Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition
and Results of Operations
Outlook
This re port 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 beginning on page 14.
While we experienced strong demand in our markets and across our full range of products in 2021, we were confronted with the direct and indirect consequences of the COVID-19 pandemic which remained ongoing throughout the year. At various times during the year, employee sickness and quarantining requirements created operational disruptions at several of our manufacturing facilities, leading to delayed shipments of our products, plant inefficiencies, and higher labor costs. We were also negatively impacted by significant input cost inflation, supply chain disruptions, and labor shortages, all of which continued throughout the year. We believe these negative forces will persist, at least for the first half of 2022.
Our record backlog level at the end of 2021 provides us with some confidence and visibility for 2022, but we remain concerned about the ongoing negative effects of the pandemic. During the first few weeks of 2022, we experienced an increase in employee absences due to illness and quarantining, and we continue to struggle with inflationary pressures, supply chain issues and labor shortages. We are hopeful that these negative influences will moderate during the course of the year, but it is hard to determine the extent to which these issues will continue with the information we currently have available to us. The extent of the pandemic’s effect on our operational and financial performance will depend in large part on future developments, which cannot be predicted with confidence at this time. Future developments include the duration, scope and severity of the pandemic, the actions taken to contain or mitigate its impact, the impact on governmental programs and budgets, the development of treatments or vaccines, the contagiousness and severity of Coronavirus variants, including Delta and Omicron, and the resumption of widespread economic activity. Due to the inherent uncertainty of the unprecedented and rapidly evolving situation, we are unable to predict with any confidence the likely impact of the COVID-19 pandemic on our future operations. Of course, we may also be negatively affected by several other unanticipated factors, such as a weakness in the overall economy; significant changes in currency exchange rates; further changes in trade or tax policy; increased levels of government regulation; weakness in the end-markets we serve; acquisition integration issues; budget constraints or revenue shortfalls in governmental entities; and other risks and uncertainties as described in “Risk Factors.”
2021 Performance
In 2021, the Company's net sales increased by 14.7% and net income increased by 38.8% compared to 2020. The increase in both net sales and net income was primarily due to a strong recovery in customer demand for our products compared to the prior year where demand for our products was materially impacted as a result of the onset of the COVID-19 pandemic. Partially offsetting the increases in net sales and net income in 2021 were the ongoing negative effects associated with the pandemic, including supply chain disruptions, labor shortages, inflationary pressures, and logistics issues.
The Company's Vegetation Management Division experienced a 24.1% increase in sales for the full year of 2021 compared to a full year of 2020. The increase in sales was primarily attributable to improved sales of forestry and tree care products and agricultural mowing products, along with solid contributions from the U.K., Europe, Brazil and Australia operations. The Division's new orders and backlog improved in all product lines, though cases of COVID-19 in certain facilities caused some operational disruptions during the first half of 2021. Negatively impacting this Division were higher input costs and supply chain disruptions which affected manufacturing efficiencies. Notwithstanding these challenges, the Division's income from operations for the full year of 2021 recorded a 69.2% improvement compared to the full year of 2020.
31
The Company's Industrial Equipment Division sales were up 2.5% for the full year of 2021 compared to a full year of 2020. The increase in sales was led by excavation/vacuum trucks and sweeper/debris collection offset by soft demand for our Snow Removal product line. The Division's income from operations for the full year of 2021 was down 21.0% compared to the full year of 2020. Negatively affecting this Division's sales and income for operations were the effects of the ongoing COVID-19 pandemic which included higher input costs, supply chain disruptions and labor shortages and related affected manufacturing efficiencies. While the Industrial Division experienced ongoing strong market conditions for most of its product categories, the supply chain and inflation cost impacts on this division were more significant than those experienced by our Vegetation Management Division in 2021. In addition, sales of snow removal products were lower in 2021 as compared to 2020 and the snow product group had both higher warranty costs with more significant impacts from steel price increases that could not be passed on to their government customers. New orders and backlog improved in all product groups for the full year 2021.
Consolidated income from operations was $116.9 million for the full year of 2021, which included a $1.1 million charge for acceleration of stock grants for our former CEO, compared to $94.8 million, which included $4.8 million of an inventory step-up expense related to the Morbark acquisition. The Company's backlog increased 126.2% to $800.8 million at the end of 2021 versus the backlog of $354.1 million at the end of 2020. The increase in the Company's backlog was primarily attributable to improved market conditions and an increase in customer demand for our products in both Divisions as outlined above.
The following discussion should be read in conjunction with the consolidated financial statements of the Company and the notes thereto included elsewhere in this Annual Report on Form 10-K.
The following tables set forth, for the periods indicated, certain financial data:
Fiscal Year Ended December 31,
Net sales (data in thousands): 2021 2020 2019
Vegetation Management $ 812,676 $ 654,630 $ 502,194
Industrial Equipment 521,547 508,836 616,944
Total net sales $ 1,334,223 $ 1,163,466 $ 1,119,138
Cost and profit margins, as percentages of net sales:
Cost of sales 74.9 % 74.8 % 75.6 %
Gross profit 25.1 % 25.2 % 24.4 %
Selling, general, administrative, and amortization expenses 16.3 % 17.1 % 16.0 %
Income from operations 8.8 % 8.1 % 8.5 %
Income before income taxes 8.2 % 6.9 % 7.6 %
Net income 6.0 % 5.0 % 5.6 %
Results of Operations
Fiscal 2021 compared to Fiscal 2020
The Company’s net sales in the fiscal year ended December 31, 2021 (“2021”) were $1,334.2 million, an increase of $170.7 million or 14.7% compared to $1,163.5 million for the fiscal year ended December 31, 2020 (“2020”). The increase in sales was attributable to the continued strong recovery in customer demand for our products in both the Vegetation Management and the Industrial Equipment Divisions. Negatively affecting sales in 2020 was the onset of the COVID-19 pandemic which materially impacted global demand for the Company's products and overall Company financial performance.
Net Vegetation Management sales were $812.7 million in 2021 compared to $654.6 million in 2020, an increase of $158.1 million or 24.1%, coming from improved sales in the forestry/tree care and agricultural mowing units along with solid contributions from the U.K., Europe, Brazil and Australia operations. Sales in
32
this Division were negatively impacted by operational and supply chain disruptions and logistics issues due to the pandemic.
Net Industrial Equipment sales were $521.5 million in 2021 compared to $508.8 million in 2020, representing an increase of $12.7 million or 2.5%. The increase primarily resulted from higher customer demand for excavation/vacuum truck products and to a lesser extent the sweeper/debris collection products, offset by softer demand for snow removal equipment. Negatively affecting this Division were delays in truck chassis deliveries due to ongoing computer chip shortages as well as other supply chain constraints and operational disruptions due to the pandemic.
Gross profit for 2021 was $334.5 million (25.1% of net sales) compared to $293.7 million (25.2% of net sales) in 2020, an increase of $40.8 million. The increase in gross profit was primarily attributable to higher sales volume in 2021 as well as pricing increases that were implemented over the course of the year. This was offset by inflationary pressures, mainly from steel, along with higher costs relating to delivery of component parts, such as airfreighting charges to meet customer deliveries, which also had a negative effect on gross margin percentage for the full year of 2021. Negatively affecting the gross margin and gross margin percentage during for the full year of 2020 was a $4.8 million charge on sales of inventory that had been previously stepped-up related to the Morbark acquisition.
Selling, general and administrative expenses (“SG&A”) were $202.9 million (15.2% of net sales) in 2021 compared to $184.2 million (15.8% of net sales) in 2020, an increase of $18.7 million. The full year of 2021 included higher administrative and marketing expenses as the Company returned to pre-pandemic expense levels. Amortization expense in 2021 was $14.6 million compared to $14.7 million in 2020, a decrease of $0.1 million.
Interest expense for 2021 was $10.5 million compared to $15.8 million in 2020, a decrease of $5.3 million or 33.5%. The decrease in interest expense in 2021 primarily came from a decrease in interest rates, and to a lesser extent, reduced borrowing levels.
Other income (expense), net was income of $1.9 million during 2021 compared to expense of $0.6 million in 2020. The income in 2021 was primarily from changes in exchange rates and the sale of a facility in the Netherlands and the expense in 2020 was primarily the result of changes in exchange rates offset by the gain on the sale of two properties, one in the U.S. and one in Canada.
Provision for income taxes was $29.3 million (26.7% of income before income taxes) for 2021 compared to $22.0 million (27.5% of income before income taxes) in 2020.
Net income for 2021 was $80.2 million compared to $57.8 million in 2020, with the increase in 2021 net income resulting from the factors described above.
Fiscal 2020 compared to Fiscal 2019
The Company’s net sales in the fiscal year ended December 31, 2020 (“2020”) were $1,163.5 million, an increase of $44.4 million or 4.0% compared to $1,119.1 million for the fiscal year ended December 31, 2019 (“2019”). The increase was attributable to the acquisitions of Morbark and Dutch Power, which year over year contributed net sales of $160.5 million. Negatively affecting sales in 2020, was the onset of the COVID-19 pandemic which began to negatively affect the Company's operations and customer demand late in the first quarter of 2020.
Net Vegetation Management sales were $654.6 million in 2020 compared to $502.2 million in 2019, an increase of $152.4 million or 30.4%, mainly coming from the acquisitions of Dutch Power and Morbark mentioned above and improved sales of agricultural mowing as demand for those products in 2020 outpaced demand in 2019. This was offset by the impacts from the COVID-19 pandemic that began to materially affect the Division late in the first quarter of 2020. This included temporary plant closures in the U.S., France and Canada along with other operational disruptions throughout our global markets resulting from health concerns and governmental directives, reduced governmental spending, lower customer demand, and customer delivery restrictions, among other things.
Net Industrial Machinery sales were $508.8 million in 2020 compared to $616.9 million in 2019, representing a decrease of $108.1 million or 17.5%. The COVID-19 pandemic materially impacted all product lines in this Division, which resulted in significantly lower sales during 2020. This Division also had
33
several operational disruptions throughout 2020 including temporary plant closures and delays in customer deliveries.
Gross profit for 2020 was $293.7 million (25.2% of net sales) compared to $273.5 million (24.4% of net sales) in 2019, an increase of $20.2 million. The increase in gross profit mainly came from the acquisitions of Dutch Power and Morbark. Gross margin percentage improved year over year primarily due to a favorable mix of parts sales and pricing actions which more than offset the negative impact of higher steel prices and lower factory utilization. Also negatively affecting the gross margin and gross margin percentage of 2020 were $4.8 million of charges on sales of inventory that had been previously stepped-up related to the Morbark acquisition.
Selling, general and administrative expenses (“SG&A”) were $184.2 million (15.8% of net sales) in 2020 compared to $172.9 million (15.5% of net sales) in 2019, an increase of $11.3 million. Morbark and Dutch Power accounted for $23.6 million of net additional SG&A expense in 2020 offset by $12.3 million in expense savings related to the COVID-19 pandemic. 2019 included $1.9 million of acquisition expenses related to the Morbark and Dutch Power . Amortization expense in 2020 was $14.7 million compared to $5.7 million in 2019, an increase of $9.0 million. The increased amortization expense in 2020 was primarily due to the acquisitions of Morbark and Dutch Power.
Interest expense for 2020 was $15.8 million compared to $10.7 million in 2019, an increase of $5.1 million or 47.4%. The increase in interest expense in 2020 was the result of increased borrowings due to the Morbark acquisition in 2019 offset by a decrease in interest rates.
Other income (expense), net was expense of $0.6 million during 2020 compared to expense of $0.8 million in 2019. The expense in 2020 and the expense in 2019 were primarily the result of changes in exchange rates.
Provision for income taxes was $22.0 million (27.5% of income before income taxes) for 2020 compared to $21.5 million (25.4% of income before income taxes) in 2019. The increase in the tax rate for 2020 was due to the reversal of a FIN 48 benefit recognized in 2019 partially offset by the benefit of the final GILTI regulations issued in July of 2020.
Net income for 2020 was $57.8 million compared to $63.1 million in 2019, due to the factors described above.
Liquidity and Capital Resources
In addition to normal operating expenses, the Company has ongoing cash requirements which are necessary to conduct the Company’s business, including inventory purchases and capital expenditures. The Company’s accounts receivable, inventory and accounts payable levels, particularly in its Vegetation Management Division, build in the first quarter and early spring and, to a lesser extent, 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 pre-season sales and year-round sales programs. These sales, primarily in the Vegetation Management Division, help balance the Company’s production during the first and fourth quarters.
As of December 31, 2021, the Company had working capital of $419.6 million, which represents a increase of $61.4 million from working capital of $358.2 million as of December 31, 2020. The increase in working capital was primarily due to sales growth and increased demand for our products as well as increased inventory to support Company's higher backlog levels along with increased work in process due to supply chain constraints.
Capital expenditures were $25.3 million for 2021, compared to $17.9 million for 2020. The increase was related to the Company returning to a more normalized level of capital expenditures as the Company limited new capital expenditures in 2020 in response to the COVID-19 pandemic. The Company will fund any future expenditure from operating cash flows or through our revolving credit facility, described below. Also contributing to the increase in capital expenditures in 2021 was approximately $2.2 million of capital projects intended to advance the Company's ongoing sustainability efforts. These capital projects included LED lighting upgrades at several of our facilities, the installation of a solar power system at one of our facilities and the replacement of less efficient capital equipment.
Net cash provided by operating activities was $49.7 million for 2021, compared to $184.3 million for 2020. The decrease of cash from operating activities came primarily from volume related increases in working capital due to higher accounts receivable and inventory levels from sales growth. In 2021 we experienced strong demand for our products coupled with supply chain disruptions and material cost inflation which led to higher inventory levels. In
34
2020, as a result of the COVID-19 pandemic, we focused on reductions in accounts receivable and inventory levels which led to a significant reduction in our debt levels.
Net cash used in investing activities was $33.4 million for 2021, compared to $14.2 million for 2020. The increase in cash used in investing activities was primarily due to the acquisition of Timberwolf, and increased purchases of Property, plant and equipment partially offset by proceeds from the sale of an facility in the Netherlands.
Net cash used by financing activities was $23.0 million for 2021, compared to $164.2 million for 2020. The majority of the net cash used by financing activities in 2020 was primarily due to the pay down of debt related to the 2019 acquisitions of Morbark and Dutch Power .
The Company had $37.2 million in cash and cash equivalents held by its foreign subsidiaries as of December 31, 2021. The majority of these funds are at our European and Canadian facilities. The Company will continue to repatriate European and Canadian cash and cash equivalents in excess of amounts needed to fund operating and investing activities, but will need to monitor exchange rates to determine the appropriate timing of such repatriation given the current relative strength of the U.S. dollar. Repatriated funds will initially be used to reduce funded debt levels under the Company's current credit facility and subsequently used to fund working capital, capital investments and acquisitions company-wide.
On October 24, 2019, the Company, as Borrower, and each of its domestic subsidiaries as guarantors, entered into a Second Amended and Restated Credit Agreement (the Credit Agreement ) with Bank of America, N.A., as Administrative Agent. The Credit Agreement provides the Company with the ability to request loans and other financial obligations in an aggregate amount of up to $650.0 million and, subject to certain conditions, the Company has the option to request an increase in aggregate commitments of up to an additional $200.0 million. Pursuant to the Credit Agreement, the Company has borrowed $300.0 million pursuant to a Term Facility repayable with interest quarterly at a percentage of the initial principal amount of the Term Facility of 5.0% per year with the remaining principal due in 2024. Up to $350.0 million is available under the Credit Agreement pursuant to a Revolver Facility which terminates in 2024. Outstanding loans under the revolving credit facility bear interest at a variable rate generally based on LIBOR or an alternative variable rate based on the highest of the Bank of America prime rate, the federal funds rate or a rate generally based on LIBOR, in each case depending on the leverage ratio. The Agreement requires the Company to maintain two financial covenants, 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 Agreement also contains other customary covenants, representations and events of defaults. The expiration date of the Term Facility and the Revolver Facility is October 24, 2024. As of December 31, 2021, $269.5 million was outstanding under the Credit Agreement, $265.5 million on the Term Facility and $4.0 million on the Revolver Facility. On December 31, 2021, $2.4 million 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 $255.0 million in available borrowings. The Company is in compliance with the covenants under the Agreement.
Management believes the Agreement 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, future challenges affecting the banking industry and credit markets in general could potentially cause changes to credit availability, which creates a level of uncertainty.
Inflation
The Company is exposed to the risk that the price of energy, steel and other purchased components may increase and the Company may not be able to increase the price of its products correspondingly. If this occurs, the Company’s results of operations would be adversely impacted. In 2021, the Company was impacted by inflationary pressures that significantly increased the price of steel as well as the price of many other purchased components. These inflationary pressures are ongoing.
New Accounting Pronouncements
As discussed in Note 2 of Notes to Consolidated Financial Statements, certain new financial accounting pronouncements became effective January 1, 2021, or will become effective in the future. The effect on our financial statements upon adoption of these pronouncements is discussed in the above-referenced note.
35
Contractual and Other Obligations
The following table shows the Company’s approximate obligations and commitments to make future payments under contractual obligations as of December 31, 2021:
Payment due by period
(in thousands) Less than 1-3 3-5 More than
Contractual Obligations Total 1 Year Years Years 5 Years
Long-term debt obligations $ 269,498 $ 15,000 $ 254,498 $ — $ —
Finance and operating lease obligations 18,259 4,981 6,492 3,696 3,090
Interest obligations 12 4 8 — —
Purchase obligations 338,017 338,017 — — —
Total $ 625,786 $ 358,002 $ 260,998 $ 3,696 $ 3,090
Definitions:
A. Long-term debt obligation means a principal payment obligation under long-term borrowings.
B. Finance lease obligation means a principal payment obligation under a lease classified as a finance lease. Operating lease obligation means a payment obligation under a lease classified as an operating lease.
C. Interest obligation means interest due on long-term debt and capital lease obligations. Interest on long-term debt assumes all floating rates of interest remain the same as those in effect at December 31, 2021.
D. Purchase obligation means an agreement to purchase goods or services that is enforceable and legally binding on the registrant that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transactions.
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 U.S. Generally Accepted Accounting Principles (“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 policy 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.
Business Combinations
We account for the acquisition of a business in accordance with the accounting standards codification guidance for business combinations, whereby the total consideration transferred is allocated to the assets acquired and liabilities assumed, including amounts attributable to intangible assets based on their respective estimated fair values as of the date of acquisition. Goodwill represents the excess of consideration transferred over the estimated fair value of the net assets acquired in a business combination.
36
Assigning estimated fair values to the assets acquired and liabilities assumed requires the use of significant estimates, judgments, inputs, and assumptions regarding the fair value of intangible assets that are separately identifiable from goodwill, inventory step-up, and property, plant, and equipment, and are based on available historical information, future expectations, and assumptions determined to be reasonable but are inherently uncertain with respect to future events, including economic conditions, competition, the useful life of the acquired assets and other factors. Such significant estimates, judgments, inputs, and assumptions include, when applicable, the selection of an appropriate valuation method depending on the nature of the respective asset, such as the income approach, the market or sales comparison approach, or the cost approach; estimating future cash flows based on projected revenues and/or margins that we expect to generate subsequent to an acquisition; applying an appropriate discount rate to estimate the present value of those projected cash flows we expect to generate subsequent to an acquisition; selecting an appropriate royalty rate or estimating a customer attrition or technological obsolescence factor where necessary and appropriate given the nature of the respective asset; assigning the appropriate contributory asset charge where needed; determining an appropriate useful life and the related depreciation or amortization method for the respective asset; and assessing the accuracy and completeness of other historical financial metrics of the acquiree used as standalone inputs or as the basis for determining estimated projected inputs such as margins, customer attrition, and costs to hold and sell product.
In determining the estimated fair value of intangible assets that are separately identifiable from goodwill, we typically utilize the income approach, which discounts the projected future cash flows using an appropriate discount rate that reflects the risks associated with the projected cash flows. However, in certain instances, particularly in relation to developed technology or patents, we may utilize the cost approach depending on the nature of the respective intangible asset and the recency of the development or procurement of such technology. In determining the estimated fair value of acquired inventory, we typically utilize the cost approach for raw materials and the sales comparison approach for finished goods, work in process and component parts. In determining the estimated fair value of acquired property, plant, and equipment, we typically utilize the sales comparison approach or the cost approach depending on the nature of the respective asset and the recency of the construction or procurement of such asset.
We may refine the estimated fair values of assets acquired and liabilities assumed, if necessary, over a period not to exceed one year from the date of acquisition by taking into consideration new information that, if known at the date of acquisition, would have affected the estimated fair values ascribed to the assets acquired and liabilities assumed. The judgments made in determining the estimated fair value assigned to assets acquired and liabilities assumed, as well as the estimated useful life and depreciation or amortization method of each asset, can materially impact the net earnings of the periods subsequent to an acquisition through depreciation and amortization, and in certain instances through impairment charges, if the asset becomes impaired in the future. During the measurement period, any purchase price allocation changes that impact the carrying value of goodwill will affect any measurement of goodwill impairment taken during the measurement period, if applicable.