ALAMO GROUP INC (ALG)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Summary and Outlook

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 beginning on page 14.

We experienced strong demand for industrial equipment products in 2024 while demand for forestry, tree care, and agricultural mowing products weakened. Gross profit margins declined slightly due to weaker Vegetation Management Division sales that slowed our production cadence and adversely impacted production efficiency. Market conditions are mixed; governmental and industrial product demand is robust while vegetation product demand has been hampered mainly by higher interest rates and elevated channel inventories.

2024 Performance

In 2024, the Company's net sales decreased by 4% and net income decreased by 15% compared to 2023. The decrease in net sales was primarily driven by weak forestry, tree care, and agricultural mowing markets, leading to lower demand in the Vegetation Management Division. Additionally, the sale of Herschel Parts on August 16, 2024, had a negative impact on year-over-year sales, though it was immaterial on a full-year basis. These challenges were nearly offset by strong sales growth in the Industrial Equipment Division.

The decline in net income was due to lower product demand in the Vegetation Management Division, which affected production efficiency, along with associated separation costs incurred to reduce division capacity. In the Industrial Equipment Division, nonrecurring costs related to the five-week labor strike at Gradall Industries negatively impacted second-quarter results. The Company reached a new five-year collective bargaining agreement at its Gradall plant in May 2024.

The Company's Vegetation Management Division experienced a 20% decrease in net sales for the full year of 2024 compared to 2023 due to a steep decline in forestry, tree care and agricultural mowing markets. The Division’s backlog has declined 47% year-over-year and is now at pre-Covid levels. Income from operations for 2024 decreased by 54% compared to 2023, reflecting market downturn and costs associated with separation and reduction of capacity. The Company continues to implement cost-saving initiatives and enhance operational efficiency, with the goal of improving operating margins.

The Company's Industrial Equipment Division reported a 19% increase in net sales for the full year of 2024 compared to 2023. Sales growth was strong in all product lines, with excavators, vacuum trucks, sweepers & safety, and snow removal contributing to year-over-year growth. Income from operations for 2024 rose 43% versus 2023, driven by increased demand, greater operational efficiencies, and an improvement in supply chain performance and truck chassis availability.

Consolidated income from operations was $165 million for the full year of 2024 compared to $198 million for the full year of 2023, a decrease of 17%. The Company's backlog decreased 22% to $669 million at the end of 2024 versus the backlog of $860 million at the end of 2023.

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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:

Results of Operations

Fiscal 2024 compared to Fiscal 2023

The Company’s net sales in the fiscal year ended December 31, 2024 (“2024”) were $1,628.5 million, a decrease of $61.2 million or 3.6% compared to $1,689.7 million for the fiscal year ended December 31, 2023 (“2023”). The decrease in sales was attributable to weaker market demand in forestry, tree care, and agricultural mowing markets, partially offset by continued strong demand for industrial equipment.

Vegetation Management net sales were $785.2 million in 2024 compared to $979.0 million in 2023, a decrease of $193.8 million or 19.8%. The decline was primarily driven by the sustained weakness in forestry, tree care, and agricultural mowing markets. The sale of Herschel Parts on August 16, 2024 was immaterial to the year-over-year sales decrease.

Industrial Equipment net sales were $843.3 million in 2024 compared to $710.6 million in 2023, representing an increase of $132.7 million or 18.7%. The increase was a result of strong performance in all product lines including excavator and vacuum trucks, sweepers & safety, and snow removal equipment.

Gross profit for 2024 was $412.5 million (25.3% of net sales) compared to $453.6 million (26.8% of net sales) in 2023, a decrease of $41.1 million. The decrease in gross profit was primarily attributable to the decline in Vegetation Management market demand, resulting in production inefficiencies, and the impact of costs to reduce capacity and separation expenses as the Division adjusted to market conditions. In addition, profitability was also impacted by the five-week strike at Gradall in Ohio, which negatively affected the Industrial Equipment Division.

Selling, general and administrative expenses (“SG&A”) were $231.5 million (14.2% of net sales) in 2024 compared to $240.2 million (14.2% of net sales) in 2023, a decrease of $8.7 million. The decrease in SG&A expenses in 2024 was attributable to labor cost savings actions taken in Vegetation Management partially offset by additional costs from the acquisition of Royal Truck. Amortization expense in 2024 was $16.2 million compared to $15.5 million in 2023, an increase of $0.7 million due to Royal Truck acquisition in the fourth quarter of 2023.

Interest expense for 2024 was $20.5 million compared to $26.1 million in 2023, a decrease of $5.6 million or 21.3%. The decrease in interest expense in 2024 was primarily due to debt reduction.

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Interest income for 2024 was $2.6 million compared to $1.5 million in 2023, an increase of $1.1 million or 77.6%. The increase in 2024 was primarily due to higher cash on hand.

Other income (expense), net was income of $2.7 million during 2024 compared to income of $1.8 million in 2023. The increase was primarily driven by foreign exchange transaction gains, offset by fixed asset losses.

Provision for income taxes was $33.7 million (22.5% of income before income taxes) for 2024 compared to $39.0 million (22.2% of income before income taxes) in 2023.

Net income for 2024 was $115.9 million compared to $136.2 million in 2023, with the decrease in 2024 net income resulting from the factors described above.

Fiscal 2023 compared to Fiscal 2022

The Company’s net sales in the fiscal year ended December 31, 2023 (“2023”) were $1,689.7 million, an increase of $176.1 million or 11.6% compared to $1,513.6 million for the fiscal year ended December 31, 2022 (“2022”). The increase in sales was attributable to continued strong customer demand for our products in both the Vegetation Management and Industrial Equipment Divisions, improved pricing, and higher throughput due to gradually improving supply chain conditions. Supply chain disruptions and a shortage of skilled labor negatively impacted net sales, especially in the first half of the year earlier.

Net Vegetation Management sales were $979.0 million in 2023 compared to $937.1 million in 2022, an increase of $41.9 million or 4.5%, coming from a strong performance in European agricultural and governmental mowing, forestry and tree care, and North American governmental mowing equipment. Skilled labor shortages and certain supplier issues constrained this division during 2023.

Net Industrial Equipment sales were $710.6 million in 2023 compared to $576.6 million in 2022, representing an increase of $134.0 million or 23.3%. The increase was a result of strong performance in all product lines including excavator and vacuum trucks, sweepers and debris collection, and snow removal equipment further supported by the acquisition of Royal Truck. This division was negatively impacted by a shortage of skilled labor and disruptions in parts of its supply chain, predominantly causing delays in receiving truck chassis.

Gross profit for 2023 was $453.6 million (26.8% of net sales) compared to $376.5 million (24.9% of net sales) in 2022, an increase of $77.1 million. The increase in gross profit was mainly attributable to higher sales volume and better operational performance during 2023 compared to 2022 as well as improved pricing which led to higher profitability as a percentage of sales in 2023 compared to 2022, though these results were partially offset by the negative impacts of supply chain disruptions and material inflation previously mentioned.

Selling, general and administrative expenses (“SG&A”) were $240.2 million (14.2% of net sales) in 2023 compared to $212.6 million (14.0% of net sales) in 2022, an increase of $27.6 million. The increase in SG&A expenses in 2023 was largely attributable to higher marketing expenses related to trade shows, sales promotions and commissions and to a lesser extent, sales volume-driven administration expense. Amortization expense in 2023 was $15.5 million compared to $15.3 million in 2022, an increase of $0.2 million.

Interest expense for 2023 was $26.1 million compared to $14.4 million in 2022, an increase of $11.7 million or 81.7%. The increase in interest expense in 2023 primarily came from higher interest rates compared to 2022.

Other income (expense), net was income of $1.8 million during 2023 compared to expense of $0.7 million in 2022. The increase in 2023 was primarily the result of a gain on fixed assets relating to the sale of a manufacturing facility located in Kent, Washington partially offset by loss on currency exchange. The expense in 2022 was primarily the result of an excise tax audit and to a lesser extent, changes in exchange rates.

Provision for income taxes was $39.0 million (22.2% of income before income taxes) for 2023 compared to $32.4 million (24.1% of income before income taxes) in 2022.

Net income for 2023 was $136.2 million compared to $101.9 million in 2022, with the increase in 2023 net income resulting from the factors described above.

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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, 2024, the Company had working capital of $667.2 million, which represents an increase of $77.2 million from working capital of $590.0 million as of December 31, 2023. The increase in working capital was primarily a result of higher cash and cash equivalents.

Capital expenditures were $25.0 million for 2024, compared to $37.7 million for 2023. The Company will fund any future expenditures from operating cash flows or through our revolving credit facility, described below.

Net cash provided by operating activities was $209.8 million for 2024, compared to $131.2 million for 2023. The increase of cash from operating activities is primarily the result of improved receivables and inventory compared to 2023.

Net cash used in investing activities was $22.2 million for 2024, compared to $52.6 million for 2023. The decrease in investing activities was in part driven by the acquisition of Royal Truck in 2023. Net cash used by financing activities was $32.0 million for 2024, compared to net cash used of $76.9 million for 2023. This reduction in cash used by financing activities is due to repayment of revolving credit.

The Company had $147.2 million in cash and cash equivalents held by its foreign subsidiaries as of December 31, 2024. The majority of these funds are held 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 28, 2022, the Company, as the borrower, and each of its domestic subsidiaries as guarantors, entered into a Third Amended and Restated Credit Agreement (the “2022 Credit Agreement”) with Bank of America, N.A., as Administrative Agent. The 2022 Credit Agreement provides the Company with the ability to request loans and other financial obligations in an aggregate amount of up to $655.0 million. Under the 2022 Credit Agreement, the Company has borrowed $255.0 million pursuant to a Term Facility, while up to $400.0 million is available to the Company pursuant to a Revolver Facility which terminates in five years. The Term Facility requires the Company to make equal quarterly principal payments of $3.75 million over the term of the loan, with the final payment of any outstanding principal amount, plus interest, due at the end of the five year term. Borrowings under the 2022 Credit Agreement bear interest, at the Company’s option, at a Term Secured Overnight Financing Rate (“SOFR”) or a Base Rate (each as defined in the 2022 Credit Agreement), plus, in each case, an applicable margin. The applicable margin ranges from 1.25% to 2.50% for Term SOFR borrowings and from 0.25% to 1.50% for Base Rate borrowings with the margin percentage based upon the Company's consolidated leverage ratio. The Company must also pay a commitment fee to the lenders ranging between 0.15% to 0.30% on any unused portion of the $400.0 million Revolver Facility. The 2022 Credit Agreement requires the Company to maintain two financial covenants, namely, a maximum consolidated leverage ratio and a minimum consolidated fixed charge coverage ratio. The Agreement also contains various covenants relating to limitations on indebtedness, limitations on investments and acquisitions, limitations on the 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 2022 Credit Agreement, including the Term Facility and the Revolver Facility, is October 28, 2027.

As of December 31, 2024, $220.5 million was outstanding under the Credit Agreement, $220.5 million on the Term Facility and zero on the Revolver Facility. On December 31, 2024, $2.7 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 $397.3 million in available borrowings. The Company is in compliance with the covenants under the Agreement.

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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 2024, while inflation moderated compared to prior years, the cost of commodities, components, parts, and accessories remained elevated relative to historical levels. Throughout 2024, we continued to implement strategic pricing actions and operational efficiency measures to help offset these sustained cost pressures. While the rate of inflation decreased during 2024, prices for many key inputs remained higher than pre-pandemic levels. Looking ahead to 2025, we expect the cost environment to remain challenging, though with less volatility than in recent years. We anticipate modest increases in the average cost of commodities, components, parts, and accessories compared to 2024 levels. However, cost inflation continues to be an ongoing challenge that could have a material impact on the Company's business and financial results, particularly if there are unexpected shifts in political policy changes (including the imposition of tariffs), global economic environment or supply chain dynamics.

New Accounting Pronouncements

As discussed in Note 2 of Notes to Consolidated Financial Statements, certain new financial accounting pronouncements became effective January 1, 2024, 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.

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 reflects 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.

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

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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.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Summary and Outlook

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 beginning on page 13.

We experienced strong demand for our products in 2023 together with improving supply chain conditions which facilitated higher throughput and better operating efficiency, leading to record net sales and income for the full year. Market conditions are mixed; governmental and industrial product demand is robust while vegetation product demand has been hampered by higher interest rates and elevated channel inventories. While our supply chain has improved, there are lingering supply chain issues and we continue to face labor challenges in some of our locations.

2023 Performance

In 2023, the Company's net sales increased by 12% and net income increased by 34% compared to 2022. The increase in both net sales and net income was primarily due to a strong demand for our products and improving operating conditions, particularly in the later part of the year. Margins improved due to the increase in demand along with pricing actions which helped mitigate inflation cost pressures. However, our full-year results were constrained to some extent by higher input costs, ongoing supply chain disruptions, and skilled labor shortages, all of which had a greater impact on our results earlier in the year.

The Company's Vegetation Management Division experienced a 4% increase in net sales for the full year of 2023 compared to the full year of 2022. The increase in net sales was primarily due to continued strong customer demand for our products and positive pricing actions. The division's income from operations for 2023 was up 13% versus the full year of 2022, due to improved sales, positive pricing actions,and better productivity, but offset by higher input costs, lingering supply chain disruptions, labor constraints, and higher marketing costs.

The Company's Industrial Equipment Division net sales were up 23% for the full year of 2023 compared to the full year of 2022. The division's net sales were strong in each of the product lines: excavator and vacuum trucks, street sweepers, debris collectors, and snow removal equipment. The division's income from operations for 2023 was up 89% versus the full year of 2022, driven by significant sales growth and improved operating efficiencies, but offset by higher input costs and certain key supplier issues, most notably, a shortage of truck chassis earlier in the year.

Consolidated income from operations was $198.0 million for the full year of 2023 compared to $148.6 million in 2022, an increase of 33%. The Company's backlog decreased 15% to $859.8 million at the end of 2023 versus the backlog of $1.0 billion at the end of 2022. The decrease in the Company's backlog was primarily attributable to a decline in Vegetation Management Division product orders which returned to normal levels from a historical perspective.

Inflationary Impacts

In 2023, the cost of commodities, components, parts, and accessories was higher compared to the cost of those items purchased in 2022, mainly as a result of inflationary pressure. Inflation moderated in the second half of 2023 and we anticipate that trend will continue in 2024 with the average cost of commodities, components, parts, and accessories increasing slightly when compared to the average costs in 2023.

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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:

Results of Operations

Fiscal 2023 compared to Fiscal 2022

The Company’s net sales in the fiscal year ended December 31, 2023 (“2023”) were $1,689.7 million, an increase of $176.1 million or 11.6% compared to $1,513.6 million for the fiscal year ended December 31, 2022 (“2022”). The increase in sales was attributable to continued strong customer demand for our products in both the Vegetation Management and Industrial Equipment Divisions, improved pricing, and higher throughput due to gradually improving supply chain conditions. Supply chain disruptions and a shortage of skilled labor negatively impacted net sales, especially in the first half of the year earlier.

Net Vegetation Management sales were $979.0 million in 2023 compared to $937.1 million in 2022, an increase of $41.9 million or 4.5%, coming from a strong performance in European agricultural and governmental mowing, forestry and tree care, and North American governmental mowing equipment. Skilled labor shortages and certain supplier issues constrained this division during 2023.

Net Industrial Equipment sales were $710.6 million in 2023 compared to $576.6 million in 2022, representing an increase of $134.0 million or 23.3%. The increase was a result of strong performance in all product lines including excavator and vacuum trucks, sweepers and debris collection, and snow removal equipment further supported by the acquisition of Royal Truck. This division was negatively impacted by a shortage of skilled labor and disruptions in parts of its supply chain, predominantly causing delays in receiving truck chassis.

Gross profit for 2023 was $453.6 million (26.8% of net sales) compared to $376.5 million (24.9% of net sales) in 2022, an increase of $77.1 million. The increase in gross profit was mainly attributable to higher sales volume and better operational performance during 2023 compared to 2022 as well as improved pricing which led to higher profitability as a percentage of sales in 2023 compared to 2022, though these results were partially offset by the negative impacts of supply chain disruptions and material inflation previously mentioned.

Selling, general and administrative expenses (“SG&A”) were $240.2 million (14.2% of net sales) in 2023 compared to $212.6 million (14.0% of net sales) in 2022, an increase of $27.6 million. The increase in SG&A expenses in 2023 was largely attributable to higher marketing expenses related to trade shows, sales promotions and commissions and to a lesser extent, sales volume-driven administration expense. Amortization expense in 2023 was $15.5 million compared to $15.3 million in 2022, an increase of $0.2 million.

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Interest expense for 2023 was $26.1 million compared to $14.4 million in 2022, an increase of $11.7 million or 81.7%. The increase in interest expense in 2023 primarily came from higher interest rates compared to 2022.

Other income (expense), net was income of $1.8 million during 2023 compared to expense of $0.7 million in 2022. The increase in 2023 was primarily the result of a gain on fixed assets relating to the sale of a manufacturing facility located in Kent, Washington partially offset by loss on currency exchange. The expense in 2022 was primarily the result of an excise tax audit and to a lesser extent, changes in exchange rates.

Provision for income taxes was $39.0 million (22.2% of income before income taxes) for 2023 compared to $32.4 million (24.1% of income before income taxes) in 2022.

Net income for 2023 was $136.2 million compared to $101.9 million in 2022, with the increase in 2023 net income resulting from the factors described above.

Fiscal 2022 compared to Fiscal 2021

The Company’s net sales in the fiscal year ended December 31, 2022 (“2022”) were $1,513.6 million, an increase of $179.4 million or 13.4% compared to $1,334.2 million for the fiscal year ended December 31, 2021 (“2021”). The increase in sales was attributable to continued strong customer demand for our products in both the Vegetation Management and Industrial Equipment Divisions and improved pricing. Negatively impacting net sales were higher costs for materials and inbound freight, supply chain disruptions and a shortage of skilled labor. Also, currency translation negatively affected sales as the U.S. dollar strengthened against the currencies of international countries where we operate.

Net Vegetation Management sales were $937.1 million in 2022 compared to $812.7 million in 2021, an increase of $124.4 million or 15.3%, coming from a strong performance in all product lines, particularly forestry and tree care and agricultural and governmental mowing equipment in both North America and Europe. Supply chain disruptions, labor constraints and unfavorable input cost changes constrained this division during 2022. Currency translation effects also negatively impacted net sales in this division.

Net Industrial Equipment sales were $576.6 million in 2022 compared to $521.5 million in 2021, representing an increase of $55.1 million or 10.5%. The increase was mainly due to continued solid results in our excavator and vacuum truck product lines with modest support from other product lines. This division was also negatively impacted by ongoing supply chain disruptions and logistics issues in 2022, including delays in receiving truck chassis and component parts from supply chain partners.

Gross profit for 2022 was $376.5 million (24.9% of net sales) compared to $334.5 million (25.1% of net sales) in 2021, an increase of $42.0 million. The increase in gross profit was mainly attributable to higher sales volume during 2022 compared to 2021 as well as improved pricing. Profitability was negatively impacted by supply chain disruptions, shortages of component parts, along with higher costs of materials and inbound freight. These factors led to lower profitability as a percentage of sales in 2022 as compared to the same period in 2021.

Selling, general and administrative expenses (“SG&A”) were $212.6 million (14.0% of net sales) in 2022 compared to $202.9 million (15.2% of net sales) in 2021, an increase of $9.7 million. The increase in SG&A expenses in 2022 was attributable to higher administrative, marketing and engineering expenses as the Company returned to pre-pandemic expense levels. Amortization expense in 2022 was $15.3 million compared to $14.6 million in 2021, an increase of $0.7 million.

Interest expense for 2022 was $14.4 million compared to $10.5 million in 2021, an increase of $3.9 million or 36.3%. The increase in interest expense in 2022 primarily came from higher interest rates and increased borrowing levels. Borrowing levels rose in 2022 primarily because of the need for the Company to increase its inventory levels to accommodate stronger market demand and to mitigate supply chain challenges. We anticipate borrowing levels will continue to be pressured by higher inventory requirements unless and until the supply chain situation improves.

Other income (expense), net was expense of $0.7 million during 2022 compared to income of $1.9 million in 2021. The expense in 2022 was primarily the result of an excise tax audit and to a lesser extent, changes in exchange rates. The income in 2021 was primarily due to changes in exchange rates and the sale of a facility in the Netherlands for $3.4 million.

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Provision for income taxes was $32.4 million (24.1% of income before income taxes) for 2022 compared to $29.3 million (26.7% of income before income taxes) in 2021.

Net income for 2022 was $101.9 million compared to $80.2 million in 2021, with the increase in 2022 net income resulting 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 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, 2023, the Company had working capital of $590.0 million, which represents an increase of $53.3 million from working capital of $536.7 million as of December 31, 2022. The increase in working capital was primarily a result of volume-driven and inflation-driven increases in accounts receivable as well as a volume driven increase in inventory to support the Company's backlog.

Capital expenditures were $37.7 million for 2023, compared to $31.1 million for 2022. The Company will fund any future expenditures from operating cash flows or through our revolving credit facility, described below.

Net cash provided by operating activities was $131.2 million for 2023, compared to $14.5 million for 2022. The increase of cash from operating activities is primarily the result of stronger net income driven by sales growth and a significantly lower year-on-year change in operating assets compared to 2022.

Net cash used in investing activities was $52.6 million for 2023, compared to $31.7 million for 2022. The increase in investing activities is driven by the acquisition of Royal Truck. Net cash used by financing activities was $76.9 million for 2023, compared to net cash provided of $24.5 million for 2022. This reduction in cash provided by financing activities is due to repayment of revolving credit.

The Company had $42.5 million in cash and cash equivalents held by its foreign subsidiaries as of December 31, 2023. The majority of these funds are held 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 28, 2022, the Company, as the borrower, and each of its domestic subsidiaries as guarantors, entered into a Third Amended and Restated Credit Agreement (the “2022 Credit Agreement”) with Bank of America, N.A., as Administrative Agent. The 2022 Credit Agreement provides the Company with the ability to request loans and other financial obligations in an aggregate amount of up to $655.0 million. Under the 2022 Credit Agreement, the Company has borrowed $255.0 million pursuant to a Term Facility, while up to $400.0 million is available to the Company pursuant to a Revolver Facility which terminates in five years. The Term Facility requires the Company to make equal quarterly principal payments of $3.75 million over the term of the loan, with the final payment of any outstanding principal amount, plus interest, due at the end of the five year term. Borrowings under the 2022 Credit Agreement bear interest, at the Company’s option, at a Term Secured Overnight Financing Rate (“SOFR”) or a Base Rate (each as defined in the 2022 Credit Agreement), plus, in each case, an applicable margin. The applicable margin ranges from 1.25% to 2.50% for Term SOFR borrowings and from .25% to 1.50% for Base Rate borrowings with the margin percentage based upon the Company's consolidated leverage ratio. The Company must also pay a commitment fee to the lenders ranging between 0.15% to 0.30% on any unused portion of the $400.0 million Revolver Facility. The 2022 Credit Agreement requires the Company to maintain two financial covenants, namely, a maximum consolidated leverage ratio and a minimum consolidated fixed charge coverage ratio. The Agreement also contains various covenants relating to limitations on indebtedness, limitations on investments and acquisitions, limitations on the sale of properties and limitations on liens and capital expenditures. The Agreement also contains

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other customary covenants, representations and events of defaults. The expiration date of the 2022 Credit Agreement, including the Term Facility and the Revolver Facility, is October 28, 2027.

As of December 31, 2023, $235.2 million was outstanding under the Credit Agreement, $235.2 million on the Term Facility and zero on the Revolver Facility. On December 31, 2023, $2.6 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 $397.4 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 2023, the cost of commodities, components, parts, and accessories was higher compared to the cost of those items purchased in 2022, mainly as a result of inflationary pressure. In 2023, we worked to mitigate some of the effects of cost increases through pricing actions. Inflation moderated in the second half of 2023 and we anticipate that trend will continue in 2024 with the average cost of commodities, components, parts, and accessories increasing slightly when compared to the average costs in 2023. However, cost inflation is an ongoing challenge that could have a material impact on the Company's business and financial results, particularly if the current inflationary environment materially worsens.

New Accounting Pronouncements

As discussed in Note 2 of Notes to Consolidated Financial Statements, certain new financial accounting pronouncements became effective January 1, 2023, 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.

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 reflects 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.

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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.

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.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Summary and Outlook

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 beginning on page 14.

We experienced strong demand for our products in 2022 which led to record net sales for the full year. Our markets continue to exhibit strength and we currently see do not anticipate a significant reduction in customer demand, at least in the near term. However, many of the same adverse operating conditions that we experienced in 2022 including, among other things, supply chain disruptions, input cost inflation, and labor shortages continue to present challenges to our business. Supply chain and labor issues have led to disruptions in our manufacturing facilities which constrain our operating efficiencies and negatively impact our overall profitability. These challenges are also partially responsible for our record high backlog levels, as we have struggled to fully complete and ship products in a timely manner. While our supply chain appears to be gradually improving, we expect that some or all of these adverse operating conditions will persist for at least a portion of 2023.

2022 Performance

In 2022, the Company's net sales increased by 13% and net income increased by 27% compared to 2021. The increase in both net sales and net income was primarily due to a strong demand for our products. Margins improved due to the increase in demand along with pricing actions we began in 2021 which helped mitigate inflation cost pressures. However, our results were constrained by higher input costs, ongoing supply chain disruptions, and skilled labor shortages.

The Company's Vegetation Management Division experienced a 15% increase in net sales for the full year of 2022 compared to the full year of 2021. The increase in net sales was primarily due to continued strong customer demand for our products and positive pricing actions. The division's income from operations for 2022 was up 37% versus the full year of 2021, due to improved sales and positive pricing actions but offset by higher input costs and operational inefficiencies due to supply chain disruptions and labor constraints.

The Company's Industrial Equipment Division net sales were up 11% for the full year of 2022 compared to the full year of 2021. The division's net sales were strong in the excavator and vacuum truck product lines and were also supported by moderate sales increases in our street sweeper, debris collector and snow removal equipment lines. Negatively impacting this division were higher input costs and supply chain disruptions including, most significantly, a shortage of truck chassis. These adverse conditions had a negative impact on the division's income from operations, which for the full year of 2022 was up only 5% compared to the full year of 2021.

Consolidated income from operations was $148.6 million for the full year of 2022 compared to $116.9 million in 2021, an increase of 27%. The Company's backlog increased 26% to $1.0 billion at the end of 2022 versus the backlog of $800.8 million at the end of 2021. The increase in the Company's backlog was primarily attributable to continued strong customer demand for our products in both of the Company's divisions as outlined above.

Inflationary Impacts

In 2022, the cost of commodities, components, parts, and accessories was significantly higher compared to the cost of those items purchased in 2021, mainly as a result of ongoing upward inflationary pressure. In 2023, we anticipate that the average cost of commodities, components, parts, and accessories will be slightly higher than the average costs experienced during 2022 but the rate of inflation appears to be moderating. Any material worsening of the current inflationary environment could lead to higher input costs which is likely to have a material adverse effect on our business and financial results.

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Impact of the War in Ukraine

In 2022, we discontinued sales into the Russian and Belarusian markets as a response to the war in Ukraine. Our sales in those markets represented an insignificant share of our overall international business and, accordingly, this decision did not have a material impact on our 2022 results nor do we expect it to have a material impact on our future financial results. The war has disrupted parts of our supply chain and has created additional inflationary pressure on some of the items we purchase for our end-products, but we do not believe these effects are material to our business. However, any significant change in or escalation of the war in Ukraine could result in unanticipated effects which may adversely impact our business.

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:

Results of Operations

Fiscal 2022 compared to Fiscal 2021

The Company’s net sales in the fiscal year ended December 31, 2022 (“2022”) were $1,513.6 million, an increase of $179.4 million or 13.4% compared to $1,334.2 million for the fiscal year ended December 31, 2021 (“2021”). The increase in sales was attributable to continued strong customer demand for our products in both the Vegetation Management and Industrial Equipment Divisions and improved pricing. Negatively impacting net sales were higher costs for materials and inbound freight, supply chain disruptions and a shortage of skilled labor. Also, currency translation negatively affected sales as the U.S. dollar strengthened against the currencies of international countries where we operate.

Net Vegetation Management sales were $937.1 million in 2022 compared to $812.7 million in 2021, an increase of $124.4 million or 15.3%, coming from a strong performance in all product lines, particularly forestry and tree care and agricultural and governmental mowing equipment in both North America and Europe. Supply chain disruptions, labor constraints and unfavorable input cost changes constrained this Division during 2022. Currency translation effects also negatively impacted net sales in this division.

Net Industrial Equipment sales were $576.6 million in 2022 compared to $521.5 million in 2021, representing an increase of $55.1 million or 10.5%. The increase was mainly due to continued solid results in our excavator and vacuum truck product lines with modest support from other product lines. This division was also negatively impacted by ongoing supply chain disruptions and logistics issues in 2022, including delays in receiving truck chassis and component parts from supply chain partners.

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Gross profit for 2022 was $376.5 million (24.9% of net sales) compared to $334.5 million (25.1% of net sales) in 2021, an increase of $42.0 million. The increase in gross profit was mainly attributable to higher sales volume during 2022 compared to 2021 as well as improved pricing. Profitability was negatively impacted by supply chain disruptions, shortages of component parts, along with higher costs of materials and inbound freight. These factors led to lower profitability as a percentage of sales in 2022 as compared to the same period in 2021.

Selling, general and administrative expenses (“SG&A”) were $212.6 million (14.0% of net sales) in 2022 compared to $202.9 million (15.2% of net sales) in 2021, an increase of $9.7 million. The increase in SG&A expenses in 2022 was attributable to higher administrative, marketing and engineering expenses as the Company returned to pre-pandemic expense levels. Amortization expense in 2022 was $15.3 million compared to $14.6 million in 2021, an increase of $0.7 million.

Interest expense for 2022 was $14.4 million compared to $10.5 million in 2021, an increase of $3.9 million or 36.3%. The increase in interest expense in 2022 primarily came from higher interest rates and increased borrowing levels. Borrowing levels rose in 2022 primarily because of the need for the Company to increase its inventory levels to accommodate stronger market demand and to mitigate supply chain challenges. We anticipate borrowing levels will continue to be pressured by higher inventory requirements unless and until the supply chain situation improves.

Other income (expense), net was expense of $0.7 million during 2022 compared to income of $1.9 million in 2021. The expense in 2022 was primarily the result of an excise tax audit and to a lesser extent, changes in exchange rates. The income in 2021 was primarily due to changes in exchange rates and the sale of a facility in the Netherlands for $3.4 million.

Provision for income taxes was $32.4 million (24.1% of income before income taxes) for 2022 compared to $29.3 million (26.7% of income before income taxes) in 2021.

Net income for 2022 was $101.9 million compared to $80.2 million in 2021, with the increase in 2022 net income resulting from the factors described above.

Fiscal 2021 compared to Fiscal 2020

The Company’s net sales in the fiscal year ended 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 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.

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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.

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, 2022, the Company had working capital of $536.7 million, which represents a increase of $117.1 million from working capital of $419.6 million as of December 31, 2021. The increase in working capital was primarily a result of volume-driven and inflation-driven increases in accounts receivable as well as an increase in inventory to support the Company's higher backlog levels.

Capital expenditures were $31.1 million for 2022, compared to $25.3 million for 2021. The Company will fund any future expenditures from operating cash flows or through our revolving credit facility, described below.

Net cash provided by operating activities was $14.5 million for 2022, compared to $49.7 million for 2021. The decrease of cash from operating activities is primarily the result of increased borrowings on the Company's revolving credit facility used for increased working capital needs in support of elevated backlog levels.

Net cash used in investing activities was $31.7 million for 2022, compared to $33.4 million for 2021. Net cash provided by financing activities was $24.5 million for 2022, compared to net cash used of $23.0 million for 2021.

The Company had $42.9 million in cash and cash equivalents held by its foreign subsidiaries as of December 31, 2022. The majority of these funds are held 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 28, 2022, the Company, as the borrower, and each of its domestic subsidiaries as guarantors, entered into a Third Amended and Restated Credit Agreement (the “2022 Credit Agreement”) with Bank of America, N.A., as Administrative Agent. The 2022 Credit Agreement provides the Company with the ability to request loans and other financial obligations in an aggregate amount of up to $655.0 million. Under the 2022 Credit Agreement, the Company has borrowed $255.0 million pursuant to a Term Facility, while up to $400.0 million is available to the Company pursuant to a Revolver Facility which terminates in five years. The Term Facility requires the Company to

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make equal quarterly principal payments of $3.75 million over the term of the loan, with the final payment of any outstanding principal amount, plus interest, due at the end of the five year term. Borrowings under the 2022 Credit Agreement bear interest, at the Company’s option, at a Term Secured Overnight Financing Rate (“SOFR”) or a Base Rate (each as defined in the 2022 Credit Agreement), plus, in each case, an applicable margin. The applicable margin ranges from 1.25% to 2.50% for Term SOFR borrowings and from .25% to 1.50% for Base Rate borrowings with the margin percentage based upon the Company's consolidated leverage ratio. The Company must also pay a commitment fee to the lenders ranging between 0.15% to 0.30% on any unused portion of the $400.0 million Revolver Facility. The 2022 Credit Agreement requires the Company to maintain two financial covenants, namely, a maximum consolidated leverage ratio and a minimum consolidated fixed charge coverage ratio. The Agreement also contains various covenants relating to limitations on indebtedness, limitations on investments and acquisitions, limitations on the 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 2022 Credit Agreement, including the Term Facility and the Revolver Facility, is October 28, 2027.

As of December 31, 2022, $301.9 million was outstanding under the Credit Agreement, $249.9 million on the Term Facility and $52.0 million on the Revolver Facility. On December 31, 2022, $2.8 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 $295.2 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 2022, the Company was materially impacted by inflationary pressures that significantly increased the price of steel as well as the price of many other purchased components. In 2022, we worked to mitigate some of the effects of cost increases through aggressive pricing actions but cost inflation is an ongoing challenge that could have a material impact on the Company's business and financial results, particularly if the current inflationary environment materially worsens.

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.

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.

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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.

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.

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Item 7. Management’s Discussion and Analysis of Financial Condition

and Results of Operations

Outlook

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 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.

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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:

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

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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

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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

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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.

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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:

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.

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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.