Alamo Group Inc Q4 FY2020 Earnings Call

Good day, and welcome to the Alamo Group Inc. Fourth Quarter 2020 Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Ed Rizzuti, Vice President, General Counsel and Secretary. Please go ahead, sir.

Thank you. By now, you should have all received a copy of the press release. However, if anyone is missing a copy and would like to receive one, please contact us at (212) 827-3746, and we will send you a release and make sure you are on the company’s distribution list. There will be a replay of the call, which will begin 1 hour after the call and run for 1 week. The replay can be accessed by dialing 1 (888) 203-1112, with the passcode 6872067. Additionally, the call is being webcast on the company’s website at www.alamo-group.com, and a replay will be available for 60 days. On the line with me today are Ron Robinson, President and Chief Executive Officer; Dan Malone, Executive Vice President and Chief Financial Officer; and Richard Wehrle, Vice President, Treasurer and Corporate Controller. Management will make some opening remarks, and then we’ll open up the line for your questions. During the call today, management may reference certain non-GAAP numbers in their remarks. Reconciliations of these non-GAAP results to applicable GAAP numbers are included in the attachments to our earnings release. Before turning the call over to Ron, I’d like to make a few comments about forward-looking statements. We will be making forward-looking statements today that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties, which may cause the company’s actual results in future periods to differ materially from forecasted results. Among those factors which could cause actual results to differ materially are the following: market demand; COVID-19 impacts, including operational and supply chain disruptions; competition; weather; seasonality; currency-related issues; geopolitical issues; and other risk factors listed from time to time in the company’s SEC reports. The company does not undertake any obligation to update the information contained herein, which speaks only as of this date. I would now like to introduce Ron. Ron, please go ahead.

Thank you, Ed, and we want to thank all of you for joining us today. Dan Malone, our CFO, will begin our call with a review of our financial results for the fourth quarter and the year-end 2020. And I will then provide a few more comments on these results. And certainly following our formal remarks, we look forward to taking your questions. So Dan, please go ahead.

Thank you, Ron. The key takeaways from our fourth quarter and full year 2020 results are: fourth quarter sales were down 3.8%; record full year sales were up 4%, with the help of acquisitions, but down 11% without; fourth quarter net income and earnings per share were down 16% from the prior fourth quarter on a GAAP basis and down about 6% on an adjusted basis; full year net income and earnings per share were down 10% from prior year on a GAAP basis, but increased more than 2% year-over-year on an adjusted basis; full year adjusted EBITDA was up 11.6% from the prior year and essentially flat to the third quarter trailing 12-month result, with adjusted EBITDA margins expanding by nearly 100 basis points over prior year. Record full year operating cash flow of $184.3 million was up 108% over prior year, and fourth quarter operating cash flow exceeded an unusually strong operating cash flow performance in the prior year quarter. Outstanding debt was reduced by $158.6 million in 2020, and our debt net of cash position improved by $166.5 million during the year. Record backlog of $354.1 million was up 35.6% over the prior year-end. Fourth quarter 2020 net sales of $288.6 million were 3.8% lower than the prior year quarter. While we saw a strong rise in order rates and backlog, the COVID-19 pandemic continues to negatively impact our manufacturing efficiencies and inbound supply chain during the quarter. Also, the timing of these new orders, and the fact that strong customer demand hasn’t been consistent across all of our business segments, has limited the immediate top-line impact. Full year 2020 net sales of $1.16 billion, a company record and 4% higher than the prior year, with the contribution of the Morbark and Dutch Power acquisitions. Without these acquisitions, organic sales were down 11% from the prior year. Net income for the fourth quarter was $8 million or $0.68 per diluted share compared to prior year fourth quarter net income of $9.6 million or $0.81 per diluted share. Excluding the Morbark inventory step-up expense, severance costs related to a plant closure, one-time acquisition transaction costs, and acquisition-related amortization expense, adjusted fourth quarter 2020 net income was $13 million or $1.10 per diluted share compared to $13.8 million or $1.18 per diluted share in the prior year quarter. Net income for full year 2020 was $56.6 million or $4.78 per diluted share compared to net income of $62.9 million or $5.33 per diluted share for the prior year. Excluding the full year impact of the adjustments I just mentioned in the quarter comparison, adjusted full year net income was $70.3 million or $5.94 per diluted share compared to $68.4 million or $5.80 per diluted share in the prior year. Industrial division fourth quarter 2020 net sales of $202.7 million represented an 8.9% decrease from the prior year quarter due to the pandemic-related impact on customer demand and disruptions to our supply chain and operations. While this division ended the year with higher backlog than the previous year-end, the surge in orders that created this favorable comparison is largely concentrated in forestry and tree care products. Other business units, notably those serving the municipal government sector, finished the year with order backlog below pre-pandemic levels. Agricultural division fourth quarter 2020 sales were $85.9 million, up 10.5% from the prior year fourth quarter. During the quarter, we continued to see strong organic growth across this division. The immediate top-line benefit of the surge in customer demand was constrained by the negative impact of the pandemic on inbound supply chain and manufacturing efficiencies, as previously mentioned. Full year 2020 adjusted EBITDA was $145.2 million, up $15.1 million or about 11.6% over the prior year and was essentially flat to the third quarter trailing 12-month result. Our adjusted 2020 EBITDA as a percentage of net sales improved by nearly 100 basis points over the prior year. Higher Morbark margins, favorable product mix, the benefits realized from facility consolidations, and other cost containment measures more than offset the negative impact of the pandemic previously mentioned. During 2020, we generated $184.3 million of operating cash flow compared to $88.8 million in the prior year, an increase of 108%. Strong operating cash flows continued during the most recent quarter as we exceeded an unusually strong operating cash generation in the prior year fourth quarter, and we further deleveraged our balance sheet. We ended the fourth quarter with a record $354.1 million in order backlog, an increase of over 35% since the prior year-end. During the fourth quarter, we saw an acceleration of customer demand, particularly for our forestry and agricultural products, while demand has grown overall for the company as all of our units have seen improvements in customer demand since the pandemic impacted the second quarter; order rates for some of our businesses are still below pre-pandemic levels. To recap our fourth quarter and full year 2020 results: fourth quarter sales down 3.8%, record full year sales up 4%, but down 11% without acquisitions; fourth quarter net income and EPS, down 16% on a GAAP basis and down 6.8% on an adjusted basis; full year adjusted EBITDA, up 11.6% from prior year and essentially flat to the third quarter trailing 12-month results, with adjusted EBITDA margins expanding by nearly 100 basis points over prior year; record full year operating cash flow, up 108% over prior year, with favorable comparisons continuing in the fourth quarter; full year debt reduction of almost $159 million and debt net of cash improvement over $166 million; and record backlog up more than 35% over the prior year-end.

Thank you, Dan. And I think we’re all sort of glad to see 2020 come to an end. But I’m certainly pleased and proud of the way our company performed, given the many ongoing challenges we all faced during the year. We’re particularly pleased to see that the momentum, which has been building for the last several quarters, really since the slowness at the end of the second quarter, built in the third, and continued in the fourth. And with strong bookings and a record backlog at the end of the year, I’m pleased that this trend has continued even into the first quarter of 2021, with our backlog continuing to grow even further, and now it’s over $400 million. However, there were also issues related to the pandemic that impacted our operations in the fourth quarter. These included sporadic cases of COVID that, while not large and not at a lot of locations, always had a follow-on effect. For example, if one person went home sick, we had to close down the whole department for several days while we cleaned and ensured everyone else was okay. Additionally, we are experiencing more supply chain issues, but these too can be small. I mean, you cannot ship a product that is missing a $0.10 old ring. And that’s the kind of ripple effect these disruptions can have. All of this together caused shipments in the fourth quarter to be a little below our expectations, but still was good. Margins were even better, particularly when adjusted for the noncash charges that were above average in the fourth quarter for 2020. The two major noncash charges were the inventory step-up charge related to the acquisition of Morbark and the reorganization reserve related to the proposed plant consolidation we’ve announced in The Netherlands. We are now finished with the inventory step-up charges at Morbark, which affected us every quarter since we bought them. But as of the end of the fourth quarter, all those are now finished and should not be affecting our results going forward. And regarding the plant consolidation in Europe, even though we took a charge in the fourth quarter, the timing was a little unfortunate; however, within the next year, we’ll have a projected payback of less than one year on that plant consolidation, so it’s a very positive move in the long term, even though it affected the fourth quarter results. Net of these two items, net income from the quarter was just below the previous year’s; adjusted net income was just below the previous year’s adjusted net income, despite soft sales and less organic sales and certainly the ongoing COVID issues. Overall, we were pleased. Additionally, we were extremely pleased with our efforts in the fourth quarter and throughout 2020 in controlling costs and managing our assets, which, as Dan pointed out, resulted in very strong levels of cash generation, record EBITDA, and reductions in outstanding debt, ensuring the company’s solid financial stability, despite the certainly challenging economic environment in which we were operating. Despite the limitations imposed on us during most of the year 2020 that restricted our travel and caused many of our office personnel to work remotely for some periods of time, we were able to complete many of our operational developments that we already had planned for the year. These include most of the integration initiatives related to the 2019 acquisitions of Morbark and Dutch Power. We also completed the construction of a new manufacturing plant for our Super Products unit in Wisconsin that allowed us to consolidate three facilities into one modern and efficient facility, and we were able to complete that project entirely in 2020. Furthermore, there was continuous progress on a range of other product development and operational improvement initiatives ongoing throughout the year. We really made a lot of progress in a very challenging year. Alamo Group’s industrial division performed well in both the fourth quarter of 2020 and for the full year, even though, for us, they probably faced the most market challenges due to COVID. The biggest end user of their products are governmental entities, most of which struggled with budgetary issues during the year and are still being impacted today. Yet while organically, our sales were off, they still held up well due to the stable nature of the demand for our types of products that continue to be used throughout the year for infrastructure maintenance. We placed bookings, which were very soft in the second quarter and gradually and steadily increased each quarter since then, have continued this trend as we moved into 2021. As Dan pointed out, some of it is spotty; some units are doing better than others, but certainly, overall, they’re up. Interestingly, one of our new units, Morbark, was probably hurt the most early on due to COVID, yet they have come back strong as things have continued to build back up. It’s been a little inconsistent, but overall, it’s a positive sign. Our agricultural division has held up even better and actually showed a small increase in sales for the year, and margins did even better. I believe the ag sector in general benefitted from increased subsidies to farmers during the year and started off with relatively low levels of dealer inventories due to the weak agricultural industry over the last several years. As a result, we ended the year with record backlogs, and dealer inventories are still fairly low, indicating that there’s still more upside potential there. We are also seeing improved commodity prices in the ag industry, making the outlook for further growth in that division very positive as we move into 2021. In fact, we believe the positive trends we are seeing in both of our divisions bode well for Alamo Group’s outlook for 2021, though the pandemic and its repercussions, as well as all the impacts it has had on the global economy, are still far from over. For us, specifically, ongoing COVID infections are sporadic, but certainly are still causing challenges. Supply chain issues are affecting us and many, almost everyone in our industry. Everything from truck chassis to tractors is facing increased lead times. Adverse weather conditions, particularly in Texas, recently caused a couple of our plants to close for several days, and we saw one major supplier closed for four days, resulting in delays. These issues, along with inflationary pressures, are anticipated to affect our short-term operations, particularly in the first quarter. However, we feel optimistic about the overall performance in 2021. There’s positive momentum in our markets, and there is stable demand for our types of products, which continue to be used regularly in maintenance and operations. Contributions from recent acquisitions and ongoing operational improvements, such as the plant consolidation initiatives we’ve implemented, all contribute to a very bright outlook for the full year 2021 for Alamo Group. We sincerely hope that the increasing availability of COVID vaccines will have a positive impact on the pandemic, and we can all return to a more regular state of operations. Regardless, we feel very optimistic about the outlook for Alamo Group for 2021. We want to thank you for your support during these trying times. With that, I would now like to open the floor for any questions you might have.

We’ll go first to Chris Moore at CJS Securities.

Ron, you had just mentioned that Q1 could be a little softer. I’m just trying to reconcile that with the backlog that’s really building, just trying to get a sense as to, are those deliveries a couple of quarters out? Or how does that match up against some of the COVID challenges and things like that you’re seeing in Q1?

Yes. It’s not that the deliveries are out; it's just that with a few COVID issues and a few supply chain issues, we think it’s going to dampen results a little bit, similar to how it did in the fourth quarter. The backlog is longer term, and ideally, we would like to reduce some of this backlog a little quicker, but I think operational challenges and supply chain issues will prolong this. We’re working closely with our vendors to determine when we’ll receive key components like chassis and tractors, which have experienced doubled lead times. Thus, it’s just taking longer to scale up production to meet demand. The backlog, in some cases, is stronger than I’d like, but I’m not worried that it’s at risk because the lead times are being extended across the board.

Got it. And you had said it’s more skewed towards the ag and Morbark?

No, no. I think it’s fairly broad-based. All of our units are being affected somewhat similarly. I think the ag sector is being slightly more impacted by some of the port issues because we have a lot of product in transit. We have some international products like gearboxes and drivetrains that are waiting on the ocean longer than we would like right now, and that’s affecting the ag division a bit more severely than others. Overall, it’s not a large issue; it’s just one component can hinder our ability to ship a full piece of equipment.

Got it. I appreciate that. So parts with much higher gross margins made up about 21.5% of revenue in fiscal '20 due to the COVID impact. First, I think 18.5% the last couple of years; do you expect that to trend back towards the high teens in 21?

There are two factors at play here. One is when we acquired Morbark, the nature of its equipment results in a higher level of parts revenue compared to the historical average prior to the acquisition. So that will remain elevated. The part that might revert back is when whole good equipment sales recover, the percentage of parts to total sales will decrease since whole goods will be increasing. However, we will continue to operate at a level higher than 18.5% because of Morbark. So it may not reach 21.2%, but it could be more in the vicinity of 20%.

We’ll go next to Mike Shlisky at Colliers Securities.

Speaking of mix, you’re mentioning that Morbark has been doing quite well from an order and backlog standpoint. If that kind of holds with how shipments go forward, is there a good gross margin or operating profit mix coming up in the industrial group? Those are often high-margin products. Is that going to stick in 2021?

Mike, this is Richard. I think what Ron was saying is that we’re seeing, and Dan pointed out in his comments, that forestry and tree care, which is the Morbark segment, actually have seen their orders pick up.

As we mentioned when we acquired Morbark, their margins were slightly higher than our average margins, and that has remained consistent. With some of the synergies we’re realizing from them, we’re confident that margins will remain strong. However, they did encounter delays in shipments in December due to COVID-related issues, particularly in the shipping department, where we had a few cases that forced a shutdown.

Their EBITDA margins are a little higher than the average for the company. Their whole goods equipment margins are pretty much consistent with the company average, but they have a more favorable mix of parts sales and a better ratio of margin to SG&A. This drives their higher EBITDA margins compared to the average at Alamo Group.

Just to add to that, the backlog for industrial is solid; we just have varied mixes where higher orders in forestry and tree care have improved, while some units are experiencing lower orders.

That makes sense. And that actually brings up my other question about the synergies you were getting at Morbark. Can you give us some sense of how that progressed during 2020? And is there a lot left to go in 2021?

There is still more to be achieved, particularly in the initiatives we implemented. We got some of their operations onto our systems, although the process was delayed due to restrictions on travel and remote work. Most of the purchasing initiatives we identified were put in place as well, and we've started seeing benefits as their backlogs have grown. We also completed a plant consolidation; they had three plants and we closed the smallest one and moved operations into the other two. Overall, we still have initiatives to pursue and will continue to see gains from what we've already established.

The one initiative that we didn’t complete this year due to COVID was increasing Morbark's exposure in international sales. We were unable to conduct outreach internationally since travel was restricted, but we plan to pursue this as soon as the situation allows.

Got you. Can we turn to maybe zero turns and how that’s going? Anything you can tell us about Dixie Chopper's performance and how the zero turns are doing?

Yes. We haven’t disclosed any numbers publicly, but we can say that Dixie Chopper has really been paying off. Its performance has significantly grown since we acquired it, and it is positively influencing our agricultural division numbers.

It met our expectations for this past year and we believe exceeded it, especially considering the circumstances of COVID.

Fortunately, when we acquired that plant in 2019, we managed its consolidation ahead of time and we started realizing the benefits from 2020 onwards. Overall, the contribution has been modest, but we find it a positive addition.

But the overall strength in that and the order and backlog you’re seeing going forward is not strictly a zero-turn-based thing? It’s more broad-based than that?

No, it’s across all product lines. Bush Hog is performing well, and we are even seeing improvement in order rates in Europe. So yes, it's broad-based.

Indeed, Europe, which had been lagging, is now improving significantly. Their order rate has picked up. Similarly, Brazil has also shown modest improvements. Overall, our agricultural backlog is where we've seen the most growth.

One last one for me. I did notice that your leverage was down quite a bit from this time last year, even cut in half. I thought that was a very strong result. Does that mean maybe it’s time to start looking at some other sizable deals that might be out there? Can you give us some insight into the M&A market in general for you?

Yes. The M&A market is definitely rebounding. I think it’s slightly lagging in industrials because conducting due diligence virtually can be quite challenging. Valuations may also be difficult for some as it seems folks are assuming COVID has finished. I lean towards caution at this moment. However, I anticipate that in the second half of this year, we will actively begin to explore opportunities. Numerous potential deals that had previously been put on hold are expected to come back into play, so we will certainly consider them. But I expect that achieving a deal in the short term may prove challenging.

Got it. Just don't get caught by a stack, you should be in good shape. I’ll leave it there.

Thank you. There’s a lot of capital out there pursuing deals. We’re cautious in our acquisitions and focus on the price we pay for assets. We won't get swept up in the excitement.

We’ll go next to Greg Burns at Sidoti & Company.

When I look at the puts and takes between some of the maybe positive mix shifts for next year versus some of the inflationary pressures and maybe COVID efficiencies, do you think that you can expand margins in 2024 from where you ended 2020?

You sort of broke up, but I think you’re asking if we can expand margins? Yes, inflationary pressures are real, but we have showcased strong adaptability to these challenges. We anticipated some increases and adjusted our pricing accordingly. We even implemented selective surcharges to address various cost increases. While the first-quarter results may reflect some dampening due to prior backlog not incorporating these costs, I think we will recover throughout the year. As our new backlog now includes these inflationary considerations, we expect margins to hold firm. Historically, we’ve managed these scenarios effectively, so I'm optimistic.

Once our volumes recover and as the COVID impacts wane, our larger backlog should drive favorable operating leverage into our margins as well.

Okay. Makes sense. And then when you think about the demand in the industrial segment, looking at the relief and support from state and local governments, how do you see that potentially benefiting Alamo Group?

It’s an interesting situation. State and local governments have their own challenges. While I've been surprised that state budgets have held up better than I expected, municipal governments continue to feel the pressure. Early in the pandemic, our bookings suffered as government operations tried to work remotely, which created some operational challenges. However, by mid-year, they improved significantly, leading to a recovery in orders as they resumed regular functioning. Our equipment is being utilized consistently, and while their budgets remain tight, I’m pleased that they haven’t suffered as much as anticipated, and our equipment continues to be regularly used.

We’ll take a follow-up from Mike Shlisky at Colliers Securities.

One thing that’s not been discussed, Ron, has been your upcoming retirement. Congrats, first of all. Do we have maybe one more quarter left here? And how’s the search going? Anything to share about the Board’s progress?

Thank you for your kind words. This process has been planned for a number of years. While I know I won’t be here forever, I believe we’ll conclude our search in the next month or so. I’ll be ready to announce the outcome, ensuring a smooth transition afterward. We're primarily looking internally for candidates who are familiar with our operations and share our philosophy. It should be a fluid transition, and while I may step back from daily operations, I will remain on the Board and retain vested interests in the company’s success.

And that does conclude today’s question-and-answer session. I’ll turn the conference back over to management for any closing remarks.

Again, thank you for joining us today. We appreciate your questions, comments, and ongoing support during these challenging times. We feel optimistic about our position and look forward to discussing our 2021 first quarter results in May. Thank you, and have a good day.

And that does conclude today’s conference. Again, thank you for your participation.