Alamo Group Inc: Form 10-Q for the period ended Mar 31, 2018

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 unless the context otherwise requires, the terms the "Company", "we", "our" and "us" means Alamo Group Inc..

For the first three months of 2018, the Company's net income increased by approximately 19.9% when compared to the same period in 2017. This increase was primarily the result of the Tax Cuts and Jobs Act of 2017 ("TCJA") which lowered the Company's effective tax rate to 27.0% for the first three months of 2018 compared to 34.7% for the same period in 2017. The lower tax rate resulted in an increase of approximately $1.5 million in net income. Improved sales growth in all three of the Company's Divisions and ongoing operational improvements contributed to the increase in net income as well. Also, to a lesser extent, were contributions from the acquisitions of Santa Izabel and Old Dominion completed in June of 2017 and the acquisition of RPM, which was completed in August of 2017. Alamo's Industrial Division experienced a 5.0% increase in sales for the first three months of 2018 which includes $14.5 million in net sales from Old Dominion and RPM. Sales of vacuum trucks and snow removal products outperformed the same period in 2017, while sales of mowing, sweeping and excavator equipment declined during the first three months of 2018 compared to the first three months of 2017. Sales of excavator products were negatively impacted in the first quarter of 2018 due to a labor strike at the Company's Gradall facility which began on March 12, 2018 and was settled on April 5, 2018. Normal operations resumed on April 9, 2018. Agricultural sales were up in the first three months of 2018 by 13.3% compared to the first three months of 2017 as a result of improved demand for our products despite soft agricultural market conditions. Sales from the recently acquired Santa Izabel business contributed $5.0 million to our Agricultural Division for the first three months of 2018. European sales for the first three months of 2018 were up in U.S. dollars by 25.1% compared to the same period in 2017 primarily as a result of increased demand for products in this Division. Consolidated income from operations was $21.4 million in the first three months of 2018 compared to $20.3 million for the first three months of 2017. The Company's backlog was $237.8 million at the end of the first quarter of 2018, which is an increase of 62.0% versus the backlog of $146.8 million at the end of the first quarter of 2017. The increase in the Company's backlog was primarily attributable to greater demand for our products in all three of the Company's Divisions and, to a lesser extent, the acquisitions of Santa Izabel, Old Dominion and RPM.

The Company anticipates that its markets for the remainder of 2018 will be stable. However, we remain cautious in terms of our outlook for the remainder of the year. In response to our strong backlog position we are increasing personnel and outsourcing to address short term demands and in the longer term we are increasing our capital expenditure levels to continue production efficiency gains and expand our production capacity. We have experienced a general increase in the price of raw materials and other input costs and expect inflationary pressures will persist, particularly if new tariffs are imposed, directly or indirectly, on items that we use in the manufacture of our products. We are also concerned about new tariffs that may be imposed on products that we export or on agricultural commodities, which could negatively impact the sales of our products. We may also be negatively affected by several other unanticipated factors such as a weakness in the overall economy; significant changes in currency exchange rates; negative economic impacts resulting from geopolitical events, changes in trade policy, increased levels of government regulations; weakness in the agricultural sector; acquisition integration issues; budget constraints or revenue shortfalls in governmental entities; and other risks and uncertainties as described in “Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2017 (the "2017 Form 10-K").”

Results of Operations

Three Months Ended March 31, 2018 vs. Three Months Ended March 31, 2017

Net sales for the first quarter of 2018 were $238,087,000, an increase of $22,698,000, or 10.5% compared to $215,389,000 for the first quarter of 2017. The increase was mainly attributable to $14,542,000 of revenues due to the acquisitions of Santa Izabel, Old Dominion and RPM. Also contributing to the increase in sales was a strong demand for our products in all three of the Company's Divisions.

Net Industrial sales increased by $6,351,000 or 5.0% to $132,167,000 for the first quarter of 2018 compared to $125,816,000 during the same period in 2017. The increase was primarily attributable to the acquisitions of Old Dominion and RPM which added $9,567,000 of net sales during the quarter. Negatively impacting the sales of this Division during the first quarter of 2018 was a strike at the Company's Gradall facility which began on March 12, 2018 and was settled on April 5, 2018.

Net Agricultural sales were $58,647,000 in the first quarter of 2018 compared to $51,777,000 for the same period in 2017, an increase of $6,870,000 or 13.3%. The increase primarily came from the acquisition of Santa Izabel which contributed $4,975,000 during the quarter. Also adding to the increase was improved demand for agricultural mowers in the markets we serve despite continued soft agricultural market conditions.

Net European sales for the first quarter of 2018 were $47,273,000, an increase of $9,477,000 or 25.1% compared to $37,796,000 during the first quarter of 2017. The increase was primarily driven by higher agricultural sales in both the U.K. and French product lines as well as improved sales in Rivard vacuum trucks. Also contributing to the increase was improved currency translation rates in the first quarter of 2018 compared to the first quarter of 2017.

Gross profit for the first quarter of 2018 was $60,257,000 (25.3% of net sales) compared to $54,164,000 (25.1% of net sales) during the same period in 2017, an increase of $6,093,000. The increase in gross profit during the first quarter of 2018 was due to higher equipment sales from all three Divisions and, to a lesser extent, the acquisitions of Santa Izabel, Old Dominion and RPM. Also contributing to the higher margin percentage for the quarter were ongoing productivity improvements as well as pricing actions and purchasing initiatives which offset generally higher commodity costs.

Selling, general and administrative expenses (“SG&A”) were $38,896,000 (16.3% of net sales) during the first quarter of 2018 compared to $33,913,000 (15.7% of net sales) during the same period of 2017, an increase of $4,983,000. The increase primarily came from our recently acquired Santa Izabel, Old Dominion and RPM businesses in the amount of $2,487,000 and to a lesser extent commissions and other selling expenses and higher spending on research and development projects.

Interest expense was $1,337,000 for the first quarter of 2018 compared to $1,327,000 during the same period in 2017, an increase of $10,000.

Other income (expense), net was $134,000 of expense for the first quarter of 2018 compared to $358,000 of expense during the same period in 2017. The expense in 2018 and 2017 were primarily the result of changes in currency exchange rates.

Provision for income taxes was $5,407,000 (27.0% of income before income tax) in the first quarter of 2018 compared to $6,475,000 (34.7% of income before income tax) during the same period in 2017. The decrease in both income taxes and the effective tax rate was due to the recent enactment of the TCJA that lowered the U.S. corporate tax rate from 35% to 21% for 2018.

The Company’s net income after tax was $14,583,000 or $1.24 per share on a diluted basis for the first quarter of 2018 compared to $12,167,000 or $1.05 per share on a diluted basis for the first quarter of 2017. The increase of $2,416,000 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 March 31, 2018, the Company had working capital of $386,978,000 which represents an increase of $95,814,000 from working capital of $291,164,000 at December 31, 2017. The increase in working capital was primarily due to seasonality and to a lesser extent the acquisitions of Santa Izabel, Old Dominion and RPM.

Capital expenditures were $7,645,000 for the first three months of 2018, compared to $2,257,000 during the first three months of 2017. The Company is expected to have higher capital expenditures in 2018 and will fund future expenditures from operating cash flows or through its revolving credit facility, described below.

Net cash provided by financing activities was $85,990,000 and $56,920,000 during the three month periods ended March 31, 2018 and March 31, 2017, respectively. The increase in net cash provided by financing activities in 2017 resulted from an increase in net borrowings under our bank credit facility due to seasonal funding of operations.

The Company had $73,061,000 in cash and cash equivalents held by its foreign subsidiaries as of March 31, 2018. The majority of these funds are at our European and Canadian facilities. As a result of the fundamental changes to the taxation of multinational corporations created by TCJA, we no longer intend to reinvest all of the undistributed earnings of our foreign affiliates. While the Company intends to use some of these funds for working capital and capital expenditures outside the U.S., recent changes in the U.S. tax laws have substantially mitigated the cost of repatriation. Consequently, the Company now intends to repatriate foreign cash and cash equivalents in excess of amounts needed to fund foreign operating and investing activities. Repatriated funds will initially be used to reduce funded debt levels under the Company's current credit facility and subsequently used to fund working capital, capital investments and acquisitions company-wide.

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 and bank approval, 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. Effective December 20, 2016, the Company amended its revolving credit facility to extend the termination date, reduce LIBOR interest margin and to modify certain financial and other covenants in order to meet the ongoing needs of the Company's business and to allow for greater flexibility in relation to future acquisitions. The expiration date of the revolving credit facility is December 20, 2021. As of March 31, 2018, $147,000,000 was outstanding under the Agreement. On March 31, 2018, $1,655,000 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 $101,345,000 in available borrowings. As of March 31, 2018, 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, future 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 2017 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 2017 Form 10-K.

The enactment of the TCJA on December 22, 2017 made broad and complex changes to the U.S. tax code, including a new tax law that may subject the Company to a tax on global intangible low-taxed income (“GILTI”) beginning in 2018. GILTI is a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations. Companies subject to GILTI have the option to account for the GILTI tax as a period cost if and when incurred, or to recognize deferred taxes for temporary differences including outside basis differences expected to reverse as GILTI. We are still assessing impacts GILTI may have.

As of March 31, 2018, the Company has not completed its accounting for the tax effects of the enactment of the TCJA. The Company operates in many countries throughout the world through numerous subsidiaries. In order to complete the accounting associated with the TCJA, the Company will continue to accumulate the relevant data, refine computational elements, monitor and analyze U.S. federal and state guidance if and when issued, and adjust its provisional estimates accordingly within the measurement period prescribed by SAB 118. Any adjustments could be material to income tax expense.

Off-Balance Sheet Arrangements

There are no off-balance sheet arrangements that have or are 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 2 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,” "anticipate," “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; increase in input costs; our inability to increase profit margins through continuing production efficiencies and cost reductions; repercussions from the pending exit by the U.K. from the European Union (EU); acquisition integration issues; 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 including related fines and penalties (such as the new European General Data Protection Regulation); the imposition of tariffs; negative economic impacts resulting from geopolitical events; the potential effects on the buying habits of our customers due to animal disease outbreaks 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 including Santa Izabel, Old Dominion and RPM; the ability to hire and retain quality employees; and cyber security risks affecting information technology or data security breaches.

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 March 31, 2018, the Company had $2,408,000 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 $361,000. 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 increased stockholders’ equity by $3,117,000.

The Company’s earnings are affected by fluctuations in the value of the U.S. dollar as compared to foreign currencies, predominately in Europe and Canada, 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 or 10% decrease in the value of the dollar relative to the currencies in which the Company’s sales are denominated would result in a change in gross profit of $1,844,000 for the three month period ending March 31, 2018. 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 first quarter 2018 average interest rate under these borrowings, the Company’s interest expense would have changed by approximately $735,000. 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 2017 Form 10-K for the year ended December 31, 2017.