Alamo Group Inc Q1 FY2022 Earnings Call

Good day, and welcome to the Alamo Group Inc. First Quarter 2022 Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Edward 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’re 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 7515566. 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 Jeff Leonard, President and Chief Executive Officer; Richard Wehrle, Executive Vice President, Chief Financial Officer and Treasurer; and Dan Malone, Executive Vice President and Chief Sustainability Officer. 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 Jeff, 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 and 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 impact, 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 Jeff Leonard. Jeff, please go ahead.

Thank you, Ed. We want to thank all of you for joining us today. Richard will begin our call with a review of our financial results for the first quarter of 2022. I will then provide more comments on the results. Following our formal remarks, we look forward to taking your questions. So Richard, please go ahead.

Thanks, Jeff, and good afternoon, everyone. The Alamo Group team started 2022 with a solid first quarter performance that produced record results for the quarter, driven by continued strong demand for our products in a very challenging operating environment. First quarter consolidated net sales for 2022 came in at $362 million, an increase of 16% compared to $311.2 million in the first quarter of last year. Gross margin dollars in the quarter improved compared to the first quarter of 2021 by just over $10.2 million. However, our gross margin percent was down about 60 basis points. Freight costs on inbound inventory were up significantly as tariffs and surcharges were included in already significantly higher freight invoices. Consolidated net income for the first quarter of 2022 was $18.5 million or $1.55 per diluted share, an increase of 5.8% versus net income of $17.5 million or $1.47 per diluted share for the first quarter of 2021. The company completed an excise tax audit covering a 5-year period that resulted in a one-time $1.3 million expense in the first quarter of 2022. Excluding this charge, adjusted net income for the quarter was $19.4 million or $1.63 per diluted share. The Vegetation Management division had a strong first quarter for 2022 as markets were solid and new orders were higher than the first quarter of 2021. First quarter net sales were $221 million, an increase of 20% compared to $183.9 million for the first quarter of 2021. The division continues to see strong demand for agricultural, forestry, tree care, and governmental mowing products in North America and Europe. Margins during the first quarter of 2022 were down 145 basis points compared to the first quarter of 2021 as higher material and labor costs compressed the division’s margin by 106 basis points, while the remaining 39 basis points impact resulted from a combination of lower operating efficiencies and significantly higher inbound freight costs. Despite this margin compression, income from the operations for the first quarter of 2022 was $18.3 million, up 14% compared to $16.1 million for the same period in 2021. Industrial Equipment division net sales in the first quarter of 2022 were $141 million, up 11% compared to $127.3 million for the first quarter of 2021 due to a strong performance in North American excavator and vacuum truck operations, along with improved net sales in the division’s other product lines. First quarter margins in the division improved by 40 basis points versus the first quarter last year due primarily to favorable product mix and improved operational efficiencies. Extended lead times for truck chassis and shortages of other component parts continued to have a significant impact on this division’s operations, along with higher-than-expected inbound freight on inventory. Income from operations in the first quarter of 2022 was $10.8 million, up 15% compared to $9.3 million for the first quarter of 2021, still a solid performance in the division despite the ongoing issues I covered above. For the fifth quarter in a row, strong order bookings continued during the first quarter of 2022, resulting in a record backlog of just under $918 million, an increase of 103% compared to the backlog at the end of the first quarter of 2021. The backlog is also up compared to the end of 2021 by 15%. We had record new order bookings in the first quarter, which is the primary reason for the increase in backlog. However, some of the increase in our backlog was due to the ongoing supply chain issues that delayed shipments of finished products. Turning to a few additional financial items for the first quarter of 2022. Our balance sheet continues to remain healthy. Receivables were almost $297 million, up 22% from a year ago from solid sales volume. Receivables are also up 25% compared to the end of 2021. Inventory is up almost $93 million compared to Q1 of 2021 and is up $34 million compared to the end of the year 2021. This is a reflection of higher work in process, material cost inflation as well as our efforts to support the growing demand for our products by purchasing higher levels of key components and service parts for our customers during this time of constrained supplies. Finally, the company’s trailing 12-month EBITDA is $165.7 million that's up 2% compared to the full year 2021. For the balance of this year, we will be disciplined in controlling costs and expenses to mitigate the effects of ongoing inflationary pressures on our margins and operating performance. We’ll also continue to raise prices to meet the rising material and transportation costs in order to maintain target margin levels as a percent of sales. Our biggest challenge remains meeting the heightened demand for our products throughout the company given the current supply chain restraints. As we did in the first quarter of this year, the company approved a quarterly dividend of $0.18 per share for the second quarter of 2022, a 29% increase over the second quarter of 2021. One final item to go over with you during the second quarter of this year, the company will publicly release the 2021 quarterly historical financial information for the 2 new divisions that we announced at the start of the fourth quarter last year, for Vegetation Management and Industrial Equipment. With that, I’d like to turn the call back over to Jeff.

Thank you, Richard. First, I’d like to again thank everyone who joined the call this afternoon. The past several months have certainly been challenging for us, but I’m very pleased with the results that our teams were able to achieve in the face of a number of formidable supply-related headwinds, including resurgent COVID-19 illness related to the Omicron variant, persistent supply chain disruptions, shortages, cost inflation, and finally, the terrible war in Ukraine. Repeating the pattern of the past few quarters, the level of activity in our markets remains very strong across all of our business segments and served market areas. First quarter order bookings of $469 million were up 22% compared to the first quarter last year, and the company’s order backlog increased nearly 103% to $918 million. Our Vegetation Management division saw its order bookings increase by more than 28% and backlog rose 97% compared to the first quarter of 2021. Prices for most agricultural commodities remained elevated in the quarter as post-pandemic economic recovery, market disruptions due to the war in Ukraine, associated international economic sanctions, and lower crop yields in several countries led prices higher. This was a mixed blessing for farmers because costs associated with fertilizers and other agrochemicals and fuel also increased. Governmental agencies continued to enjoy healthy revenues, thanks largely to lingering benefits of federal government stimulus spending, rising property taxes derived from housing market strength, and rising income from user fees. They continue to invest in maintenance equipment and fleet upgrades. As a result, activity in our governmental mowing businesses remained strong in both North America and Europe. U.S. lumber prices dipped in the quarter after beginning the quarter modestly higher. However, demand for our wood recycling, tree care, and land clearing equipment remained excellent. Our backlog in this area continues to rise at a brisk pace. Demand for the company’s Industrial Equipment from contractors and governmental agencies also remained very strong. The Industrial Equipment division’s first quarter order bookings increased almost 15% and backlog rose 116% compared to the first quarter of 2021. The division’s vacuum trucks and associated rental equipment continued to experience very strong demand. Demand for its sweepers, debris collectors, and snow removal equipment also increased, but at a more modest pace. From an operations perspective, our first quarter got off to a slow start. The Omicron variant of COVID-19 impacted our North American workforce in the early weeks of January as workers returned from the year-end holiday break. With many employees ill, productivity suffered, and January sales did not meet our expectations. In February, COVID-19 similarly impacted our European teams again, constraining our capacity and resulting in lower sales. Fortunately, in March, most of our employees were able to return to work, and we were able to add shifts and moderate overtime to regain our stride and have a solid finish to the quarter. As much as it would be nice to talk about something else on this call, the disruption and increased demand on the supply chain continues to be the most significant factor affecting company performance. As in recent quarters, chassis availability and its constraining impact on sales growth in our Industrial Equipment division continues to be the most persistent supply chain problem confronting us, although new problems seem to arise almost daily. While heavy and medium-duty truck chassis deliveries were initially delayed in 2021 by shortages of semiconductors, in the first quarter, shortages of items such as wiring, harnesses, axles, and transmissions exacerbated the problem and delayed the hope for improvement in chassis availability. The tragic war in Ukraine that broke out during the quarter has further impacted truck manufacturers as that country is a significant supplier of truck components. During the first quarter, the war began to cause more serious chassis delays in Europe, and this led to a holdback of sales of our vacuum trucks in the European market. Unsurprisingly, truck manufacturers have continued to pass through cost increases and surcharges that we’ve had also to pass along to our customers. During the first quarter, some new problems in our supply chain emerged, and these began to affect our Vegetation Management division as well. This division is somewhat more dependent on mechanical components manufactured in China, and the recent COVID-19 lockdowns there have had delayed anticipated shipments for us as well as for many other manufacturers. Compounding this, China’s major ports are backlogged with numerous vessels waiting to berth, so it’s taking somewhat longer to get goods loaded to board a vessel, causing further extension to lead times. Inbound freight created additional costs and logistics challenges for us in the quarter. We experienced sharply higher truck transportation costs and related surcharges as a result of higher labor and fuel costs. Outbound truck shipping presented its own set of headaches. Securing trucks and drivers to load products for delivery to our customers, where and when needed, continued to be problematic this quarter, although we did experience some improvement in the final weeks of the quarter. Our Vegetation Management division experienced sharp cost increases during the quarter for both inbound logistics surcharges and tariffs. While outbound freight costs have also risen, we were able to pass these through to our customers. Notably in early March, the trucking industry began to report a surprising and unexpected decline in per-mile rates, and we expect this will provide some much-needed shipping cost relief in the second quarter. In spite of these compounded headwinds, our production teams delivered the highest ever single quarter net sales in company history. Company net sales were 16% higher than the first quarter of 2021, with sales in the Vegetation Management division up 20% and Industrial Equipment division sales up 11%. While certainly a portion of the increase is attributable to higher prices, more than half represents real growth, and given the significant supply chain disruptions we experienced, I’m pleased that our teams accomplished this nice top line growth during the quarter. Moving on to the operating performance of our divisions. Vegetation Management experienced a 145 basis point erosion of margin compared to the first quarter of 2021. Material and labor cost inflation, combined with higher freight costs compressed the division’s margin. Expenses related to inbound freight were 101% higher relative to the first quarter of 2021 with tariffs and surcharges representing 40% of the increase. The division’s SG&A expenses declined as a percentage of sales, and this somewhat moderated the impact of the lower margin. In spite of the higher costs, operating income in Vegetation Management benefited from the higher sales volume and rose nearly 13% compared to the first quarter of 2021, although income as a percentage of sales declined modestly as a result of the margin pressure. The Industrial Equipment division’s first quarter margin improved relative to the prior year first quarter. The improvement was the result of a combination of favorable product mix, better capacity utilization, and improved operational efficiencies. This division’s SG&A expenses as a percentage of sales were unchanged relative to the first quarter of 2021. Although the Industrial Equipment division’s net sales growth was more modest, the top line leverage, combined with the higher margin, resulted in a nearly 23% improvement in operating income. In light of the persistent chassis shortage that has continued to slow this division’s sales growth, I’m very pleased with the division’s performance during the quarter. Turning now to our expectations for the second quarter. The company’s operating environment continues to be extremely dynamic. We don’t currently see signals from our markets that would indicate significant changes in near-term demand for our products, and dealer inventories remain historically low and aren’t yet rising. We, therefore, expect order bookings will remain at a healthy level in the second quarter. Our backlog also remains solid. We have experienced significant order cancellations to date, and we don’t anticipate changes in customer sentiment in the remaining weeks of the quarter. So our expectation is that the pattern of the past several quarters will continue in the second quarter. We expect that sales will continue to show solid growth, although perhaps at a slightly more modest pace than we saw in the first quarter, given what’s happening in the supply chain. Margins will remain under pressure, but I’m confident that our recent pricing actions will largely keep us ahead of the inflation we’re experiencing. Our teams continue to become more adept at working with the increasingly frequent supply disruptions, and I’m proud of the record they have continued to set under difficult circumstances. Finally, I expect the additional top line strength will sustain moderate improvement in net income in the second quarter relative to the results achieved last year. The outlook for the third quarter and the balance of 2022 is somewhat more uncertain. In addition to the inflation pressure and other headwinds we experienced in the first quarter, accelerated interest rate hikes, aggressive COVID-19 lockdowns in China, and potential impacts of the war in Ukraine on markets in Europe pose incremental risks. Rising interest rates will increase the cost of equipment financing and could potentially dampen demand among farmers, ranchers, and contractors. I’m confident that our governmental businesses will hold up well though and continue to show steady growth. As always, we will continue to take actions on price to defend margin and we won’t hesitate to adjust our internal costs should we see clear evidence of a change in customer sentiment in our markets. Given our strong order backlog, improving labor availability, and untapped internal manufacturing capacity, even a modest improvement in the supply chain will allow the company to accelerate sales growth. So while the business environment continues to be quite dynamic, I remain confident in the sustained positive development of the company for the foreseeable future. This concludes our prepared remarks. We’re now ready to take your questions. Operator, please go ahead.

All right and our first question will come from Chris Moore with CJS Securities.

I was hoping you could provide more details about the expected revenue increase in Q2. What do you anticipate in terms of revenue and margins for the rest of 2022? For instance, considering the backlog, do you expect revenue to grow sequentially each quarter in 2022?

Yes. I think it will continue to grow sequentially, Chris. I just don’t know at what pace. I’m not really concerned. I don’t want to raise that. It’s just there are more risks about it. They haven’t impacted us yet materially. But for example, I mentioned the war in Ukraine is one example. Late in the quarter, we had a number of trucks that were delayed very unexpectedly. There are trucks that were being supplied to us by our customers, manufactured by MAN, and MAN told us very late, we source a lot of components out of Ukraine. And we can’t tell you when you’re going to get those chassis. We frankly didn’t see that one coming, to be honest. And then both Richard and I touched on the higher shipping costs, which were certainly higher than we expected. We’ve been tuning up our burden on inventories as we went along. But the magnitude of the surcharges I mentioned that was about 40% of the total increase in shipping. That also was a surprise to us during the quarter. But no, I still think we’re going to see decent sales growth in Q2 and even beyond the rest of the year. I didn’t want to signal any contraction in sales, and I was pretty careful with my wording with that. But we had a nice pace of sales growth in the first quarter. And I think as long as we don’t have more surprises, we’ll see a nice pace again in the second quarter and beyond. The problem is the visibility is getting a little bit murky with all that’s happening out there in the market. So all I really wanted to signal was that I think the risk profile in the market generally is increasing for everybody, not just for Alamo Group, but for all manufacturers. There’s just a lot of things going on right now. And of course, we’ve seen in the equity markets today rising interest rates are a real factor that people are paying attention.

Absolutely. I appreciate that. That’s helpful. So Vegetation grew 20%, Industrial 11%. Roughly how much of that was volume in each segment?

I think if you try to peel that back and you look at Vegetation Management, about one-third of the total growth came from pricing, but the rest of it was incremental volume. And I feel pretty comfortable with that number. In the Industrial division, out of the 11%, my own estimate is about 5% of that was price. And even that came relatively late in the quarter. We had raised our prices late last year, knowing our costs were coming. So I think this quarter, we actually saw some pretty decent growth. And I used a different word this quarter to describe the chassis situation, you may not have picked up on it, Chris. But I talked about it in terms of extended lead times rather than delays because we are starting to get chassis flowing into our businesses reliably. In other words, we get them when the manufacturers tell us we’re going to get them, which is great. It’s allowing us to plan our production better, and that improved our efficiencies as I made a remark about in my comments on the call. So as long as that continues, there’s no reason why our earnings should suddenly jump again that I can see. So as I said, I think Q2 is going to look a lot like Q1. I just wanted to raise the specter that sort of the risk profile in the market generally is rising a bit.

Got it. With regard to pricing, have you raised prices again this year after the increase at the end of 2021?

We have. In fact, we were given another surcharge on our truck chassis from our largest supplier, and we’ve had to go back to customers now and open up contracts even on our governmental side, which is not normally an easy thing to do. But we’ve been very transparent about that with our customers. We’ve offered them the opportunity to cancel orders, and not a single customer has taken us up on it. So yes, we are continuing to adjust pricing right along the way. And the Vegetation Management group is adjusting prices constantly, both in terms of raw price and also in terms of surcharges.

Got it. Last one for me. Parts were, I think, 18.8% of Q1 versus 20.4% year-over-year. Given the challenge in shipping some whole goods, I would have thought that might have ticked up some. Is there any chance that parts is meaningfully above 20% at some point in 2022?

Yes, they will in the second quarter and the third quarter. That’s usually our highest two quarters where we ship parts. This is Richard.

And Chris, a big chunk of that is the incremental parts business that came with the Morbark acquisition, and those customers run really hard in Q2 and Q3, and they’re burning through wear parts. So I second what Richard just said to you.

Up next, we will hear from Mike Shlisky with D.A. Davidson.

Can we start quickly with just a follow-up on some of your margin comments earlier. Typically, most years, just given the seasonality, Q2 is often nicely higher margin quarter than Q1. But given the challenges of this year, could actually Q2 margins this year be down quarter-over-quarter?

No, this is Richard. I don’t believe that. As I mentioned to Chris, our parts sales increased in Q2 and Q3, so we should see an uptick from that situation. Additionally, as Jeff mentioned, the Vegetation Management aspect is a bit easier for them as they can implement additional surcharges on many of their existing orders, as well as any new ones going forward. We are attempting to keep pace with the rising costs, and we hope that this will balance out in the end. Q1 was exceptionally challenging, as virtually every inbound freight invoice included frame surcharges and tariffs. When asked if these could be removed, the response was no, and if it’s unacceptable, the only option is to go elsewhere. It’s been quite difficult to navigate this situation. Each of the two divisions is working to increase their prices as quickly as they can to help mitigate some of these additional costs.

And Mike, it’s Jeff here. There’s another factor we shouldn’t overlook. I mentioned that our chassis delivery reliability has improved significantly. We are now receiving chassis more predictably, although not in the quantities we prefer. This reliability allows us to operate our factories much more smoothly, which has increased operational efficiency in the Industrial Equipment division. This change began in the middle to later part of the quarter, so I anticipate we will experience a full quarter of solid performance. I expect operational efficiency to keep improving sequentially quarter-over-quarter, at least through Q2 and possibly into Q3 as well.

I think also too there, Mike, as long as we don’t have a COVID-19 breakout, we should have efficiencies just from full plant operation as well.

Got it. I want to turn to your ag business, your core row crop ag business, and your probably your livestock as well. Given that it’s hard to find some raw materials, prices are awfully high, if you can even get them in the first place. Do you guys sense that dealers are unwilling to order equipment or take any risk on equipment at this point? Or are they saying, 'I can’t get the fertilizer; I got to make sure I have good equipment to get the best possible yield.' I am just trying to understand the formula on the ag outlook here.

Understand, Mike, it’s Jeff here. I think our dealers will take all the equipment we can get to without any hesitation at all. We have not seen any reluctance on the part of our dealer network in ag whatsoever, to take equipment or to replenish orders. Where are we in the ag cycle? Well, I certainly think we’re near the top of it. I don’t want to signal anything else. And inventory levels in the ag side remain historically low. They’ve not tipped up at all. That’s why I wanted to point that out in the call. So I mean our dealers are retailing equipment as fast as we deliver to them. In the ag sector, generally, I mean, I flagged a couple of things in the press release. But I think everybody ought to be thinking about when they evaluate the ag market, you’ve got sort of opposing forces going on in ag at a macro level at the moment. On the one hand, the war in Ukraine, particularly as it starts to spread closer to the port of Odessa is going to really put a crimp in global supplies of wheat and other grains. I mean, we all know that that’s coming. So for U.S. farmers, they’ll be able to sell all the crops they can grow. And my guess is they’re going to be in a rising price environment. That won’t be an issue. But at the same time, we’ve got rising interest rates, which makes it harder for them to finance equipment. And so farmers are going to have to weigh how long and how far can they push the equipment they have when they are really trying to get crop yields rising. They’re trying to get all the crops they can to market. So I think it will be very interesting to see how that plays out over time. But on balance, I think it’s bullish. I think out of the two factors, I mean, I think overall, it’s bullish for ag. And I think it may sustain this high peak in the ag market longer than we would otherwise see in a normal cycle.

Got it. Just to kind of follow up there. This might not be your purview, guys, but I know you’re seeing chassis supply issues on some of the truck-mounted equipment that you do. But are there any issues with getting tractors or the other appropriate prime movers for your products in the ag business?

No, tractor deliveries are actually improving. We primarily purchase John Deere equipment, along with some CNH, but John Deere is our main focus. Their tractor deliveries are getting better, and they appeared optimistic about their future prospects, indicating that they are beginning to resolve their supply chain issues. I'm not worried about that aspect of our business. If you were to look behind our headquarters, you would see that we have a larger inventory of tractors than we have had in some time, which gives me confidence about that part of our operations. Regarding other prime movers, the situation varies by location. The industry is facing challenges with components coming from China, particularly hydraulics, and to a lesser degree, pneumatics. I remain concerned about the potential impact of lockdowns in China over the next few quarters on the availability of hydraulic cylinders, flow dividers, and other essential components for machinery. The congestion at the port of Shanghai is significant, with many ships waiting to load. However, concerning our own exports from China that support our agricultural business, we've been performing well and have secured about a quarter to two quarters' worth of supply already en route. If there are risks to our business in this area, they would likely manifest in the fourth quarter at the earliest, but more probably in 2023. The suppliers responsible for our driveline components for mowers and similar products are still operational and have not shut down. Our main challenge lies in getting goods out of China. Some of the freight costs mentioned were due to air freight, which we utilized to ensure timely delivery of components to our customers.

That’s great. I appreciate that. If I can just squeeze one more in. Maybe this is for Richard. After the excise tax audit thing you had in this quarter, we need to assume a higher tax rate on models going forward? Or is it really a one-time item?

No, regarding the excise tax, that was included in the other income and expense line and won't impact the overall tax rate. However, we have stabilized the tax rate, which is expected to be around 25.5%, with possible minor fluctuations throughout the year. Typically, in the first and second quarters, we benefit from a significant credit related to the exercise of RSA options, allowing us to deduct that from our tax rate. By stabilizing this, we effectively eliminate concerns about fluctuations.

And we have no further questions. I’ll turn the call back over to management for closing remarks.

Okay. Thank you for joining us today. We look forward to speaking with you on our second quarter call in August, and we’ll speak to you then. Thank you very much.

And once again, this concludes today’s call. We thank you again for your participation, and you may now disconnect.