Alamo Group Inc: Form 10-Q for the period ended Sep 30, 2016

The following tables set forth, for the periods indicated, certain financial data:

Overview

This report contains forward-looking statements that are based on Alamo Group’s current expectations. Actual results in future periods may differ materially from those expressed or implied because of a number of risks and uncertainties which are discussed below and in the Forward-Looking Information section.

For the first nine months of 2016, the Company's net income was up approximately 2.0% when compared to the same period in 2015. This increase was primarily the result of continued improvement in production efficiencies, lower material costs and control of operating expenses. Negatively influencing both our sales and profits was the effect of the currency translation rates on our non-U.S. results. Alamo's Industrial Division saw less than a 1.0% decrease in sales for the first nine months of 2016 as sales of mowing, excavator, sweeping equipment and to a lessor extent, snow removal products outperformed the same period in 2015, while sales of vacuum trucks declined during the first nine months of 2016 compared to the same period in 2015. Agricultural sales were down in the first nine months of 2016 by 2.1% compared to the first nine months of 2015 as soft market conditions continue to affect the agricultural market. European sales for the first nine months of 2016 were down in U.S. dollars by 8.6% compared to the same period in 2015. Consolidated income from operations was up 6.2% in the first nine months of 2016 as compared to the same period in 2015. The Company's backlog was $137 million at the end of the first nine months of 2016, which was down 21.5% versus the backlog of $175 million at the end of the first nine months of 2015. The decrease in the Company's backlog was primarily attributable to softness in the Industrial Division's vacuum truck orders from non-governmental end users, weak markets in the Agricultural Division and challenging economic conditions and unfavorable foreign currency translation affecting new orders in the European Division, and to a lesser extent, high prior year backlogs of initial orders related to new product introductions.

The Company believes that its markets for the remainder of 2016 will remain soft and could be negatively affected by a variety of factors such as a continued weakness in the overall economy, sovereign debt issues, credit availability, changes in currency exchange rates, increased levels of government regulations; ongoing weakness in the agricultural sector; changes in farm incomes due to commodity prices or governmental aid programs; adverse situations that could affect our customers such as animal disease epidemics, extreme weather conditions; repercussions from the proposed exit by the U.K. from the European Union (Brexit); budget constraints or revenue shortfalls in governmental entities and changes in our customers' buying habits due to lack of confidence in the economic outlook.

Results of Operations

Three Months Ended September 30, 2016 vs. Three Months Ended September 30, 2015

Net sales for the third quarter of 2016 were $216,766,000, a decrease of $14,848,000, or 6.4% compared to $231,614,000 for the third quarter of 2015. The decrease was mainly attributable to weak demand for vacuum trucks, soft agricultural markets, continued weakness in the European economy and currency translation effects all of which continued to negatively impact our sales. Sales in the Industrial Division were down 4.9% as increased sales of sweepers, mowing equipment and snow removal equipment failed to offset decreased sales of vacuum trucks due to soft non-governmental demand. Sales in the Agricultural Division were down 4.2% during the quarter as continued weakness in the agricultural market and low commodity prices impacted this Division. European sales were down 13.7% as currency translation rates negatively affected the sales of U.K. and European products.

Net Industrial sales decreased during the third quarter by $6,180,000 or 4.9% to $121,205,000 for 2016 compared to $127,385,000 during the same period in 2015. The decrease was due to softness in the vacuum trucks market to non-governmental end users. Increases in sweepers, excavators, mowing equipment and to a lessor extent, snow removal equipment were not enough to offset the lower vacuum truck sales.

Net Agricultural sales were $56,443,000 in the third quarter of 2016 compared to $58,919,000 for the same period in 2015, a decrease of $2,476,000 or 4.2%. Weak agricultural market conditions and low commodity prices continued to negatively affect farm income which limited farmers' ability to purchase new equipment.

Net European sales for the third quarter of 2016 were $39,118,000, a decrease of $6,192,000 or 13.7% compared to $45,310,000 during the third quarter of 2015. Just over half of the decrease resulted from changes in currency translation rates which had a negative impact during the quarter. Industrial sales in France were up compared to the third quarter of 2015 as a result of increased sales of Rivard vacuum trucks while sales in the French agricultural markets reflected a slight increase. U.K. sales were down in the third quarter of 2016 compared to the third quarter of 2015 as demand for mowing products were impacted by the uncertainty surrounding the recent Brexit vote in the U.K. and continued softness in agricultural markets we serve.

Gross profit for the third quarter of 2016 was $54,711,000 (25.2% of net sales) compared to $57,509,000 (24.8% of net sales) during the same period in 2015, a decrease of $2,798,000. The decrease in gross profit during the third quarter of 2016 was due to the lower sales volume from all three divisions partially offset by continuous improvement in production efficiencies, as well as lower material costs, which helped drive up margin percent for the quarter. Negatively impacting the gross profit and margin percent during the third quarter of 2015 was $209,000 in higher cost of goods sold related to the step-up in fair value of inventory in the Specialized business units.

Selling, general and administrative expenses (“SG&A”) were $33,699,000 (15.5% of net sales) during the third quarter of 2016 compared to $33,939,000 (14.7% of net sales) during the same period of 2015, a decrease of $240,000 which relates to a non recurring system conversion in the amount of $341,000 recognized in 2015.

Interest expense was $1,405,000 for the third quarter of 2016 compared to $1,671,000 during the same period in 2015, a decrease of $266,000. The decrease in 2016 came from lower debt levels during the third quarter of 2016 compared to the third quarter of 2015.

Other income (expense), net was $127,000 of income for the third quarter of 2016 compared to $895,000 of income during the same period in 2015. The income in 2016 and 2015 were primarily the result of changes in exchange rates.

Provision for income taxes was $6,541,000 (33.1%) in the third quarter of 2016 compared to $8,065,000 (35.3%) during the same period in 2015. The decrease in taxes is from lower taxable income in the third quarter of

2016. The lower effective tax rate in 2016 is primarily related to a lower portion of our taxable income being generated in jurisdictions with higher tax rates.

The Company’s net income after tax was $13,236,000 or $1.14 per share on a diluted basis for the third quarter of 2016 compared to $14,756,000 or $1.28 per share on a diluted basis for the third quarter of 2015. The decrease of $1,520,000 resulted from the factors described above.

Nine Months Ended September 30, 2016 vs. Nine Months Ended September 30, 2015

Net sales for the first nine months of 2016 were $639,226,000, a decrease of $15,920,000 or 2.4% compared to $655,146,000 for the first nine months of 2015. Just over half of the decrease was from currency translation effects. In the Industrial Division, excavators, sweepers, mowing equipment and to a lesser extent, snow removal products were up in the first nine months of 2016 compared to the first nine months of 2015, however sales of vacuum trucks specifically to non-governmental end users were down due to soft market conditions. Agricultural Division sales were down 2.1% for the first nine months of 2016 due to a continued weak agricultural market compared to the same period in 2015. Sales in the European Division were down 8.6% as sales of products manufactured in the U.K. were negatively affected by soft market conditions and currency translation rates which the Company believed was due, in part, to the uncertainty created by the recent Brexit vote in the U.K.

Net Industrial sales decreased during the first nine months by $1,189,000 or 0.3% to $361,629,000 for 2016 compared to $362,818,000 during the same period in 2015. The decrease came from lower vacuum trucks sales to non-governmental end users. Increased sales from sweeper, excavator, mowing equipment and snow removal equipment product lines were not enough to offset the decline in sales of vacuum truck products.

Net Agricultural sales were $156,950,000 during the first nine months of 2016 compared to $160,357,000 for the same period in 2015, a decrease of $3,407,000 or 2.1%. The decrease in sales for the first nine months of 2016 compared to the first nine months of 2015 was from the continued softness in the overall agricultural market.

Net European sales for the first nine months of 2016 were $120,647,000, a decrease of $11,324,000 or 8.6% compared to $131,971,000 during the same period of 2015. Over half of the decrease in 2016 was due to the negative affect from currency translation rates. The European Division continued to be faced with challenging market conditions in the U.K. Rivard vacuum equipment and the French agricultural products had increased sales compared to the first nine months of 2015 from improvements in operational execution.

Gross profit for the first nine months of 2016 was $157,166,000 (24.6% of net sales) compared to $153,711,000 (23.5% of net sales) during the same period in 2015, an increase of $3,455,000. Despite lower sales volume, the gross profit increase was due to continuous improvement in production efficiencies as well as lower material costs. Negatively affecting both the gross profit and margin percent during the first nine months of 2015 was $2,740,000 in higher cost of goods sold related to the step-up in fair value of inventory in the Specialized business units.

SG&A were $101,824,000 (15.9% of net sales) during the first nine months of 2016 compared to $101,578,000 (15.5% of net sales) during the same period of 2015, an increase of $246,000. The increase in SG&A for the first nine months of 2016 was primarily the result of increased sales commissions and marketing promotion expenses during the first quarter of 2016.

Interest expense was $4,334,000 for the first nine months of 2016 compared to $5,142,000 during the same period in 2015, a decrease of $808,000. The decrease in 2016 came from the Company's efforts to reduce our borrowings which resulted in lower interest costs.

Other income (expense), net was $(253,000) of expense during the first nine months of 2016 compared to $2,243,000 of income in the first nine months of 2015. The expense in 2016 and income in 2015 were primarily the result of changes in exchange rates.

Provision for income taxes was $18,459,000 (36.3%) in the first nine months of 2016 compared to $17,529,000 (35.5%) during the same period in 2015. The increased effective tax rate in 2016 is primarily due to a higher portion of our taxable income being generated in jurisdictions with higher tax rates as well as losses incurred in certain foreign jurisdictions that did not result in a tax benefit.

The Company's net income after tax was $32,457,000 or $2.81 per share on a diluted basis for the first nine months of 2016 compared to $31,825,000 or $2.77 per share on a diluted basis for the first nine months of 2015. The increase of $632,000 resulted from the factors described above.

Liquidity and Capital Resources

In addition to normal operating expenses, the Company has ongoing cash requirements which are necessary to operate the Company’s business, including inventory purchases and capital expenditures. The Company’s inventory and accounts payable levels typically build in the first half of the year and in the fourth quarter in anticipation of the spring and fall selling seasons. Accounts receivable historically build in the first and fourth quarters of each year as a result of fall preseason sales programs and out of season sales, particularly in our Agricultural Division. Preseason sales, primarily in the Agricultural Division, help level the Company’s production during the off season.

As of September 30, 2016, the Company had working capital of $308,102,000 which represents an increase of $30,240,000 from working capital of $277,862,000 at December 31, 2015.

Capital expenditures were $7,201,000 for the first nine months of 2016, compared to $7,030,000 during the first nine months of 2015. The Company expects to fund future expenditures from operating cash flows or through its revolving credit facility, described below.

Net cash used by financing activities was $10,523,000 and $15,659,000 during the nine month periods ended September 30, 2016 and September 30, 2015, respectively. The decrease in net cash used by financing activities in 2016 resulted from a decrease in net repayments under our bank credit facility due to seasonal funding of operations.

The Company had $52,314,000 in cash and cash equivalents held by its foreign subsidiaries as of September 30, 2016. The majority of these funds are at our U.K. and Canadian subsidiaries and would not be available for use in the United States without incurring US federal and state tax consequences. The Company plans to use these funds for capital expenditures or acquisitions outside the United States.

The Company maintains an unsecured revolving credit facility with certain lenders under its Amended and Restated Revolving Credit Agreement ("the Agreement"). The aggregate commitments from lenders under the Agreement is $250,000,000 and, subject to certain conditions, the Company has the option to request an increase in aggregate commitments of up to an additional $50,000,000. The Agreement requires the Company to maintain various financial covenants including a minimum earnings before interest and tax to interest expense ratio, a maximum leverage ratio and a minimum asset coverage ratio. The Agreement also contains various covenants relating to limitations on indebtedness, limitations on investments and acquisitions, limitations on sale of properties and limitations on liens and capital expenditures. The Agreement also contains other customary covenants, representations and events of defaults. The termination date of the Agreement is May 12, 2019. As of September 30, 2016, $134,000,000 was outstanding under the Agreement. On September 30, 2016, $1,311,000 of the revolver capacity was committed to irrevocable standby letters of credit issued in the ordinary course of business as required by vendors' contracts resulting in $114,689,000 in available borrowings. As of September 30, 2016, the Company was in compliance with the covenants under the Agreement.

Management believes the Agreement and the Company’s ability to internally generate funds from operations should be sufficient to meet the Company’s cash requirements for the foreseeable future. However, the challenges affecting the banking industry and credit markets in general could potentially cause changes to credit availability, which creates a level of uncertainty.

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 GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Critical Accounting Policies

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Management believes that of the Company's significant accounting policies, which are set forth in Note 1 of the Notes to Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2015 (the "2015 Form 10-K"), the policies relating to the business combinations, allowance for doubtful accounts, sales discounts, inventories-obsolete and slow moving, warranty, and goodwill and other intangible assets involved a higher degree of judgment and complexity. There have been no material changes to the nature of estimates, assumptions and levels of subjectivity and judgment related to critical accounting estimates disclosed in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Company's 2015 Form 10-K.

Off-Balance Sheet Arrangements

There are currently no off-balance sheet arrangements that have or are currently likely to have a current or future material effect on our financial condition.

Forward-Looking Information

Part I of this Quarterly Report on Form 10-Q and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item II of this Quarterly Report contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. In addition, forward-looking statements may be made orally or in press releases, conferences, reports or otherwise, in the future by or on behalf of the Company.

Statements that are not historical are forward-looking. When used by or on behalf of the Company, the words “estimate,” “believe,” “intend”, "will", "would", "should", "could" and similar expressions generally identify forward-looking statements made by or on behalf of the Company.

Forward-looking statements involve risks and uncertainties. These uncertainties include factors that affect all businesses operating in a global market, as well as matters specific to the Company and the markets it serves. Particular risks and uncertainties facing the Company include changes in market conditions; ongoing weakness in the agricultural sector; a strong U.S. dollar; increased competition; decreases in the prices of agricultural commodities, which could affect our customers' income levels; repercussions from the exit by the U.K. from the European Union; budget constraints or income shortfalls which could affect the purchases of our type of equipment by governmental customers; credit availability for both the Company and its customers, adverse weather conditions such as droughts, floods, snowstorms, etc. which can affect buying patterns of the Company’s customers and related contractors; the price and availability of critical raw materials, particularly steel and steel products; energy cost; increased cost of new governmental regulations which effect corporations; the potential effects on the buying habits of our customers due to animal disease outbreaks such as mad cow and other epidemics; the Company’s ability to develop and manufacture new and existing products profitably; market acceptance of new and existing products; the Company’s ability to maintain good relations with its employees; the Company's ability to successfully complete acquisitions and operate acquired businesses or assets; and the ability to hire and retain quality employees.

In addition, the Company is subject to risks and uncertainties facing the industry in general, including changes in business and political conditions and the economy in general in both domestic and international markets; weather conditions affecting demand; slower growth in the Company’s markets; financial market changes including increases in interest rates and fluctuations in foreign exchange rates; actions of competitors; the inability of the Company’s suppliers, customers, creditors, public utility providers and financial service organizations to deliver or provide their products or services to the Company; seasonal factors in the Company’s industry; litigation; government actions including budget levels, regulations and legislation, primarily relating to the environment, commerce, infrastructure spending, health and safety; and availability of materials.

The Company wishes to caution readers not to place undue reliance on any forward-looking statements and to recognize that the statements are not predictions of actual future results. Actual results could differ materially from those anticipated in the forward-looking statements and from historical results, due to the risks and uncertainties described above, as well as others not now anticipated. The foregoing statements are not exclusive and further information concerning the Company and its businesses, including factors that could potentially materially affect the Company’s financial results, may emerge from time to time. It is not possible for management to predict all risk factors or to assess the impact of such risk factors on the Company’s businesses.

The Company is exposed to various market risks. Market risks are the potential losses arising from adverse changes in market prices and rates. The Company does not enter into derivative or other financial instruments for trading or speculative purposes.

Foreign Currency Risk

International Sales

A portion of the Company’s operations consists of manufacturing and sales activities in international jurisdictions. The Company primarily manufactures its products in the U.S., U.K., France, Canada, Brazil and Australia. The Company sells its products primarily in the functional currency within the markets where the products are produced, but certain sales from the Company's U.K. and Canadian operations are denominated in other foreign currencies. As a result, the Company’s financials, specifically the value of its foreign assets, could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the other markets in which the subsidiaries of the Company distribute their products.

To mitigate the short-term effect of changes in currency exchange rates on the Company’s functional currency-based sales, the Company’s U.K. subsidiaries regularly enter into foreign exchange forward contracts to hedge approximately 90% of its future net foreign currency collections over a period of six months. As of September 30, 2016, the Company had $1,725,000 outstanding in forward exchange contracts related to accounts receivable. A 15% fluctuation in exchange rates for these currencies would change the fair value of these contracts by approximately $259,000. However, since these contracts hedge foreign currency denominated transactions, any change in the fair value of the contracts should be offset by changes in the underlying value of the transaction being hedged.

Exposure to Exchange Rates

The Company translates the assets and liabilities of foreign-owned subsidiaries at rates in effect at the balance sheet date. Revenues and expenses are translated at average rates in effect during the reporting period. Translation adjustments are included in accumulated other comprehensive income within the statement of stockholders’ equity. The total foreign currency translation adjustment for the current quarter decreased stockholders’ equity by $1,702,000.

The Company’s earnings are affected by fluctuations in the value of the U.S. dollar as compared to foreign currencies, predominately in European countries, as a result of the sales of its products in international markets. Forward currency contracts are used to hedge against the earnings effects of such fluctuations. The result of a uniform 10% strengthening in the value of the dollar relative to the currencies in which the Company’s sales are denominated would result in a decrease in gross profit of $4,306,000 for the nine month period ending September 30, 2016. Comparatively, the result of a uniform 10% strengthening in the value of the dollar relative to the currencies in which the Company’s sales are denominated would have resulted in a decrease in gross profit of approximately $4,120,000 for the nine month period ended September 30, 2015. This calculation assumes that each exchange rate would change in the same direction relative to the U.S. dollar. In addition to the direct effects of changes in exchange rates, which include a changed dollar value of the resulting sales, changes in exchange rates may also affect the volume of sales or the foreign currency sales price as competitors’ products become more or less attractive. The Company’s sensitivity analysis of the effects of changes in foreign currency exchange rates does not factor in a potential change in sales levels or local currency prices.

Interest Rate Risk

The Company’s long-term debt bears interest at variable rates. Accordingly, the Company’s net income is affected by changes in interest rates. Assuming the current level of borrowings at variable rates and a two percentage point change for the third quarter 2016 average interest rate under these borrowings, the Company’s interest expense would have changed by approximately $670,000. In the event of an adverse change in interest rates, management could take actions to mitigate its exposure. However, due to the uncertainty of the actions that would be taken and their possible effects this analysis assumes no such actions. Further this analysis does not consider the effects of the change in the level of overall economic activity that could exist in such an environment.

Disclosure Controls and Procedures.

An evaluation was carried out under the supervision and with the participation of Alamo’s management, including our President and Chief Executive Officer, Executive Vice President and Chief Financial Officer (Principal Financial Officer) and Vice-President and Corporate Controller, (Principal Accounting Officer), of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon the evaluation, the President and Chief Executive Officer, Executive Vice President and Chief Financial Officer (Principal Financial Officer) and Vice-President, Corporate Controller, (Principal Accounting Officer) concluded that the Company’s design and operation of these disclosure controls and procedures were effective at the end of the period covered by this report.

Changes in internal control over financial reporting

There has been no change in our internal control over financial reporting that occurred during our last fiscal year that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

There have not been any material changes from the risk factors previously disclosed in the 2015 Form 10-K for the year ended December 31, 2015 and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2016.