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ALG > SEC Filings for ALG > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for ALAMO GROUP INC


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following tables set forth, for the periods indicated, certain financial data:

                       Three Months Ended        Nine Months Ended
                          September 30,            September 30,
        As a
Percent of Net Sales    2012         2011         2012        2011
North American
Industrial              39.7 %        36.7 %      41.1 %      36.2 %
Agricultural            34.7 %        35.7 %      32.5 %      35.2 %
European                25.6 %        27.6 %      26.4 %      28.6 %
Total sales, net       100.0 %       100.0 %     100.0 %     100.0 %




                                    Three Months Ended         Nine Months Ended
                                       September 30,             September 30,
Cost Trends and Profit Margin, as
    Percentages of Net Sales         2012         2011         2012         2011

Gross margin                         23.8 %        24.0 %      23.3 %        23.3 %
Income from operations                8.4 %         9.3 %       8.0 %         8.2 %
Income before income taxes            8.0 %         9.5 %       7.6 %         8.0 %
Net income                            5.5 %         6.5 %       5.2 %         5.4 %

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.

In the third quarter of 2012, the Company's net income was down due to weakness in the European economy, slower sales of agricultural equipment, lower sales of higher-margin replacement parts, and an unfavorable comparison of foreign exchange losses relative to prior year gains. Agricultural markets continue to reflect a trend of slower market growth that began during the first quarter of 2012 and has continued into the third quarter. While activity of row-crop farms has remained steady, equipment sales to hobby farmers has remained depressed as they remain cautious about the U.S. economy. Also affecting agricultural sales in the quarter were drought conditions throughout the mid-west part of the United States. Alamo's Industrial Division saw a 9% increase in sales versus the third quarter of 2011, mainly from the acquisition of Tenco along with improved sales in mower products and vacuum trucks. However, budget constraints continue to be an issue as sales of excavators and street sweepers to governmental entities were below expectations. European sales were down compared to the third quarter of 2011. Agricultural markets in Europe continue to remain steady, though governmental markets remain challenged by weak conditions caused by the general slowdown in the European economy.

The Company remains concerned that our markets for the remainder of 2012 could be negatively affected by a variety of factors such as a continued weakness in the overall economy, sovereign debt issues, credit availability, increased levels of government regulations; changes in farm incomes due to commodity prices or governmental aid programs; adverse situations that could affect our customers such as animal disease epidemics, weather conditions such as droughts, floods, snowstorms, etc.; budget constraints or revenue shortfalls in governmental entities and changes in our customers' buying habits due to lack of confidence in the economic outlook.


Results of Operations

Three Months Ended September 30, 2012 vs. Three Months Ended September 30, 2011

Net sales for the third quarter of 2012 were $156,078,000, an increase of $1,021,000, or 0.7% compared to $155,057,000 for the third quarter of 2011. The increase was from the acquisition of Tenco in the amount of $5,018,000. Agricultural markets continued to experience slower growth during the third quarter of 2012 as farmers were cautious about the U.S. economy. European sales for the third quarter of 2012 also were down especially in France as economic uncertainty and financial turmoil continued to affect the entire region.

Net North American Industrial sales increased during the third quarter by $5,007,000 or 8.8% to $61,972,000 for 2012 compared to $56,965,000 during the same period in 2011. The increase came primarily from the acquisition of Tenco in the amount of $5,018,000 and higher sales of mowing products and vacuum trucks. Sales of excavators and street sweepers were down compared to the third quarter of 2011 as governmental end users continued to be affected by budgetary constraints.

Net North American Agricultural sales were $54,135,000 in 2012 compared to $55,301,000 for the same period in 2011, a decrease of $1,166,000 or 2.1%. The decrease was from slower market conditions compared to high growth rates experienced the last two years. Drought conditions throughout the mid-west portion of the U.S. also affected sales in this division.

Net European Sales for the third quarter of 2012 were $39,971,000, a decrease of $2,820,000 or 6.6% compared to $42,791,000 during the third quarter of 2011. The decrease was primarily due to the economic slowdown throughout Europe.

Gross profit for the third quarter of 2012 was $37,070,000 (23.8% of net sales) compared to $37,223,000 (24.0% of net sales) during the same period in 2011, a decrease of $153,000. An increase from the acquisition of Tenco in the amount of $1,012,000 was offset by reduced sales in the Company's European and Agricultural Divisions. The margin percentage was down due to lower sales of higher-margin replacement parts.

Selling, general and administrative expenses ("SG&A") were $23,992,000 (15.4% of net sales) during the third quarter of 2012 compared to $22,762,000 (14.7% of net sales) during the same period of 2011, an increase of $1,230,000. The increase was from the acquisition of Tenco in the amount of $947,000.

Interest expense was $392,000 for the third quarter of 2012 compared to $506,000 during the same period in 2011, a decrease of $114,000. The decrease in 2012 came from reduced borrowings in 2012 compared to 2011.

Other Income (expense), net was a $234,000 expense for the third quarter of 2012 compared to a $817,000 income in 2011. The expense in 2012 and income in 2011 were the result of foreign exchange rate changes.

Provision for income taxes was $3,943,000 (31.5%) in the third quarter of 2012 compared to $4,748,000 (32.1%) during the same period in 2011. The lower effective tax rate came from non recurring adjustments to tax reserves due to a reduction in the 2012 U.K. tax rate.

The Company's net income after tax was $8,575,000 or $0.71 per share on a diluted basis for the third quarter of 2012 compared to $10,056,000 or $0.84 per share on a diluted basis for the third quarter of 2011. The decrease of $1,481,000 resulted from the factors described above.

Nine Months Ended September 30, 2012 vs. Nine Months Ended September 30, 2011

Net sales for the first nine months of 2012 were $478,998,000, an increase of $22,402,000 or 4.9% compared to $456,596,000 for the first nine months of 2011. The increase was mainly from the acquisition of Tenco in the amount of $20,130,000 and improved sales of mowing equipment in the Industrial Division. The Company's Agricultural Division was down as agricultural markets continued to experience slower growth for the first nine months of 2012 as farmers remained cautious about the weak U.S. economy. Sales in the European Division were down in the first nine months of 2012 compared to the same time in 2011 as governmental markets continued to be soft due to the economic slowdown in Europe.


Net North American Industrial sales increased during the first nine months by $31,522,000 or 19.1% to $196,841,000 for 2012 compared to $165,319,000 during the same period in 2011. The increase was from the acquisition of Tenco in the amount of $20,130,000 and improved sales in mowing equipment and vacuum trucks. Sales of excavators and street sweepers were negatively affected by slower markets related to governmental municipalities.

Net North American Agricultural sales were $155,487,000 in 2012 compared to $160,510,000 for the same period in 2011, a decrease of $5,023,000 or 3.1%. The decrease was from slower market conditions and decreased shipments of preseason orders as average dealer inventory for both Bush Hog and Rhino were higher than 2011 levels. Also affecting demand has been the reduction of sales to hobby farmers who have been reluctant to buy due to the uncertain economic conditions. Drought conditions in Oklahoma and Texas have improved but affected the mid-west part of the U.S.

Net European sales for the first nine months of 2012 were $126,670,000, a decrease of $4,097,000 or 3.1% compared to $130,767,000 during the same period of 2011. The decrease in 2012 was from soft market conditions in governmental markets which were caused by the slowdown in the European economy. This Division has had some improvement in its U.K. agricultural sales.

Gross profit for the first nine months of 2012 was $111,469,000 (23.3% of net sales) compared to $106,515,000 (23.3% of net sales) during the same period in 2011, an increase of $4,954,000. The increase was from the acquisition of Tenco in the amount of $4,111,000, improved sales in the Company's Industrial Division and, to a lesser extent, lower manufacturing costs.

Selling, general and administrative expenses ("SG&A") were $73,073,000 (15.3% of net sales) during the first nine months of 2012 compared to $69,007,000 (15.1% of net sales) during the same period of 2011, an increase of $4,066,000. The increase in SG&A for the first nine months of 2012 was mainly from the acquisition of Tenco in the amount of $3,351,000.

Interest expense was $1,360,000 for the first nine months of 2012 compared to $1,715,000 during the same period in 2011, a decrease of $355,000. The decrease came from reduced borrowings and lower interest rates in 2012 compared to 2011.

Other income (expense), net was $656,000 of expense during the first nine months of 2012 compared to $595,000 of income in the first nine months of 2011. The expense in 2012 and income in 2011 were from changes in foreign exchange rates.

Provision for income taxes was $11,855,000 (32.4%) in the first nine months of 2012 compared to $11,907,000 (32.6%) during the same period in 2011.

The Company's net income after tax was $24,704,000 or $2.05 per share on a diluted basis for the first nine months of 2012 compared to $24,637,000 or $2.06 per share on a diluted basis for the first nine months of 2011. The increase of $67,000 resulted from the factors described above.

Liquidity and Capital Resources

In addition to normal operating expenses, the Company has ongoing cash requirements which are necessary to operate the Company's business, including inventory purchases and capital expenditures. The Company's inventory and accounts payable levels typically build in the first half of the year and in the fourth quarter in anticipation of the spring and fall selling seasons. Accounts receivable historically build in the first and fourth quarters of each year as a result of fall preseason sales programs and out of season sales, particularly in our Agricultural Division. Preseason sales help level the Company's production during the off season.

As of September 30, 2012, the Company had working capital of $235,876,000 which represents an increase of $35,340,000 from working capital of $200,536,000 of December 31, 2011. The increase in working capital was primarily from higher levels of accounts receivable and inventory due to seasonality and the acquisition of Tenco.


Capital expenditures were $3,540,000 for the first nine months of 2012, compared to $4,705,000 during the first nine months of 2011. The Company expects to fund expenditures from operating cash flows or through its revolving credit facility, described below.

The Company was authorized by its Board of Directors in 1997 to repurchase up to 1,000,000 shares of the Company's common stock to be funded through working capital and credit facility borrowings. There were no shares purchased in 2011 or through the third quarter of 2012. The authorization to repurchase up to 1,000,000 shares remains available less 42,600 shares previously repurchased.

Net cash provided by financing activities was $2,719,000 during the nine month period ending September 30, 2012, compared to $4,480,000 for the same period in 2011.

The Company has $36,909,000 in cash and cash equivalents held by its foreign subsidiaries as of September 30, 2012. The majority of these funds are at our UK and Canadian facilities and would not be available for use in the United States without incurring US federal and state tax consequences. The Company plans to use these funds for capital expenditures or acquisitions outside the United States.

On March 28, 2011, the Company entered into the Eighth Amendment of Amended and Restated Revolving Credit Agreement (the "Eighth Credit Agreement Amendment"), by and among the Company, the lenders party thereto and Bank of America, N.A. as administrative agent. The Eighth Credit Agreement Amendment amends certain provisions of the Company's existing credit facility to, among other things, (i) release the previously pledged security interest in certain assets of the Company and its specified subsidiaries which secured any indebtedness under the existing credit facility, (ii) extend the termination date of the Company's credit facility to March 28, 2016, (iii) reduce the aggregate commitments to $100,000,000, (iv) provide the Company the option to request an increase in aggregate commitments under the existing credit facility of up to $50,000,000, subject to the conditions set forth therein (v) lower the applicable leverage ratio, subject to certain exceptions and conditions, (vi) modify the limitation on capital expenditure, (vii) modify the limitation on other indebtedness and
(viii) decrease the applicable interest margin for specified advances.

As of September 30, 2012, there was $12,000,000 borrowed under the revolving credit facility. On September 30, 2012, $1,400,000 of the revolver capacity was committed to irrevocable standby letters of credit issued in the ordinary course of business as required by vendors' contracts resulting in approximately $87,000,000 in available borrowings.

On October 24, 2011, Lloyd TSB Bank plc renewed its 5.5 million overdraft facility to Alamo Group Europe Limited through October 31, 2012. The facility is unsecured but guaranteed by the borrowers' U.K. subsidiaries. Interest is payable on amounts owing at 1.40% per annum over the Bank's Base Rate. At September 30, 2012, there were no amounts outstanding under this facility.

There are additional lines of credit: for the Company's French operations in the amount of 6,200,000 Euros; for our Canadian operation in the amount of 3,500,000 Canadian dollars; and for our Australian operation in the amount of 400,000 Australian dollars. As of September 30, 2012, 714,000 Euros were borrowed against the French line of credit; no Canadian dollars were outstanding on the Canadian line of credit; and no Australian dollars were outstanding under its facility. The Canadian and Australian revolving credit facilities are guaranteed by the Company.

As of September 30, 2012, the Company is in compliance with the terms and conditions of its credit facilities.

Management believes the bank credit facilities 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, the challenges affecting the banking industry and credit markets in general can potentially cause changes to credit availability which creates a level of uncertainty.

Critical Accounting Estimates
Management's Discussion and Analysis of Financial Condition and Results of Operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of these


financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Critical Accounting Policies
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Management believes the following critical accounting policies reflect its more significant estimates and assumptions used in the preparation of the Consolidated Financial Statements. For further information on the critical accounting policies, see Note 1 of our Notes to Consolidated Financial Statements.

Allowance for Doubtful Accounts

The Company evaluates its ability to collect accounts receivable based on a combination of factors. In circumstances where it is aware of a specific customer's inability to meet its financial obligations, it records a specific reserve to reduce the amounts recorded to what it believes will be collected. For all other customers, it recognizes reserves for bad debt based on historical experience of bad debts as a percent of revenues for each business unit, adjusted for relative improvements or deteriorations in the agings and changes in current economic conditions.

The Company evaluates all aged receivables that are over 60 days old and reserves specifically on a 90-day basis. The Company's U.S. operations have Uniform Commercial Code ("UCC") filings on practically all wholegoods each dealer purchases. This allows the Company in times of a difficult economy when the customer is unable to pay or has filed for bankruptcy (usually Chapter 11), to repossess the customer's inventory. This also allows Alamo Group to maintain a reserve over its cost which usually represents the margin on the original sales price.

The bad debt reserve balance was $3,113,000 at September 30, 2012 and $3,215,000 at December 31, 2011.

Sales Discounts

At September 30, 2012 the Company had $14,890,000 in reserves for sales discounts compared to $14,567,000 at December 31, 2011 on products shipped to our customers under various promotional programs. The Company reviews the reserve quarterly based on analysis made on each program outstanding at the time.

The Company bases its reserves on historical data relating to discounts taken by the customer under each program. Historically between 85% and 95% of the Company's customers who qualify for each program, actually take the discount that is available.

Inventories - Obsolescence and Slow Moving

The Company had $8,239,000 at September 30, 2012 and $7,630,000 at December 31, 2011 in reserve to cover obsolete and slow moving inventory. The increase in reserve for obsolescence was from the Company's quarterly review during its normal course of business. The obsolete and slow moving policy states that the reserve is to be calculated on a basis of: 1) no inventory usage over a three year period and inventory with quantity on hand is deemed obsolete and reserved at 100 percent and 2) slow moving inventory with little usage requires a 100 percent reserve on items that have a quantity greater than a three year supply. There are exceptions to the obsolete and slow moving classifications if approved by an officer of the Company based on specific identification of an item or items that are deemed to be either included or excluded from this classification. In cases where there is no historical data, management makes a judgment based on a specific review of the inventory in question to


determine what reserves, if any are appropriate. New products or parts are generally excluded from the reserve policy until a three year history has been established.

The reserve is reviewed and if necessary, adjustments made, on a quarterly basis. The Company relies on historical information to support its reserve.
Once the inventory is written down, the Company does not adjust the reserve balance until the inventory is sold.

Warranty

The Company's warranty policy is generally to provide its customers warranty for up to one year on all equipment and 90 days for parts.

Warranty reserve, as a percent of sales, is calculated by taking the current twelve months of expenses and prorating that based on twelve months of sales with a six month lag period. The Company's historical experience is that an end-user takes approximately 90 days to six months from the receipt of the unit to file a warranty claim. A warranty reserve is established for each different marketing group. Reserve balances are evaluated on a quarterly basis and adjustments are made when required.

The current liability warranty reserve balance was $5,148,000 at September 30, 2012 and $5,083,000 at December 31, 2011.

Product Liability

At September 30, 2012 the Company had accrued $275,000 in reserves for product liability cases compared to $131,000 at December 31, 2011. The Company accrues primarily on a case by case basis and adjusts the balance quarterly. The Company renewed its U.S. insurance coverage on September 30, 2012 and the S.I.R. for all U.S. products was $100,000 per claim. The Company also carries product liability coverage in Europe, Canada and Australia which contain substantially lower S.I.R.'s or deductibles.

Goodwill

Goodwill consists of the excess of the purchase price over the fair value of identifiable net assets of businesses acquired. We perform our annual goodwill impairment test as of October 1 and monitor for interim triggering events on an ongoing basis. Goodwill is reviewed for impairment utilizing a qualitative assessment or a two-step process. We have an option to make a qualitative assessment of a reporting unit's goodwill for impairment. If we choose to perform a qualitative assessment and determine the fair value more likely than not exceeds the carrying value, no further evaluation is necessary. For reporting units where we perform the two-step process, the first step requires us to compare the fair value of each reporting unit, which we primarily determine using an income approach based on the present value of discounted cash flows, to the respective carrying value, which includes goodwill. If the fair value of the reporting unit exceeds its carrying value, the goodwill is not considered impaired. If the carrying value is higher than the fair value, there is an indication that an impairment may exist and the second step is required. In step two, the implied fair value of goodwill is calculated as the excess of the fair value of a reporting unit over the fair values assigned to its assets and liabilities. If the implied fair value of goodwill is less than the carrying value of the reporting unit's goodwill, the difference is recognized as an impairment loss.

The Company estimates the fair value of its reporting units using a discounted cash flow analysis. This analysis requires the Company to make significant assumptions and estimates about the extent and timing of future cash flows, discount rates and growth rates. The cash flows are estimated over a significant future period of time, which makes those estimates and assumptions subject to an even higher degree of uncertainty. The Company also utilizes market valuation models and other financial ratios, which require the Company to make certain assumptions and estimates regarding the applicability of those models to its assets and businesses. As of September 30, 2012, the Company had $32,019,000 of goodwill, which represents 8% of total assets.

The Company recognized goodwill impairment at two of its French operations, SMA and Rousseau, in the Company's European division of $1,898,000 in 2011. The primary reason for the goodwill impairment was the general economic downturn that began to affect the Company in late 2008. This caused the Company to revise its


expectations about future revenue, which is a significant factor in the discounted cash flow analysis used to estimate the fair value of the Company's reporting units. During the 2011 impairment analysis review, it was noted that even though the fair value of the Schwarze, Rivard and Faucheux reporting units were above carrying value it was not materially different. On September 30, 2012, there was approximately $6.9 million, $11.5 million and $0.6 million of goodwill related to the Schwarze, Rivard and Faucheux reporting units respectively. These reporting units would be most likely affected by changes in the Company's assumptions and estimates. The calculation of fair value could increase or decrease depending on changes in the inputs and assumptions used, such as changes in the reporting unit's future growth rates, discount rates, etc.

Management believes that the estimated valuations it arrived at are reasonable and consistent with what other marketplace participants would use in valuing the Company's components. However, management cannot give any assurance that these market values will not change in the future. For example, if discount rates demanded by the market increase, this could lead to reduced valuations under the income approach. If the Company's projections are not achieved in the future, this could lead management to reassess their assumptions and lead to reduced valuations under the income approach. If the market price of the Company's stock decreases, this could cause the Company to reassess the reasonableness of the implied control premium, which might cause management to assume a higher discount rate under the income approach which could lead to reduced valuations. If future similar transactions exhibit lower multiples than those observed in the past, this could lead to reduced valuations under the similar transactions approach. And finally, if there is a general decline in the stock market and particularly in those companies selected as comparable to the Company's components, this could lead to reduced valuations under the public company market multiple approach. The Company's annual impairment test is performed during the fourth quarter of each fiscal year. Given the current market conditions and continued economic uncertainty, the fair value of the Company's components could deteriorate which could result in the need to record impairment charges in future periods. The Company also monitors potential triggering events including changes in the business climate in which it operates, attrition of key personnel, volatility in the capital markets, the Company's market capitalization compared to its book value, the Company's recent operating performance, and the Company's financial projections. The occurrence of one or more triggering events could require additional impairment testing, which could result in future impairment charges. In particular, since the carrying value of the Schwarze, Rivard and Faucheux, reporting units are not materially different from fair value, any changes to the Company's assumptions could lead to an indicated impairment in step one, requiring the Company to . . .

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