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ALG > SEC Filings for ALG > Form 10-Q on 8-Aug-2014All Recent SEC Filings

Show all filings for ALAMO GROUP INC

Form 10-Q for ALAMO GROUP INC


8-Aug-2014

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         Six Months Ended
                              June 30,                 June 30,
        As a
Percent of Net Sales    2014           2013         2014       2013
North American
Industrial               50.9 %         43.6 %      48.3 %     43.7 %
Agricultural             25.5 %         32.2 %      27.1 %     31.8 %
European                 23.6 %         24.2 %      24.6 %     24.5 %
Total sales, net        100.0 %        100.0 %     100.0 %    100.0 %




                                    Three Months Ended      Six Months Ended
                                          June 30,              June 30,
Cost Trends and Profit Margin, as
    Percentages of Net Sales         2014         2013      2014         2013

Gross margin                         22.9 %        24.8 %   22.6 %       23.5 %
Income from operations                7.2 %         9.9 %    6.7 %        8.1 %
Income before income taxes            6.8 %         9.9 %    6.6 %        8.2 %
Net income                            4.5 %         6.6 %    4.4 %        5.6 %

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.

For the first half of 2014, the Company's net income was down 12.0% compared to the same time in 2013. This was primarily related to soft market conditions in the Agricultural Division which resulted in a 6% decrease in sales excluding the acquisitions of Fieldquip and Superior. Alamo's Industrial Division saw a 11.0% increase in sales versus 2013 excluding the acquisition of Specialized. This came from improved sales in sweepers, mowing equipment, excavators, and snow equipment products. European sales for the first half of 2014 excluding the acquisition of Kellands were up 8% compared to the same time in 2013. Favorable exchange rates provided most of the improvement. Consolidated gross margins were down in the first half of 2014 without the acquisitions as increased sales in both the Industrial and European Divisions could not offset the decline from the Agricultural Division. Also negatively affecting net income were transaction costs and additional stock option expense from accelerated vesting of options to retirement eligible recipients. The Company's backlog improved 69% to $163 million during the first half of 2014 versus $96 million during the same period in 2013 which should benefit sales through the rest of the year. Excluding the acquisitions of Specialized, Kellands, Fieldquip and Superior backlog increased by 9%. The increase in the backlog came from the Company's European and Industrial Divisions. Negatively affecting backlogs were lower new orders in the Agricultural Division.

The Company believes that its markets for 2014 will be steady but they 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 June 30, 2014 vs. Three Months Ended June 30, 2013

Net sales for the second quarter of 2014 were $206,353,000, an increase of $28,289,000, or 15.9% compared to $178,064,000 for the second quarter of 2013. The increase was mainly from the acquisitions of Specialized in the amount of $18,977,000, Kellands in the amount of $3,282,000, Superior in the amount of $724,000 and Fieldquip in the amount of $655,000. The Company also experienced improved equipment sales and tractors in the Company's Industrial and European Divisions. In the Industrial Division, sweepers, mowing equipment, excavators and snow removal products were the main product lines to show sales improvement. Sales of mowing equipment in the Agricultural Division were down during the quarter due to the softness of the overall agricultural market. Excluding the acquisition of Kellands, European sales for the second quarter of 2014 were slightly up as favorable exchange rates were the main contributing factor to improved sales levels.

Net North American Industrial sales increased during the second quarter by $27,443,000 or 35.3% to $105,082,000 for 2014 compared to $77,639,000 during the same period in 2013. The increase came primarily from the acquisition of Specialized in the amount of $18,977,000 and higher sales of mowing and sweeper units, as well as excavator and snow removal equipment.

Net North American Agricultural sales were $52,631,000 in 2014 compared to $57,255,000 for the same period in 2013, a decrease of $4,624,000 or 8.1%. Lower crop prices and rising production costs affected farmers' ability to purchase new equipment. This also resulted in higher dealer inventory levels for both tractors and attachments.

Net European Sales for the second quarter of 2014 were $48,640,000, an increase of $5,470,000 or 12.7% compared to $43,170,000 during the second quarter of 2013. The increase was primarily due to the acquisition of Kellands in the amount of $3,282,000. Also affecting sales favorably in the second quarter of 2014 were changes in currency exchange rates.

Gross profit for the second quarter of 2014 was $47,286,000 (22.9% of net sales) compared to $44,091,000 (24.8% of net sales) during the same period in 2013, an increase of $3,195,000. The increase in margin dollars were mainly due to the acquisitions of Specialized and Kellands in the amount of $5,799,000. Also higher sales volume in the Industrial Division, particularly mowing, excavator and sweeping products helped increase gross margins. Negatively affecting both the gross margin and margin percent during the second quarter of 2014 were inefficiencies from lower absorption on reduced sales volumes in the Agricultural Division.

Selling, general and administrative expenses ("SG&A") were $32,490,000 (15.7% of net sales) during the second quarter of 2014 compared to $26,530,000 (14.9% of net sales) during the same period of 2013, an increase of $5,960,000. The increase in SG&A expenses in 2014 was primarily from the acquisitions of Specilaized in the amount of $2,730,000 and Kellands, Fieldquip and Superior in the amount of $645,000. Also there were $1,346,000 of acquisition expenses and $906,000 of additional stock option expense related to the accelerated vesting options to retirement eligible recipients.

Interest expense was $1,044,000 for the second quarter of 2014 compared to $336,000 during the same period in 2013, an increase of $708,000. The increase in 2014 came from increased borrowings due to the acquisition of Specialized.

Other income (expense), net was $153,000 of income for the second quarter of 2014 compared to $343,000 of income during the same period in 2013. The income in 2014 was from the gain on the sale of the SMC facility offset by losses relating to foreign exchange rate changes. In 2013 the gain was mainly the result of foreign exchange rate changes.

Provision for income taxes was $4,745,000 (34.0%) in the second quarter of 2014 compared to $5,822,000 (33.1%) during the same period in 2013. The increased tax rate in 2014 reflects that Research and Development tax credits have not yet been approved by the U.S. federal government for 2014.


The Company's net income after tax was $9,195,000 or $0.75 per share on a diluted basis for the second quarter of 2014 compared to $11,787,000 or $0.97 per share on a diluted basis for the second quarter of 2013. The decrease of $2,592,000 resulted from the factors described above.

Six Months Ended June 30, 2014 vs. Six Months Ended June 30, 2013

Net sales for the first six months of 2014 were $377,603,000, an increase of $41,110,000 or 12.2% compared to $336,493,000 for the first six months of 2013. The increase was mainly from the acquisitions of Specialized in the amount of $18,977,000, Kellands in the amount of $3,282,000, Superior in the amount of $1,459,000 and Fieldquip in the amount of $655,000. Also improved sales in the Company's North American Industrial Division which was up 11% without the Specialized acquisition was a contributing factor. Agricultural Division sales were down 6% for the first half of 2014 from a weak overall agricultural market and the prolonged winter weather conditions in the early part of 2014. Sales in the European Division were up 8% in the first half of 2014 compared to the same time in 2013 as overall conditions in the European economy remain weak but showed some signs of improvement. Favorable exchange rate changes also had a significant impact on sales.

Net North American Industrial sales increased during the first six months by $35,423,000 or 24.1% to $182,396,000 for 2014 compared to $146,973,000 during the same period in 2013. The increase came primarily from the acquisition of Specialized in the amount of $18,977,000. Also, favorably affecting sales were the increase from mowing, sweeper, excavator and snow equipment product lines.

Net North American Agricultural sales were $102,476,000 in 2014 compared to $106,891,000 for the same period in 2013, a decrease of $4,415,000 or 4.1%. The decrease in sales for the first six months of 2014 compared to the first six months of 2013 was from soft market conditions in the agricultural market. Lower crop prices and rising production costs dampened retail sales and resulted in higher dealer inventory levels.

Net European sales for the first six months of 2014 were $92,731,000, a increase of $10,102,000 or 12.2% compared to $82,629,000 during the same period of 2013. The increase in 2014 was primarily due to the Kellands acquisition in the amount of $3,282,000 and improved sales in the UK. Also affecting sales favorably were changes in currency exchange rates. The European Division continued to be faced with challenging market conditions and both our governmental and agricultural markets were constrained by Europe's overall economic uncertainty.

Gross profit for the first six months of 2014 was $85,416,000 (22.6% of net sales) compared to $79,003,000 (23.5% of net sales) during the same period in 2013, an increase of $6,413,000. The increase in margin dollars was mainly due to the acquisitions of Specialized and Kellands in the amount of $5,799,000, and favorable performance in the Industrial Division. Negatively affecting both the gross margin and margin percent during the first half of 2014 were inefficiencies from lower absorption on reduced sales volumes in the Agricultural Division.

Selling, general and administrative expenses ("SG&A") were $59,989,000 (15.9% of net sales) during the first six months of 2014 compared to $51,703,000 (15.4% of net sales) during the same period of 2013, an increase of $8,286,000. The increase in SG&A for the first six months of 2014 was primarily from the acquisitions of Specilaized $2,730,000 and Kellands, Fieldquip and Superior in the amount of $845,000. Also there were $1,708,000 of acquisition expenses and $1,015,000 of additional stock option expense related to the accelerated vesting options to retirement eligible recipients. The Company also had increased trades show and advertising expenses, recruiting and relocation expenses and increased costs related to IT projects.

Interest expense was $1,283,000 for the first six months of 2014 compared to $578,000 during the same period in 2013, a increase of $705,000. The increase in 2014 came from increased borrowings due to the acquisition of Specialized.

Other income (expense), net was $627,000 of income during the first six months of 2014 compared to $632,000 of income in the first six months of 2013. The income in 2014 was from the gain on the sale of the SMC facility partially offset by losses relating to foreign exchange rate changes. In 2013 the gain was mainly the result of foreign exchange rate changes.

Provision for income taxes was $8,434,000 (33.9%) in the first six months of 2014 compared to $8,702,000 (31.7%) during the same period in 2013. Due to the delay in signing the American Taxpayer Relief Act of 2012 which extended research and development tax credits, the Company was not able to include $350,000 of tax


credits in its 2012 financial statements but instead recognized this tax benefit in the first quarter of 2013. The increased tax rate in 2014 reflects that Research and Development tax credits have not yet been approved by the U.S. federal government for 2014.

The Company's net income after tax was $16,433,000 or $1.34 per share on a diluted basis for the first six months of 2014 compared to $18,737,000 or $1.54 per share on a diluted basis for the first six months of 2013. The decrease of $2,304,000 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 June 30, 2014, the Company had working capital of $321,512,000 which represents an increase of $65,180,000 from working capital of $256,332,000 of December 31, 2013. The increase in working capital was primarily from the acquisitions of Specialized, Kellands and Fieldquip.

Capital expenditures were $4,319,000 for the first six months of 2014, compared to $7,195,000 during the first six months of 2013. 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 2013 or through the second quarter of 2014. The authorization to repurchase up to 1,000,000 shares remains available less 42,600 shares previously repurchased.

Net cash provided by (used in) financing activities was $186,910,000 and ($852,000) during the six month period ending June 30, 2014 and June 30, 2013, respectively. The Company had $188,000,000 borrowed from its revolving credit facility at June 30, 2014 versus $0 borrowed at June 30, 2013. This change was due to the acquisition of Specialized.

The Company had $31,478,000 in cash and cash equivalents held by its foreign subsidiaries as of June 30, 2014. 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.

Effective May 12, 2014, the Company amended its revolving credit facility and increased its line of credit from $100 million to $250 million to accommodate the acquisition of Specialized and meet the ongoing needs of the combined entities.

The Company maintains a revolving credit facility with certain lenders under its Amended and Restated Revolving Credit Agreement. The aggregate commitments from lenders under such revolving credit facility is $250,000,000 and, subject to certain conditions, the Company has the option to request an increase in aggregate commitments of up to an additional $50,000,000. The revolving credit agreement requires us to maintain various financial covenants including a minimum EBIT to interest expense ratio, a maximum leverage ratio and a minimum asset coverage ratio. The agreement also contains various covenants relating to limitations on indebtedness, limitations on investments and acquisitions, limitations on sale of properties and limitations on liens and capital expenditures. The revolving credit agreement also contains other customary covenants, representations and events of defaults. As of June 30, 2014, the Company was in compliance with the covenants under the revolving credit facility. The termination date of the revolving credit facility is May 12, 2019. As of June 30, 2014, $188,000,000 was outstanding under the revolving credit facility. On June 30, 2014, $722,000 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 $61,278,000 in available borrowings.


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 could potentially cause changes to credit availability, which creates a level of uncertainty.

Critical Accounting Estimates

Management's Discussion and Analysis of Financial Condition and Results of Operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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 in the Company's 2013 10-K and Note 2 of these interim condensed 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 $2,785,000 at June 30, 2014 and $2,738,000 at December 31, 2013.

Sales Discounts

At June 30, 2014 the Company had $20,040,000 in reserves for sales discounts compared to $16,724,000 at December 31, 2013 on products shipped to our customers under various promotional programs. The increase was primarily due to seasonally additional discounts reserved on the Company's agricultural products during the pre-season, which runs from August to December of each year and orders are shipped through the second quarter of 2014. 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 $8,559,000 at June 30, 2014 and $8,596,000 at December 31, 2013 in reserve to cover obsolete and slow moving inventory. The decrease in reserve for obsolescence resulted from the Company's 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 $6,394,000 at June 30, 2014 and $4,994,000 at December 31, 2013. The increase was mainly from the acquisitions of Specialized in the amount of $1,097,000 and to a lessor extent increases in our European Division.

Product Liability

At June 30, 2014 the Company had accrued $332,000 in reserves for product liability cases compared to $259,000 at December 31, 2013. The Company accrues primarily on a case by case basis and adjusts the balance quarterly.

The S.I.R. (Self Insurance Retention) for all U.S. products is $100,000 per claim or less. The Company also carries product liability coverage in Europe, Canada and Australia which contain substantially lower S.I.R.'s or deductibles.

Goodwill

We test goodwill for impairment annually, at the reporting unit level, and whenever events or circumstances make it likely that an impairment may have occurred, such as a significant adverse change in the business climate or a decision to sell all or a portion of a reporting unit. 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 June 30, 2014, the Company had $73,594,000 of goodwill, which represents 11% of total assets. The increase was from the the acquisitions of Specialized, Kellands and Fieldquip in the amount of $ 41,403,000. The Company expects to finalize these amounts as soon as possible but no later than one year from the acquisition date.

The Company recognized no goodwill impairment in 2013. The Company recognized goodwill impairment at one of its French operations, Faucheux of $656,000 in 2012 and at two of its French operations, SMA and Rousseau of $1,898,000 in 2011. The primary reason for the goodwill impairment in 2012 and 2011 was the general economic downturn that continues to affect the Company's European operations. 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 2013 impairment analysis review, we performed a sensitivity analysis for goodwill impairment with respect to each of our reporting units and determined that a hypothetical 15% decline in the fair value of each reporting unit as of December . . .

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