Alamo Group Inc: Form 10-Q for the period ended Jun 30, 2021

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.

We are seeing steadily improving overall business conditions in the markets we serve and remain focused on meeting customer demand as efficiently as possible. The recent resurgence of COVID-19 variant cases is concerning and we are monitoring this situation, but we have not yet seen any new material negative impacts on our business coming from this resurgence of cases. We have experienced a slight increase in cases at several of our locations but we are currently operating at full or nearly full capacity at most of our facilities worldwide. Both new orders and backlogs in our Industrial and Agricultural Divisions continued to improve.

For the first six months of 2021, the Company's net sales increased by 13%, and net income increased by 53% compared to the same period in 2020. The increase in both net sales and net income was primarily due to a strong recovery in customer demand for our products compared to the prior year which was materially impacted by the COVID-19 pandemic. Offsetting the increase were disruptions in our supply chain, labor shortages, significant input cost inflation, logistics issues and, to a lesser extent, COVID-19 pandemic operational disruptions.

The Company's Industrial Division experienced a 7% increase in sales for the first six months of 2021 compared to the first six months of 2020 due to increased customer demand. The Division's new orders and backlog improved in all product lines, though cases of COVID-19 in certain facilities caused some operational delays. The Division's income from operations for the first six months of 2021 was up 12% versus the same period in 2020, due to increased demand and offset by supply chain issues and higher input costs on materials.

The Company's Agricultural Division sales increased in the first six months of 2021 by 26% compared to the first six months of 2020. Agricultural sales continue to rebound due to improved commodity prices, government subsidies, and increased customer demand for our products aided by lower dealer inventory. Negatively impacting this Division were supply chain disruptions and higher input costs. Notwithstanding these challenges, the Division's income from operations recorded a 61% improvement compared to the first six months of 2020.

Consolidated income from operations was $33.6 million in the first six months of 2021 compared to $22.7 million in the first six months of 2020. The 2020 first six months results included a $2.7 million non-cash inventory step-up expense related to the Morbark acquisition which was completed in October of 2019. The Company's backlog increased 132% to $503.6 million at the end of the second quarter of 2021 versus a backlog of $216.6 million at the end of the second quarter of 2020. The increase in the Company's backlog was primarily attributable to improved market conditions and an increase in customer demand for our products in both Divisions as outlined above.

We believe the COVID-19 pandemic will continue to impact our business during 2021. However, the nature and severity of the impact will remain uncertain for some time and will depend on numerous evolving factors which cannot be predicted, including the duration and scope of the pandemic, the availability, effectiveness and acceptance of treatment efforts and vaccines, and the immediate and longer term economic consequences felt by our dealers and government customers, which could result in changes in demand for our products. We are concerned about the recent resurgence of COVID-19 variant cases and the direct and indirect impacts this may have on our business for the balance of 2021. Thus far, we have not seen a significant rise in COVID-19 cases in our facilities, but a continuing resurgence of cases could negatively impact us in the future by, among other things, reducing overall customer demand or creating operational disruptions that could lead to delayed deliveries or negative cost impacts. As a consequence of the pandemic, we are still facing several challenges, most notably supply chain and logistics challenges including shipping bottlenecks (on both sea and land) and the unavailability of certain raw materials and key product components. These issues can lead to delays in shipment, cost increases and other effects that may negatively impact us. In addition, we continue to experience inflationary pressure on input costs and a difficult labor market.

While the direct and indirect consequences of the COVID-19 pandemic will certainly pose the greatest risk for the Company during 2021, the Company may also be negatively affected by several other factors such as changes in tariff regulations and the imposition of new tariffs, ongoing trade disputes, further supply chain issues, changes in U.S. fiscal policy such as changes in the federal tax rate, weakness in the overall world-wide 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" section in our Annual Report on Form 10-K for the year ended December 31, 2020 (the "2020 Form 10-K").

Results of Operations

Three Months Ended June 30, 2021 vs. Three Months Ended June 30, 2020

Net sales for the second quarter of 2021 were $347.6 million, an increase of $79.0 million or 29% compared to $268.6 million for the second quarter of 2020. Net sales during the second quarter of 2021 improved due to increased customer demand for our products versus the second quarter of 2020 which was negatively affected by the COVID-19 pandemic.

Net Industrial sales increased by $48.9 million or 27% to $231.2 million for the second quarter of 2021 compared to $182.3 million during the same period in 2020. The increase was due to strong customer demand for the Company's Industrial products and to a lessor extent pricing actions. Governmental sales were robust during the second quarter of 2021 as both state and municipal governmental budgets recovered at a faster pace than was expected, but have not yet recovered to pre-pandemic levels. Non-governmental sales were also up as forestry and tree care markets were stronger as compared to the second quarter of 2020 where those markets were materially impacted by the COVID-19 pandemic. Supply chain and logistics disruptions had an overall negative impact during the second quarter of 2021.

Net Agricultural sales were $116.3 million in the second quarter of 2021 compared to $86.4 million for the same period in 2020, an increase of $29.9 million or 35%. The increase was mainly due to the continued strengthening of the agricultural market that began in the second half of 2020 and recent price increases. This Division also experienced supply chain disruptions in the second quarter of 2021 including delays in receiving component parts from supply chain partners and logistics issues.

Gross profit for the second quarter of 2021 was $88.1 million (25% of net sales) compared to $67.8 million (25% of net sales) during the same period in 2020, an increase of $20.3 million. The increase in gross profit during the second quarter of 2021 compared to the second quarter of 2020 was due to higher sales volume. This was offset by higher input costs, mainly from steel, along with higher costs of component parts which also had a negative affect on the gross margin percentage during the second quarter of 2021. The second quarter of 2020 included $0.7 million of charges on sales of inventory that had been previously stepped-up related to the Morbark acquisition.

Selling, general and administrative expenses (“SG&A”) were $50.9 million (15% of net sales) during the second quarter of 2021 compared to $41.6 million (15% of net sales) during the same period of 2020, an increase of $9.3 million. The increase in SG&A expense in the second quarter of 2021 compared to the second quarter of 2020 was attributable to higher administrative expenses as the Company returns to pre-pandemic expense levels. Amortization expense in the second quarter of 2021 was $3.7 million compared to $3.6 million in the same period in 2020, an increase of $0.1 million.

Interest expense was $2.9 million for the second quarter of 2021 compared to $3.9 million during the same period in 2020, a decrease of $1.0 million. The decrease in interest expense during the second quarter of 2021 versus the second quarter of 2020 was attributable to the Company's continued reduction of debt levels.

Other income (expense), net was $3.3 million of income for the second quarter of 2021 compared to $1.3 million of expense during the same period in 2020. The income in 2021 was primarily the result of changes in currency exchange rates and a gain of $3.4 million from the sale of a facility in the Netherlands. The expense in 2020 was primarily the result of changes in currency exchange rates.

Provision for income taxes was $8.2 million (24% of income before income tax) in the second quarter of 2021 compared to $4.7 million (27% of income before income tax) during the same period in 2020. The decrease in the tax rate for 2021 was a result of discrete tax benefits associated with stock based compensation, and a tax benefit associated with a state audit.

The Company’s net income after tax was $26.0 million or $2.19 per share on a diluted basis for the second quarter of 2021 compared to $13.0 million or $1.10 per share on a diluted basis for the second quarter of 2020. The increase of $13.0 million resulted from the factors described above.

Six Months Ended June 30, 2021 vs. Six Months Ended June 30, 2020

Net sales for the first six months of 2021 were $658.7 million, an increase of $75.6 million or 13% compared to $583.1 million for the first six months of 2020. The increase was attributable to a strong recovery in customer demand for our products in both the Industrial and Agricultural Divisions and to a lessor extent pricing actions. The Company's performance during the first six months of 2020 were materially impacted by the COVID-19 pandemic.

Net Industrial sales increased during the first six months by $30.9 million or 7% to $443.1 million for 2021 compared to $412.2 million during the same period in 2020. The increase came from higher customer demand during the second quarter of 2021 which more than offset lower sales in the first quarter of 2021 due to the negative effects from the COVID-19 pandemic which began at the end of the first quarter of 2020. Supply chain disruptions and unfavorable input cost changes constrained this Division during the first six months of 2021.

Net Agricultural sales were $215.6 million during the first six months of 2021 compared to $170.9 million for the same period in 2020, an increase of $44.7 million or 26%. The increase in sales for the first six months of 2021 compared to the first six months of 2020 was attributable to increased customer demand aided by low dealer inventories. North American and European markets not only continued to remain strong, but Brazil and Australian markets have shown solid increases as our presence in those markets has steadily improved since early last year. This Division was also negatively affected by supply chain disruptions and higher input costs.

Gross profit for the first six months of 2021 was $164.6 million (25% of net sales) compared to $146.8 million (25% of net sales) during the same period in 2020, an increase of $17.8 million. The increase in gross profit was due to higher sales volume during the first six months of 2021. This was offset by inflationary pressures, mainly from steel, along with higher costs relating to delivery of component parts, such as airfreighting charges to meet customer deliveries. This also had a negative impact on gross margin percent for the first six months of 2021. Negatively affecting the gross margin and gross margin percentage during the first six months of 2020 was $2.7 million of charges on sales of inventory that had been previously stepped-up related to the Morbark acquisition..

SG&A expenses were $98.2 million (15% of net sales) during the first six months of 2021 compared to $92.8 million (16% of net sales) during the same period of 2020, an increase of $5.4 million. The first six months of 2021 included higher administrative expenses as the Company returns to pre-pandemic expense levels. Amortization expense in the first six months of 2021 was $7.3 million compared to $7.4 million in the same period in 2020, a decrease of $0.1 million.

Interest expense was $5.5 million for the first six months of 2021 compared to $9.5 million during the same period in 2020, a decrease of $4.0 million. The decrease during the first six months of 2021 compared to the first six months of 2020 came from the Company's continued reduction of debt levels.

Other income (expense), net was $2.6 million of income during the first six months of 2021 compared to $1.1 million of income in the first six months of 2020. The income in 2021 is primarily from changes in exchange rates and the sale of a facility in the Netherlands of $3.4 million. The income in 2020 were primarily the result of changes in exchange rates and to a lesser extent the gain on the sale of two properties, one in the U.S. and one in Canada.

Provision for income taxes was $13.3 million (23% of income before income taxes) in the first six months of 2021 compared to $10.3 million (26% of income before income taxes) during the same period in 2020. The decrease in the tax rate for 2021 was due was a result of a discrete benefit for state tax rate changes, discrete tax benefits associated with stock based compensation, and a tax benefit associated with the reduction in US taxation of certain foreign earnings.

The Company's net income after tax was $43.5 million or $3.66 per share on a diluted basis for the first six months of 2021 compared to $28.5 million or $2.41 per share on a diluted basis for the first six months of 2020. The increase of $15.0 million 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 June 30, 2021, the Company had working capital of $437.9 million which represents an increase of $92.2 million from working capital of $345.7 million at December 31, 2020. The increase in working capital was primarily a result of volume-driven and inflation increases in accounts receivable and inventory levels.

Capital expenditures were $9.4 million for the first six months of 2021, compared to $12.5 million during the first six months of 2020. In response to the COVID-19 pandemic, we limited new capital expenditures in projects in 2020, however, for the full year of 2021 we expect to return to a more normalized capital expenditure level. The Company will fund any future expenditures from operating cash flows or through our revolving credit facility, described below.

Net cash used for investing activities was $— million during the first six months of 2021 compared to $9.4 million during the first six months of 2020.

Net cash provided by financing activities was $26.3 million and net cash used in financing activities was $8.5 million during the six month periods ended June 30, 2021 and June 30, 2020, respectively. Higher Net cash provided by financing activities for the first six months of 2021 relates to increase borrowings on the revolving credit facility for increased working capital in support of elevated backlog levels.

The Company had $79.4 million in cash and cash equivalents held by its foreign subsidiaries as of June 30, 2021. The majority of these funds are at our European and Canadian facilities. The Company will continue to repatriate European and Canadian cash and cash equivalents in excess of amounts needed to fund operating and investing activities, but will need to monitor exchange rates to determine the appropriate timing of such repatriation given the current relative value of the U.S. dollar. 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.

On October 24, 2019, the Company, as Borrower, and each of its domestic subsidiaries as guarantors, entered into a Second Amended and Restated Credit Agreement (the Credit Agreement) with Bank of America, N.A., as Administrative Agent. The Credit Agreement provides the Company with the ability to request loans and other financial obligations in an aggregate amount of up to $650.0 million and, subject to certain conditions, the Company has the option to request an increase in aggregate commitments of up to an additional $200.0 million. Pursuant to the Credit Agreement, the Company borrowed $300.0 million pursuant to a Term Facility repayable at a percentage of the initial principal amount of the Term Facility equal to 5.0% per year along with interest payable quarterly. The remaining principal amount is due in 2024. Up to $350.0 million is available under the Credit Agreement pursuant to a Revolver Facility. The Agreement requires the Company to maintain two financial covenants, a maximum consolidated leverage ratio and a minimum consolidated fixed charge 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 expiration date of the Term Facility and the Revolver Facility is October 24, 2024. As of June 30, 2021, $315.8 million was outstanding under the Credit Agreement, $273.8 million on the Term Facility and $42.0 million on the Revolver Facility. On June 30, 2021, $2.2 million 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 $174.2 million in available borrowings. The Company is in compliance with the covenants under the Agreement as of June 30, 2021.

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, particularly given the uncertainty created by the COVID-19 pandemic.

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 2020 Form 10-K, the policies relating to the business combinations involve 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 2020 Form 10-K.

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," "expect," “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; the ongoing impact of the COVID-19 pandemic, including the recent surge of COVID-19 variant cases in the U.S. and in the other markets we serve; changes in tariff regulations and the imposition of new tariffs; a strong U.S. dollar; increased competition; trade wars or other negative economic impacts resulting from geopolitical events; decreases in the prices of agricultural commodities, which could affect our customers' income levels; increase in input costs; weakness in our Industrial Division due to changes in customer behavior; our inability to increase profit margins through continuing production efficiencies and cost reductions; repercussions from the 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 raw materials and product components, particularly steel and steel products; energy cost; increased cost of governmental regulations which effect corporations including related fines and penalties (such as the European General Data Protection Regulation and the California Consumer Privacy Act); 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; the ability to hire and retain quality skilled employees; cyber security risks affecting information technology or data security breaches; and the possible effects of events beyond our control, such as political unrest, acts of terror, natural disasters and pandemics, on the Company or its customers, suppliers and the economy in general. The Company continues to experience the impacts of COVID-19 on its markets and operations including, most notably, operational and supply chain disruptions. The full extent to which COVID-19 will continue to adversely impact the Company’s business depends on future developments, which are highly uncertain and unpredictable.

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, Australia and the Netherlands. 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. Foreign exchange rates and economic conditions in these foreign markets may be further impacted by the effects of the COVID-19 pandemic.

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 $4.6 million.

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 $4.6 million for the six month period ended June 30, 2021. 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.

In March 2019, the Company entered into fixed-to-fixed cross-currency swaps and designated these swaps to hedge a portion of its net investment in a euro functional currency denominated subsidiary against foreign currency fluctuations. These contracts involve the exchange of fixed U.S. dollars with fixed euro interest payments periodically over the life of the contracts and an exchange of the notional amounts at maturity. The fixed-to-fixed cross-currency swaps include €40 million ($45 million) maturing December 2021.

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 second quarter 2021 average interest rate under these borrowings, the Company’s interest expense would have changed by approximately $1.6 million. 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.

In January 2020, the Company entered into an interest rate swap agreement with three of its total lenders that hedge future cash flows related to its outstanding debt obligations. As of June 30, 2021, the Company had $315.8 million outstanding under the Credit Agreement of which $200.0 million was hedged in a three year interest rate swap contract with a fixed LIBOR base rate of 1.43%.

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, Controller and Treasurer, (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, Controller and Treasurer, (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 2020 Form 10-K for the year ended December 31, 2020.