U.S.
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During 2020, the decrease in cash provided by operating activities as compared to 2019 was equally impacted by net income, accrued liabilities, and inventories. Moreover, inventories in 2020 increased due to the push out of orders related to the COVID-19 pandemic, building inventory for new product launches and purchasing additional inventory in order to secure supply. Accrued expenses in 2020 decreased based on timing of income tax payments and reduced amounts of incentive compensation.
The significant cash used in investing activities in 2020 reflects the acquisition of Dynamic Controls for $14,728 net of cash acquired. Purchases of property and equipment were $9,371 in 2020 compared to $14,882 during 2019 reflecting cash preservation efforts during the COVID-19 pandemic.
The increase in cash provided by financing activities reflects the Amended Revolving Facility borrowing for the acquisition of Dynamic Controls for approximately $26,000 in the first quarter of 2020. Subsequent to the acquisition, we have made payments of $16,897 on the Amended Revolving Facility. During 2019, the Company utilized revolver borrowings to fund working capital needed to support growth, and for the payment of normal year-end accruals. At December 31, 2020, we had $120,656 of obligations under the Amended Revolving Facility, excluding deferred financing costs.
The Amended Credit Agreement contains certain financial covenants related to minimum interest coverage and total leverage ratio at the end of each quarter. The Amended Credit Agreement also includes other covenants and restrictions, including limits on the amount of additional indebtedness, and restrictions on the ability to merge, consolidate or sell all or substantially all our assets. We were in compliance with all covenants at December 31, 2020.
As of December 31, 2020, the unused Amended Revolving Facility was $104,344. The amount available to borrow may be lower and may vary from period to period based upon our debt and EBITDA levels, which impacts our covenant calculations. The Amended Credit Agreement matures in February 2025.
There were no borrowings for the China Facility balance during 2020 or 2019.
The Company declared dividends of $0.03 per share during each quarter of 2020 and 2019. The Company’s working capital, capital expenditure and dividend requirements are expected to be funded from cash provided by operations and amounts available under the Amended Credit Agreement (refer to Note 7, Debt Obligations , of the notes to consolidated financial statements for definition and terms).
Although there is uncertainty related to the anticipated impact of the COVID-19 pandemic on our future results, we believe our diverse market channel strategy and the steps we have taken to strengthen our balance sheet, such as retaining cash to support shorter term needs and extending the maturity of our revolving credit facility leaves us well-positioned to manage our business through the crisis as it continues to unfold. Based on our analysis, we believe our existing balances of cash, the flexibility of our Amended Credit Agreement and our currently anticipated operating cash flows will be sufficient to meet our cash needs arising in the ordinary course of business for the next twelve months.
Contractual Obligations
The following table summarizes contractual obligations and borrowings as of December 31, 2020 and the timing and effect that such commitments are expected to have on our liquidity and capital requirements in future periods. We expect to fund other commitments primarily with operating cash flows generated in the normal course of business. At December 31, 2020, our long-term contractual obligations were limited to debt and leases.
Payments Due by Period
Less Than 1
More Than 5
Total
Year
1 - 3 Years
3 - 5 Years
Years
Operating leases
$
20,975
$
5,043
$
6,948
$
4,378
$
4,606
Debt Obligations (1)
120,656
—
—
120,656
—
Interest on Debt (2)
12,243
3,281
5,743
3,219
—
Total
$
153,874
$
8,324
$
12,691
$
128,253
$
4,606
(1) Amounts represent our debt obligations as of December 31, 2020.
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(2) Amounts represent the estimated interest payments based on the balances as of December 31, 2020 and applicable interest rates under the Amended Revolving Facility.
Item 7A. Qualitative and Quantitative Disclosures about Market Risk
Foreign Currency
We have international operations in The Netherlands, Sweden, Germany, China, Portugal, Canada, Czech Republic, Mexico, the United Kingdom and New Zealand which expose us to foreign currency exchange rate fluctuations due to transactions denominated in Euros, Swedish Krona, Chinese Renminbi, Canadian dollar, Czech Krona, Mexican pesos, British Pound Sterling, and New Zealand dollar, respectively. We continuously evaluate our foreign currency risk and we take action from time to time in order to best mitigate these risks. A hypothetical 10% change in the value of the U.S. dollar in relation to our most significant foreign currency exposures would have had an impact of approximately $15,200 on our 2020 sales. This amount is not indicative of the hypothetical net earnings impact due to partially offsetting impacts on cost of sales and operating expenses in those currencies. We estimate that foreign currency exchange rate fluctuations increased sales in 2020 compared to 2019 by approximately $1,800.
We translate all assets and liabilities of foreign operations, where the U.S. dollar is not the functional currency, at the period-end exchange rate and translate sales and expenses at the average exchange rates in effect during the period. The net effect of these translation adjustments is recorded in the consolidated financial statements as comprehensive income. The translation adjustment was a gain of $8,410 for 2020 and a loss of $680 for 2019. Translation adjustments are not adjusted for income taxes as they relate to permanent investments in our foreign subsidiaries. A hypothetical 10% change in the value of the U.S. dollar in relation to our most significant foreign currency net assets would have had an impact of approximately $10,000 and $7,000 on our foreign net assets as of December 31, 2020 and 2019, respectively.
To the extent that our monetary assets and liabilities, including short-term and long-term intercompany loans, are recorded in a currency other than the functional currency of the subsidiary, these amounts are remeasured each period at the period-end exchange rate, with the resulting gain or loss recorded in other expense, net in the consolidated statement of income and comprehensive income. Net foreign currency transaction gains and losses included in total other expense, net amounted to losses of $1,035 and $111 in 2020 and 2019, respectively. In the first quarter of 2021, the Company began a hedging program to help mitigate these foreign currency transaction gains and losses. Accordingly, we expect these gains and losses to be lower in the future.
Interest Rates
Interest rates on our Amended Credit Agreement are based on the LIBOR plus a margin of 1.00% to 1.75% (1.625% at December 31, 2020) or the Prime Rate plus a margin of 0% to 0.75% (0.625% at December 31, 2020), in each case depending on the Company’s ratio of total funded indebtedness to Consolidated EBITDA. We use interest rate derivatives to add stability to interest expense and to manage our exposure to interest rate movements. We primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. In February 2017, we entered into three interest rate swaps with a combined notional amount of $40,000 that matures in February 2022. In March 2020, the Company entered into two additional interest rate swaps with a combined notional amount of $20,000 that increases to $60,000 in March 2022 and matures in December 2024.
As of December 31, 2020, we had $120,656 outstanding under the Amended Revolving Facility (excluding deferred financing fees), of which $60,000 is currently being hedged. Refer to Note 7, Debt Obligations , of the notes to consolidated financial statements for additional information about our outstanding debt. A hypothetical one percentage point (100 basis points) change in the Base Rate on the $60,656 of unhedged floating rate debt outstanding at December 31, 2020 would have an impact of approximately $607 on our interest expense for 2020. A hypothetical one percentage point (100 basis points) change in the Base Rate on the $70,085 of unhedged floating rate debt outstanding at December 31, 2019 would have had an impact of approximately $701 on our interest expense for 2019.
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