Earnings Call Transcript - ALG Q2 2023

Operator, Operator

Good morning ladies and gentlemen and welcome to the Alamo Group Inc. Second Quarter 2023 Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. This call is being recorded on Thursday, August 3, 2023. I would now like to turn the conference over to Edward Rizzuti, Executive Vice President, General Counsel, and Secretary. Please go ahead.

Edward Rizzuti, Executive Vice President, General Counsel, and Secretary

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 one hour after the call and run for one week. The replay can be accessed by dialing 1-844-512-2921 with the passcode 97441743. 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 will 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 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 Jeff Leonard. Jeff, please go ahead.

Jeff Leonard, President and Chief Executive Officer

Thank you, Ed. We want to thank all of you for joining us on the call today. Rich will begin our call with a review of our financial results for the second quarter of 2023. I will then provide additional comments on the results. Following our formal remarks, we look forward to taking your questions. So Richard, please go ahead.

Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer

Thanks, Jeff, and good morning, everyone. Alamo Group's second quarter 2023 closed with an excellent performance that produced record net sales and net income driven by strong demand for our products. Second quarter consolidated net sales were $440.7 million, an increase of 11% compared to $396.2 million in the second quarter of last year. Gross margin dollars in the quarter improved compared to the second quarter of 2022 by $18.4 million as the gross margin percent increased by 160 basis points. Both margin dollars and percentage increases came from high volume and pricing initiatives we began in early 2022 along with productivity gains. We continue to experience improvements in our supply chain as we saw more consistent deliveries throughout the quarter. Operating income for the second quarter was $54.4 million versus $40.9 million in the second quarter of 2022, an increase of 33%. Operating income as a percentage of sales was 12.3% for the second quarter of 2023 versus 10.3% for the same quarter last year, an increase of 2%. Consolidated net income for the second quarter was $36.4 million or $3.03 per diluted share, an increase of 27% versus net income of $28.5 million or $2.39 per diluted share for the second quarter of 2022. Our continuous efforts to control both costs and expenses helped support the increase in profitability despite a dynamic operating environment. The Vegetation Management Division once again delivered solid results in the second quarter of 2023. Net income was $261.3 million, an increase of 3% compared to $255 million for the second quarter of 2022. Strong sales of forestry, tree care, and governmental mowing products in North America, the U.K., and Europe led the way for this division. Despite labor shortages and to a lesser extent supply chain disruptions, margins improved primarily due to an increase in net price realization and improvements in operating efficiency. Operating income for the second quarter in this division was $35.6 million, up 8% versus $32.8 million for the same period in 2022. In the Industrial Equipment division, net sales in the second quarter were $179.3 million, up 27% compared to $141.2 million for the second quarter of 2022. This was due to a solid performance across all product lines, particularly vacuum trucks, sweepers, tree collectors, and snow removal equipment. While truck chassis deliveries showed improvement in the quarter, component parts shortages continued to impact the division's operations, which constrained efficiencies, although not as significantly as in previous quarters. This resulted in a significant rise in operating income in the second quarter for 2023 of $18.8 million compared to $8.1 million for the second quarter of 2022, an increase of 132%. Consolidated net sales for the company were a record for the first half of 2023, coming in at $852.5 million, up 12% compared to $758.2 million for the first half of 2022. Strong demand for our products in both divisions, along with positive impacts of pricing initiatives and improved supply chain and productivity were the main drivers of the increase. For the first half of 2023, net sales for the Vegetation Management division were $517.8 million compared to $476 million for 2022, up 9%. The division experienced robust demand in all product categories, particularly in forestry, tree care, land clearing, agriculture, and governmental mowing in North America, U.K., and Europe. The Company's backlog at the end of the second quarter of 2023 came in at just over $891 million. This is slightly down compared to the backlog at the end of the second quarter for 2022, which was $894 million. The working capital increased to $657 million from $537 million at the end of the second quarter. The increase in working capital resulted mainly from higher accounts receivable and to a lesser extent, inventory. Accounts receivable were $379 million, up 23% from a year ago from solid sales volume. We are pleased with receivables, with no major issues on collections and incoming cash remaining steady. Inventory was up $16 million compared to June of 2022, mainly due to several large orders we were not able to ship at the end of the quarter, as well as a significant influx of tractors and chassis in late June. Material cost inflation drove the bulk of the year-over-year increase. During the second quarter, we reduced our debt level on our credit facility by almost $25 million. Finally, the company's trailing 12 months EBITDA was a record coming in at just over $230 million, up 18% compared to calendar 2022. For the balance of 2023, cash flow should remain strong, as our focus on the balance sheet will continue to reduce both inventory and debt levels. Increased consolidated profits for 2023 will remain extremely important. We will also remain disciplined in controlling costs and expenses, as inflation continues to put pressure on our margins. We will also adjust prices as needed based on changes in material and transportation costs in order to maintain our target margins. We are also focusing on further improving supply chain performance to help reduce the amount of inventory we hold in work in process. Our biggest challenge will continue to be meeting the heightened demand for our products throughout the company, given current supply chain constraints and labor shortages. We are pleased that our Board recently approved a regular quarterly dividend of $0.22 per share for the second quarter of 2023. In summary, key takeaways from the second quarter include sales up 11%, resulting in a 33% increase in operating income, coming in at 12.3% of sales and a 27% increase in earnings per share.

Jeff Leonard, President and Chief Executive Officer

Thank you, Richard. I'd like to express my personal thanks to everyone who has joined our call today. We were very pleased that in the second quarter our teams once again set new all-time company records for quarterly sales and net income. We had anticipated lower material cost inflation and a further improvement in the performance of our supply chain, which helped to increase sales, stabilize our manufacturing cadence, and improve operating margins. Sales improved across both of our operating divisions, and consolidated sales were up over 11% compared to the second quarter of 2022. Our teams again did an excellent job of keeping our operating expenses under tight control. Operating expenses, although 9% higher than the first quarter, declined nearly 30 basis points as a percentage of sales. With this solid cost discipline, we were able to achieve excellent leverage on the higher top line. The operating margin in the second quarter was 12.3% of sales, an improvement of 200 basis points versus the prior year. Second quarter net interest and currency translation costs were 114% higher than the prior year. Despite these headwinds, net income improved nearly 28% versus the second quarter of 2022. This strong second quarter performance has led to a consolidated operating margin slightly above our 12% target for the first half of 2023. In aggregate, our markets continued to display strength during the quarter, and activity remains strong in most areas. Part sales during the quarter were somewhat lower than we had anticipated due to the impact of the extended drought in many parts of North America and Europe. Some market segments began to come under pressure this quarter due to rising channel inventory and the effect of higher interest rates. Second quarter bookings declined approximately 9% compared to the prior year, although backlog was essentially unchanged compared to the second quarter of 2022. Our governmental markets continued to display significant strength across all geographic markets and product lines. Orders received from municipalities and contractors to serve them improved, and inquiry activity remains at historically elevated levels. Our Vegetation Management division produced strong results again in the second quarter. Sales were modestly higher; however, operating income was up 8.5% compared to the second quarter of 2022, reflecting better pricing and improved manufacturing efficiencies. Order bookings of $150 million in the quarter declined 18% from the same period of 2022 as we anticipated. The division's forestry, tree care, North American hobby farm and ranch segments experienced softer activity during the quarter. We received some order cancellations, primarily for mulching equipment and other land clearing equipment, partly due to the ongoing shortage of tool carriers in dealer inventories and also to the elimination of certain speculative orders. Increasing dealer caution toward rising inventories was evident in the face of rising interest rates.

Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer

As also expected, activity slowed in the North American hobby farm and ranch segment as channel inventories reached levels that many dealers are not comfortable with given higher and still rising financing costs. To combat this, we offered our dealers retail incentives during the second quarter. These were successful and helped to reduce inventory in the channel and improved collections in the quarter. Sales of this division's products to governmental customers continued at a brisk pace in North America, Brazil, Europe, United Kingdom, and Australia. North American governmental demand for tractor-mounted mowing equipment remained at record levels. Vegetation Management division backlog at the end of the quarter was $416 million, down 32% from the same period of 2022, which is in line with our expectations. On balance, we were very pleased that despite these headwinds, the Vegetation Management Division produced excellent results again and the division's backlog remains at a historically elevated level. Our Industrial Equipment Division also had an excellent second quarter. This division's sales for the quarter were up 27% compared to the same period of 2022.

Jeff Leonard, President and Chief Executive Officer

Operating income was up 132% compared to the second quarter of 2022. With improvement in supply chain performance and higher truck chassis receipts driving improved efficiencies, this division produced stronger results with operating income above 10%, and again in line with our expectations. The division received new orders valued at $175 million during the second quarter. While bookings in this division were flat compared to the prior year, this was lower than expected due to order timing issues. Orders for the division's major product lines improved, most notably excavators and vacuum trucks. Our governmental customers and the specialty contractors that serve them continued to invest in upgrading their maintenance fleets, and we believe we are beginning to see incremental benefits in certain product lines from demand stimulated by the Infrastructure Bill. Most of our Industrial Equipment dealers do not carry an appreciable inventory of our products beyond the central product demonstrators, and therefore, they have not been impacted to the same extent by higher costs associated with rising interest rates. The Industrial Equipment division backlog of $475 million is an increase of nearly $130 million or 38% compared to the same period of 2022.

Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer

The increase was driven primarily by sharply higher orders for its vacuum trucks and excavators, partly offset by slightly lower sales of sweepers and snow removal equipment. Looking ahead, we continue to like how our company is positioned. Our order backlog of $891 million remains very robust, and the sequential decline in order backlog in our Vegetation Management division was actually less than we'd anticipated.

Jeff Leonard, President and Chief Executive Officer

Recent indicators show the hobby farm and ranch segment stabilizing as farmer sentiment is rising, and the AEM recently reported that June U.S sales of small tractors under 40 horsepower ticked upward for the first time this year. The strong activity in the governmental markets, supported by moderating inflation and improving supply chain performance, provides confidence that we will continue to perform well for the balance of this year. We expect that our Vegetation Management division will continue to perform at a high level, although with more moderate sales growth. Our Industrial Equipment division is expected to continue to expand both sales and margin in the second half of the year as supply chain improvements allow it to accelerate shipments and drive efficiencies higher. Beyond 2023, uncertainty remains. It's not yet clear whether the U.S economy will achieve a soft landing or if further interest rate hikes will be required. Before closing my remarks today, I'd like to thank our customers, dealers, suppliers, our thousands of exceptional employees, and our financial stakeholders for their continued support for the company. This concludes our prepared remarks. We are now ready to take your questions. Operator, please go ahead.

Operator, Operator

Thank you. First question comes from Chris Moore at CJS Securities. Please go ahead.

Chris Moore, Analyst

Good morning, guys. Thanks for taking a couple of questions and great quarter. Maybe we will just start with backlog pricing. Backlog was $1 billion or so in April, down to $890 million, pricing looks very favorable in April for at least a couple of quarters. How are you looking at this point?

Jeff Leonard, President and Chief Executive Officer

I think the pricing in the backlog is still in great shape, Chris. I'm not really concerned about that. But the buildup of inventory in the channel is occurring faster than I had thought it would at the end of Q1. We were getting some requests for help from the dealers to move that channel inventory forward to retail sales. Therefore, we did implement some incentives to achieve that. However, that hasn't directly impacted the margin and the backlog at all. From an Industrial Equipment division point of view, the margin and the backlog remain outstanding. There has really been no new price pressure on that side of our business at all.

Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer

I think we are feeling a little bit of pressure, especially in the Vegetation Management side of the business because material costs are starting to drop a little bit. Some of the pricing that we will have going forward into the new orders we taken will probably just drop off some steel surcharges that we have in there, but still maintain our overall net price that we've been charging.

Jeff Leonard, President and Chief Executive Officer

For what it's worth, if you look at where we are from a dealer perspective with higher pricing that's been implemented over the last couple of years, it effectively means, while they have the same amount of space on their balance sheet expressed in dollar terms, it means fewer units that they can afford to have in the channel, as interest rates rise. So that's the caution I'm referring to, which has really been confined to the hobby farm and ranch segment. That's the only segment where we experienced any of that pressure.

Chris Moore, Analyst

Got it. How are you looking at Morbark at this point in time? With interest rates rising, you talked a little bit about potential challenges that could make demand less certain, maybe just talk about how you're seeing Morbark now for the rest of the year?

Jeff Leonard, President and Chief Executive Officer

Morbark's order book is holding up pretty well, Chris. I've been pleased with that along the way. I think the combination of higher interest rates and a slowing housing market are beginning to impact their business, although it hasn't materialized in our numbers yet. I don't really have any evidence of that. When housing starts slow and consumption of lumber falls, it means less branches to be shredded to make mulch. The cost of feedstock for pellets rises, and that's a negative indicator for that business going forward. However, overall, Morbark is in great shape. Operations are stabilizing, and net margins are actually improving at the moment.

Chris Moore, Analyst

Got it. Helpful. And maybe just shift gears to operating margins. 12.3% this quarter even though parts weren't quite as good as you thought. We are estimating north of 12% again in Q3. What are the puts and takes, and trying to gauge the likelihood of Q4 being able to generate operating margins in the 12% range?

Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer

I think you can go back to the fourth. If you go back to the fourth quarter of last year, we generated an 11.7% operating income in the fourth quarter. It is definitely doable. Shipping an extremely high volume of units pulled that margin. We were at 27.3% for the first quarter and we are 26.8% here. Overall, we are still pleased with the margins that we've got, especially since we expect another good quarter for part sales.

Jeff Leonard, President and Chief Executive Officer

In the third quarter, we start to see the parts activity in snow removal as pre-season snow removal parts ordering begins to pick up, which is potentially a bullish indicator. Additionally, the Industrial Equipment division will continue to gain momentum, and I have reminded the audience a number of times that historically, Industrial Equipment division margins were very much on par with those of Vegetation Management, and I think that gap will continue to close. I am confident we can sustain this 12% level for the rest of this year based on current trends.

Chris Moore, Analyst

Awesome. All right. I will leave it there. Thanks, guys.

Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer

Thanks, Chris.

Operator, Operator

Thank you. The next question comes from Mike Shlisky from D.A. Davidson. Please go ahead.

Mike Shlisky, Analyst

Yes. Hi, good morning. Thanks for taking my question.

Jeff Leonard, President and Chief Executive Officer

Hi, Mike.

Mike Shlisky, Analyst

Maybe to follow up your comments there, Jeff, maybe ask two quick follow-ups from what you just mentioned in your last answer there. I'll start with the positive feeling on parts of Industrial and maybe less positive on some of the Vegetation business. I guess net-net, do you feel like the infrastructure bill and sort of off-grass types of applications are more than offsetting what you're seeing on the farm right now? I mean on the whole, do you feel better this quarter compared to last quarter about how things are kind of looking here?

Jeff Leonard, President and Chief Executive Officer

I do, Mike. I wouldn't say it's higher than it was a quarter ago, but I still feel very good about our position, and I think Vegetation Management can hold its position as expected. I still think we'll see modest sales growth out of that division in Q3. I don't expect their margins to erode. We haven't seen the full impact of their pre-season yet, which looks positive this year compared to previous expectations. So I expect both divisions will continue their momentum.

Mike Shlisky, Analyst

I want to follow up on the snow business. I noticed that the orders may not have been as strong as they were in the past quarter. I'm curious if this is because you are already at capacity for the year and prefer to take fewer orders, or if there are more significant concerns.

Jeff Leonard, President and Chief Executive Officer

No, it's not really complicated, Mike. A year ago, we received up to $30 million in single orders in snow removal in the second quarter. The second quarter is typically the doldrums for snow removal. Nobody is ordering or talking about ordering, and last year we had an unusually strong second quarter. Our position in snow removal is very good and optimistic. The chassis situation is improving significantly at the moment, allowing us to allocate more chassis to snow removal to support continued growth.

Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer

One other thing to add is that with some of this loosening on chassis, specifically in the Industrial Equipment division, we’ve negotiated consignment agreements with our major suppliers for freight. Having that on consignment is going to be extremely helpful for us from an inventory standpoint because we'll be able to consume the unit, ship it, invoice it, and then record the actual receipt of that chassis.

Mike Shlisky, Analyst

That’s great color. Thanks for that. Then turning to your margin commentary, you've got this 12% plus despite some of the headwinds on chassis supply chain and I was kind of wondering if this is the right time to talk about a new little higher target going forward, or are you still focused on maintaining that 12% range?

Jeff Leonard, President and Chief Executive Officer

Mike, I knew you were going to ask me that. We are still discussing it, but I've said consistently that once we achieve 3 or 4 quarters of operating at 12%, we should consider establishing a new target. However, with the general uncertainty in the business environment at the moment, I don't think we should raise that today, but I still have confidence in sustaining at 12% and potentially widening the gap even more. Our chassis receipts are rising nicely, and we have restructured our snow removal group to lower its operating cost threshold.

Mike Shlisky, Analyst

If I can throw one more question in there. You mentioned the ranching business having a little tough time with drought and so forth hobby farms, ranch, and so forth. Do you feel okay about the small part of your business that does large row crops, like corn, soybean, etc.?

Jeff Leonard, President and Chief Executive Officer

Yes, I do. I think the AEM tractor retail numbers for June actually ticked up in the under 40 horsepower category. Farmers appear to be seeing a little better outlook, despite the ongoing war in Ukraine. That segment is stabilizing, though the negative impact in the hobby farm and ranch is due to higher dealer inventories. We did some incentives this quarter that drove our marketing costs up a little, helping clear channel inventory.

Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer

In the ag space, we also introduced a pre-season program that started in mid-June and ran through the end of July, and we got excellent results out of that, which bodes well for the remainder of the year.

Mike Shlisky, Analyst

Thanks so much. I appreciate your thoughts. I will pass it along.

Jeff Leonard, President and Chief Executive Officer

Thank you, Mike.

Operator, Operator

Thank you. The next question comes from Tim Moore at EF Hutton. Please go ahead.

Tim Moore, Analyst

Thanks and congratulations on the continued strong sales growth. It makes sense that the industrial orders have been up significantly over the past year to offset the Vegetation orders. If you look at your backlog and it's double what it was the month before COVID started. I have a multi-part question that can probably count as my complete time, Jeff, if you want to take some time on this. I know someone just beat me to it about getting you to raise your 12% operating margin after 11.9% last quarter and 12.3% this quarter. But I'm wondering, just maybe if you can talk more high-level about the continued overall margin expansion drivers if the economy remains steady. Specifically, I'm curious about the improved fixed cost absorption. It seems like the supply chain disruptions are starting to abate, two-thirds of the way back to normal today. That means operating leverage is going to help Industrial with growth.

Jeff Leonard, President and Chief Executive Officer

In terms of margin expansion, I am confident Industrial will get to that 12% threshold. We still have plant closures in the pipeline that we are working on, and we are selling off facilities and booking gains along the way. However, labor shortages are impacting consolidation operations. We are short on manufacturing capacity in Europe, and we are planning significant capital expenditures in both our French and U.K. operations to add that capacity, allowing us to accelerate our make-in-market initiatives.

Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer

As Jeff mentioned, we cannot bring back 99% of our cash on our balance sheet due to unfavorable exchange rates. So we are pivoting to conduct necessary capital expenditures in Europe.

Jeff Leonard, President and Chief Executive Officer

These capital expenditures are focused on increasing our in-country manufacturing to minimize transportation costs. We have a positive outlook on our Timberwolf and new product introductions that we're excited to leverage demand across markets.

Tim Moore, Analyst

Great. That’s terrific color. I appreciate the detailed answers. I'll save my other questions for offline later today.

Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer

Okay.

Jeff Leonard, President and Chief Executive Officer

Thanks, Tim.

Operator, Operator

Thank you. Next question comes from Felix Boeschen at Raymond James. Please go ahead.

Felix Boeschen, Analyst

Hey, good morning, everybody.

Jeff Leonard, President and Chief Executive Officer

Hi, Felix.

Felix Boeschen, Analyst

Hey, I appreciate the comments on getting Industrial back to 12% margins over time. I guess what I'm curious about is you mentioned chassis flow improving quite a bit on the call, but could you maybe comment on the magnitude of cost inefficiencies that are still running in the P&L today in that business line. What I'm trying to figure out is if those were to normalize from here, could you reach that 12% margin target within that existing revenue base, or is it really about further volume throughput output from here?

Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer

Yes, we definitely feel like we can get there. Under absorption in Industrial is hurting margins by a point to a point and a half. We can achieve higher margins as missing component parts constraints improve, and as a result, that would quickly pull margins closer to that 12% goal.

Jeff Leonard, President and Chief Executive Officer

We don't need the top line to get to 12% in Industrial. To be clear, we don't need it.

Felix Boeschen, Analyst

Got it. Super clear. And then I know you've made some operational changes in your snow removal business, and I think the idea is really to help drive profit per unit output. What I'm curious about is how much of that improvement is already in the numbers today versus what you think might still be on the horizon in the back half of the year and coming years.

Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer

Yes, it has improved significantly, by at least 150% where we were last year. However, just remember that in the second quarter, we won't have a lot of opportunities to push that margin higher due to summer effects. But as we move into the third and fourth quarters, it is indeed on our radar for achieving those targets.

Jeff Leonard, President and Chief Executive Officer

Snow removal is one of our lower margin businesses with plenty of room to grow. We've done the right things with the fixed cost structure, and the team is strong with a large backlog of significant price truck builds. We expect a positive seasonality for snow removal this year and even into the next quarter.

Felix Boeschen, Analyst

Got it. And then just my last one, but again with the chassis flow improving, could you go over the size of your rental fleet today versus how that might shake out in coming years? Again, I'm curious if you think it's nearing the point where you can reignite growth in that business.

Jeff Leonard, President and Chief Executive Officer

Our vacuum truck fleet has been stable, and we haven't been able to add trucks to the fleet the way we would like. However, with more chassis coming in, we will be able to add trucks, which will drive higher profitability in Industrial. This is another profit improvement level for Industrial.

Felix Boeschen, Analyst

Got it. I will stop there. I appreciate the time.

Jeff Leonard, President and Chief Executive Officer

Thanks, Felix. Look forward to talking to you again.

Operator, Operator

At this time, there are no further questions. I will turn the call back over to management for closing comments.

Jeff Leonard, President and Chief Executive Officer

Thank you for joining us today. We look forward to speaking with you on our third quarter conference call in November. Thank you very much.

Operator, Operator

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.