Greetings and welcome to the Alamo Group Inc. First Quarter 2023 Conference Call. [Operator Instructions] It is now my pleasure to introduce your host, Edward Rizzuti, Vice President, General Counsel and Secretary. You may begin, sir.

Thank you. By now, you should have all received a copy of the press release. However, if anyone is missing a copy and would like to receive one, please contact us at 212-827-3746 and we will send you a release and make sure you are on the company’s distribution list. There will be a replay of the call, which will begin 1 hour after the call and runs for 1 week. The replay can be accessed by dialing 844-512-2921 with the passcode 13738073. Additionally, the call is being webcast on the company’s website at www.alamo-group.com and a replay will be available for 60 days. On the line with me today are Jeff Leonard, President and Chief Executive Officer; Richard Wehrle, Executive Vice President, Chief Financial Officer and Treasurer; and Dan Malone, Executive Vice President and Chief Sustainability Officer. Management will make some opening remarks, and then we’ll open up the line for your questions. During the call today, management may reference certain non-GAAP numbers in their remarks. Reconciliations of these non-GAAP results to applicable GAAP numbers are included in the attachments to our earnings release. Before turning the call over to Jeff, I’d like to make a few comments about forward-looking statements. We will be making forward-looking statements today that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties which may cause the company’s actual results in future periods to differ materially from forecasted results. Among those factors which could cause actual results to differ materially are the following: adverse economic conditions, which could lead to a reduction in overall market demand, supply chain disruptions, labor constraints, competition, weather, seasonality, currency-related issues, geopolitical issues and other risk factors listed from time to time in the company’s SEC reports. The company does not undertake any obligation to update the information contained herein, which speaks only as of this date. I would now like to introduce Jeff Leonard. Jeff, please go ahead.

Thank you, Ed. We want to thank all of you for joining us today. Richard will begin our call with a review of our financial results for the first quarter 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.

Thanks Jeff and good morning everyone. Alamo Group’s first quarter 2023 close with another solid performance that produced record net sales and net income. This was driven by a strong demand for our products in what remain – remains a dynamic operating climate. First quarter consolidated net sales for 2023 were $411.8 million, an increase of 14% compared to $362 million in the first quarter of last year. 2023 net sales were negatively impacted just over 2% by currency translation compared to the same time last year as the U.S. dollar continued to strengthen as it did throughout all of 2022. Gross margin dollars in the quarter improved compared to the first quarter of 2020 – gross margin dollars in the quarter improved compared to the first quarter of 2022 by $25.9 million as it did – as did gross margin percentage, which was up 340 basis points. Both increases were due to price initiatives taken early in 2022, as well as improved manufacturing efficiencies. We experienced improvement in the supply chain as deliveries of inbound inventory were more dependable throughout the quarter. This enabled the company to manufacture its products on a more consistent basis, which in turn allowed for better absorption of manufacturing costs. As a percentage of sales, operating expenses for the first quarter of 2023 came in at just over 15% compared to almost 16% during the same time last year. This, along with improved supply chain, more favorable pricing and higher manufacturing efficiencies led to an operating income for 2023 of $49.0 million, just shy of 12% of sales compared to $29.1 million, or 8%, of sales in the first quarter of 2022, an increase of 390 basis points. Consolidated net income for the first quarter of 2023 was $33.4 million, or $2.79, per diluted…

Thank you, Richard. I’d like to offer my personal thanks to everyone who’s joined our conference call today. We were certainly pleased with the strong first quarter results we reported today, and I’m exceptionally proud of our teams who made them possible. As we had anticipated, healthy markets and a modest but notable improvement in the performance of our supply chain drove our quarterly sales above the $400 million mark for the first time in company history. Sales were up nicely across both company operating divisions as previously past due supplier parts began to arrive in quantities that allowed us to increase the pace of our shipments with superb support from our key suppliers, manufacturing flow improved in our larger operations, resulting in better efficiencies. We have commented on previous calls about our confidence in the price quality of our backlog, and this was evident in our first quarter results. Gross margin improved 30% or 340 basis points compared to the first quarter of 2022, as improved pricing and supplier performance allowed more and better quality backlog to convert to sales. Concurrently, our teams continue to keep tight control over costs and our expenses expressed as a percentage of sales were down slightly. The combination of higher sales, better pricing, improved efficiency and strict cost discipline drove operating income to 11.9% of sales. We were obviously pleased that operating income is approaching the upgraded target of 12% that we established at the start of 2022 and this was achieved in the company’s normally weaker first quarter. After tax, company first quarter earnings of $33.4 million were slightly more than 80% higher than the first quarter of 2022. The changes to our manufacturing strategy that we initiated in 2021 also contributed to our first quarter results. As we reported earlier, we…

Thank you. [Operator Instructions] Our first question comes from Mike Shlisky with D.A. Davidson. Please go ahead.

Yes. Good morning, and thanks for taking my question. In the first quarter here, you essentially hit the 12% operating margin. You’re very, very close to it. That target is very much in view here. Just looking back to history, though Q2 and Q3 are typically higher margin quarters than Q1 are, as you’ve alluded to on the seasonality of your business, I just want to make sure, is that still the case here in 2023? And is there a good shot then that you can actually make 12% or higher operating margin for the year?

Yes, Mike. Thanks for the call and nice to talk to you again. I do believe that’s the case, Mike. Q2 and Q3 are normally better for spare parts in our business, and that tends to blend in a better margin. So I’m not going to say I’m 100% confident, but I’m confident we should be knocking on the door 12% for the next couple of quarters.

Great. And I guess I would want to ask if you do get to 12%, how sustainable is that or do you have a next goal in mind? When I look at one of your top peers they are already – they have already exceeded 12%. You’re not too far behind, and I think you actually beat them on margin this past quarter from an EBITDA perspective. I’d be curious if you think you could perhaps reach some of those peer margins, which are a few hundred basis points above 12% in the near future, barring a large economic meltdown or something like that?

I think, Mike, as I always say, when we sustainably hit 12% over a couple of quarters, then we will reset our aspirations a little bit higher. This is a continuous improvement company. And once we hit the mark consistently, then we set it higher. When that will be, I can’t say for sure. As I said in the call, I’m a little worried about where interest rates are going and what that might impact on dealer behaviors as we head into 2024. Having said that, our efficiencies are still rising, our operations in great shape and our bigger units are performing exceptionally well. So I think you could look for a further discussion about targets from us in the back half of this year.

Okay. A follow-up on your comment there, you just made, Jeff, on the 2024 trends. Are those comments very much meant towards the private sector customers that you’re working with? Or is it everything? I’m kind of curious whether there you’ve got the backlog in Industrial or in both segments [indiscernible] 2024 regardless of the broader environment, maybe secondly, whether you think that government’s got to build a bit more staying power, if you will, in 2024?

Yes. I would say these comments toward 2024 are more confined to private customers. The governmental sector remains in great shape, Mike. And everything I read about the state of governmental finances at the state, municipal and county levels is very optimistic and blunt. And the order book inside the Industrial Equipment division from governmental customers reflects that. So I think the Industrial division will have a nice strong running in 2024. I think in Vegetation Management, the only real significant concern at this point is Ag and Ag is cycling down a little bit, at least at the low end. I was interested in watching the earnings reports out of the big Ag OEMs, and they are still commenting about the strength in Ag, and I see that, but I think that’s more in the larger row-crop farms. At least that’s what CNH commented this morning in their earnings release that I got a chance to look at.

Got it. Maybe one last one for me. You did mention it in your prepared comments, but just some thoughts on the acquisition pipeline. Any interesting targets out there? What you’re working on? How you might look to pay for something if you can’t [indiscernible] size, etcetera, would be appreciated.

Our pipeline is looking robust at the moment, Mike, and we’re in a position of – we’re trying to stay close to our strategy, to be clear, be a little less opportunistic and really focus on the areas of the business we want to grow. But the pipeline looks encouraging, and our balance sheet continues to improve, which makes doing a little bit larger deal easier for us and certainly more strategic for us over time. So it’s looking good at the moment.

Okay. Well, thanks very much. I will pass it on.

Thank you, Mike. Appreciate the questions.

Your next question comes from Greg Burns with Sidoti & Company. Please go ahead.

Good morning. Just wanted to get your view on like the historic performance of the Ag market, and I’m thinking more in terms of like how the cycles typically run, how many years peak to trough, you might see? Because I know there was a number of years where it’s kind of flattish. We’ve been in kind of this up-cycle for the last couple of years, and it seems like it’s softening now. So – do you just have any historical perspective on kind of the ag market cycle?

What I would say, Greg, is the normal cycle in the ag business is 4 to 5 years for the kinds of products that we produce. I think we are at the late stage of that. Having said that, the whole cycle was distorted by the pandemic and the backlog in our Ag business still remains historically high, not as high as they were, but historically high. If you go back even to pre-pandemic levels, they are significantly higher. So I think we are going to see this kind of a peaking of the – tipping of the peaks, cutting off the peaks and filling in the valleys a little bit. So what I’m trying to say is I think the size will remain as it is normally, but I think the highs and lows will be more attracted – more close to each other. Still on the dips a little bit.

Yes. Alright. That makes sense. And then on the Forestry and tree care side of the business, what are the main demand drivers that we could look to, to kind of monitor the health of that segment of your business?

I think the most important one for our business in Forestry is the price of wood pellets. That’s a very significant driver for the bigger machines that more bar producers that are used in recycling wood and producing pellets. Housing starts is a more subtle indicator, but it’s there for sure. And wood pellets have trended down a little bit recently. We’ve been watching that fairly closely. But I think the more important takeaway from my remarks on the conference call about our Forestry business is in the first quarter of 2022, we looked over $100 million of orders in that one quarter. So the comparison period was just astronomical. So I was trying to be clear that people shouldn’t overreact to that. We just had a very exceptional period a year ago, and we don’t ever – I don’t think ever in history is more or come anywhere close to $100 million a quarter except for that one-time. So our Forestry business remains in really good shape. And if you go back and you map the bookings history month by month and quarter by quarter for that business, it’s very difficult to see a clear cycle. It’s a lot of spikes up and down right? We’re still learning it, to be candid with you. But the people in the business that have been with us for a long time said, look, it is difficult to spot these because the buying behaviors get a little distorted because these machines are so long lived. So, the distortions come when you introduce new technology or where there is a breakthrough that might accelerate the obsolescence of some of the machines in the field. And there was some of that. We have introduced some new products in 2021 that really took up nicely for us.

Okay. I guess with that commentary on the order bookings, have you seen any change since the end of the quarter? Can you maybe update us on kind of the first part of this quarter, how the order bookings have trended?

Yes. They have trended fairly consistently what we have reported for the first quarter, Greg. We haven’t noticed a significant change from what I have reported here today in the month of April. So, things are kind of steady as it goes at the moment. I think what we are starting to see though is more dealer caution. The inventories in the ag side of the business are back to where they were pre-pandemic or very close to that. Having said that, they weren’t exceptionally high pre-pandemic, so we are not alarmed about it at all. But I think with rising interest rates, dealers begin to pay a lot more attention to their balance sheets. So, we are watching the payables closely. We have seen a few less people taking up the prepayment discounts, early payment discounts and so on, which are a bit cautionary indicators for us. So, while I am not overly concerned, we are definitely keeping our eye on the ball and that I could just being careful about what we do, how much we produce and our inventories altogether.

Perfect. Thank you.

Our next question comes from Chip Moore with EF Hutton. Please go ahead.

Thanks and nice job on stringing together two consecutive quarters of strong sales each and robust gross margin expansions. It’s nice to see the orders and backlog holding up. Yes. It’s really nice to see the orders and backlog holding up for visibility. The first question, I just want to dive into the supply chain and under-absorption of manufacturing efficiencies. Has that – because it seems like that improved a lot, I guess maybe since February, and do you think it won’t be much of a gross margin drag as you look out past June?

I think we are going to see further improvements in the margins, particularly in industrial, because the supply chain is beginning to clear up there. It’s improved really significantly. But having moved away from the immediate crisis in chassis, that is dissipating. We are still struggling with things like oil coolers and hydraulics and other components. And again, it’s better, but it’s not where it needs to be by any stretch of the imagination. But I do expect the margins in industrial are going to improve for the next couple of quarters. And we are pretty optimistic about the way those are going to shape up for the balance of this year.

Great. That’s helpful color. What actions are you, maybe, taking to deal with the labor shortages to meet the heightened demand? And is there anything else can maybe due there?

That hasn’t been as big an issue for us in Q1. That’s beginning to dissipate. Our hiring rates have been improving. We have been focusing more on things like apprenticeship programs and preparing old force, bringing in unskilled people and training the work in our plants. So, I don’t think that’s really going to be too much of a constraint as we go into Q2 and Q3. Our bigger plants in ag still have some shortages. But at the moment, with the ag business where it is, if we can stay ahead of that at the peak of the market, I am pretty satisfied with it. Beyond that, we have continued to invest very heavily in robotics and automation. And if you go and visit our bigger factories and I will be doing at some point soon, you would see that firsthand.

Great. That’s helpful color. And what about just how quickly can you maybe add one or two manufacturing plants to – in Europe to increase the penetration of maybe mowers and sweepers while also saving on the transportation costs from the U.S. to Europe?

Yes. Very, very interesting and timely question. We just finished a Board meeting and we are discussing the expansion of several of our plants in Europe and some of them quite significant. So, those are in planning stages, and we expect to initiate those projects later this year, in both UK and France specifically.

Great. That’s helpful. And just related to CONEXPO and just electrification in general, how soon can maybe some of the prototypes convert to commercial success? I believe you were working on an electric street sweeper that can maybe operate four hours or five hours on a battery instead of diesel. Is there anything that you expect to launch that could be out by the end of the year or early next year?

Our launch time isn’t limited by ourselves. It’s limited by the availability of the electrified chassis. So, that fully electric street sweeper, we showed at CONEXPO got overwhelmingly positive feedback and lots of people are ready to take those machines. But we literally got the second chassis off the assembly line. So, as our suppliers can ramp up the manufacturing capacity of the chassis, we will accelerate the introduction – full commercial introduction of those products in the market. But from our end, we are ready, we can go at any time.

Great. And my last question maybe it’s a 2-parter maybe for Richard. Obviously, things with pricing and cost for transportation and the surcharges that you have been doing were a bit of a catch-up and freight might be coming down a little bit. Are any of those kind of surcharges rolling off on the transportation side? And just for Rich, just around free cash flow and working capital, do you expect any one-off drags on working capital when you look at the June or September quarters that might curtail free cash flow, because it seems, without that, you might be on track for at least $80 million, $85 million of free cash flow this year. I was just wondering if there was anything odd coming up in the next couple of quarters?

Yes. For your second question, no. Nothing odd that we are staring at here that caused an issue with that. So, I do not feel that’s a problem at all. What about the surcharge question, on the surcharges piece, we have dropped some surcharges where we have – when we do invoices to customers, we have not adjusted the price, but when we had so many price increases last year, when it comes so quick, we started doing surcharge, we pulled some of those off as costs have diminished related to freight and whatnot. So, I think – overall, I think we are in pretty good shape there. We are not any really major issues. Again, a major piece of this is our backlog pricing is excellent. So, I think we are managing that as we go through. And so when we do get requests to try to reduce some costs, it’s going to be first thing we do is to take off the surcharge.

And I think the other part of your question was specifically regarding the surcharges we receive on inbound or outbound shipments from shippers. And we have not seen substantive relief on those yet, to be clear. I think we have got to see a consistent, sustained fall in fuel prices before we are going to see those surcharges start to fade, just to peak there.

Great. Thanks for that color and that’s it for my questions. Thanks.

Thank you.

[Operator Instructions] Our next question comes from Chris Moore with CJS Securities. Please go ahead.

Hey, good morning guys. Thanks for taking a couple of questions. So, it sounds like backlog pricing was strong after Q4. It’s continued on a kind of from a relative strength perspective, is the pricing on vegetation or industrial, much different?

No, actually not. The margins are very close across the two divisions at the moment, and we expect to stay that way for a bit. What will change it eventually is the softening in the ag side. And I think that we will see that start to come down and some pricing pressures start to emerge in ag. I believe as we head into 2024, I don’t think we are going to see it much yet in 2023. But at the moment, the two divisions are neck-to-neck in terms of the margins they are producing.

Got it. Yes, that’s what I was asking on the margin side. It sounds like the industrial margins can tick-up through ‘23 that 14% level, which obviously Q2 and Q3 have more parts, looks like it could be sustainable for vegetation for the rest of ‘23. So, industrial then likely to keep moving into ‘24 and then we will just see what happens on the vegetation side on the margins?

Right. I think so, Chris, because on the industrial side, we have still got some efficiencies that are lagging. They are not where they need to be because as I said, the truck chassis situation is much better. I think I commented specifically chassis proceeds were up about 20% compared to a year ago. But we are not out of the woods with regard to that yet at all. And that’s why the backlog just keeps building at such an extraordinary rate. We didn’t anticipate the backlog would go quite as high as it did in industrial. So, it’s a nice problem to have. But better pricing should stay in place in the Industrial division for some time to come because governmental agencies really don’t renegotiate contracts at all. So, that the margin that we have in the backlog in industrial should be quite durable as it flows out into revenue.

Got it. Very helpful. And just on the EV side, I know that’s a bit in the future. But from a margin perspective, on the hybrid or on the electric, you expect them to be kind of a parity in terms of current equipment, or is there any premium that might be gained there?

Yes. I do believe there will be a premium. And more interestingly, Chris, I think we are going to see cost advantages over time as the cost of these electrical components come down. In many ways, an electrified product is easier to assemble than one that’s built up of hydraulics and pneumatics and other things, the complexity is lower actually. And so generally, that should translate into less assembly hours over time. So, we have been studying that a lot, trying to see where our costs might go. And the initial feedback from those studies was very encouraging about the rate at which we can assemble electrified products compared to their traditional counterparts.

Got it. It’s helpful. I will leave it there. Appreciated guys.

Thank you, Chris.

There are no further questions at this time. So, we are closing our question-and-answer session. Now, I would like to turn the floor back over to the management for closing comments.

Okay. Thank you. I would like to thank everyone who has joined us on the call today, and thank you for the excellent questions that were presented by the analysts. We look forward to speaking with all of you on our second quarter conference call in August. Until then, take care and stay safe.

That concludes today’s conference call. You may disconnect your lines at this time. Thank you for your participation.