Alamo Group Inc

NYSE:ALG

Earnings Call Transcript 2022-Q4

[Operator]

Greetings and welcome to the Alamo Group's Fourth Quarter 2022 Conference Call. At this time, all participants are in a listen only mode. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Ed Rizzuti, Executive Vice President, General Counsel and Secretary. Please go ahead.

[Edward Rizzuti]

Thank you. By now you should have all received a copy of the press release. However, anyone is missing a copy, but would like to receive one please contact us at 2128273746, we will send you a release and make sure you're on the company's distribution list. There will be a replay of the call, which will begin one hour after the call and run for one week. The replay can be accessed by dialing 8445122921 with the passcode one 13734940. Additionally, the call is being webcast on the company's website at www.alamo-group.com, and a replay will be available for 60 days.

On the line with me today are Jeff Leonard, President and Chief Executive Officer; Richard Wehrle, Executive Vice President, Chief Financial Officer, and Treasurer; and Dan Malone, Executive Vice President and Chief Sustainability Officer. Management will make some opening remarks, and then we'll open up the line for your questions.

During the call today management may reference certain non-GAAP numbers in their remarks. Reconciliations of non-GAAP results to applicable GAAP numbers are included in the attachments to our earnings release.

Before turning the call over to Jeff, I'd like to make a few comments about forward-looking statements. We will be making forward-looking statements today that are made pursuant to the safe harbor provisions of the private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties, which may cause the company's actual results in future periods to differ materially from forecasted results. Among those factors which could cause actual results to differ materially are the following: Market demand, COVID-19 impacts, including operational supply chain disruptions, competition, weather, seasonality, currency related issues, geopolitical issues and other risk factors listed from time to time in the company's SEC reports. The company does not undertake any obligation to update the information contained herein, which speaks only as of this date.

I would now like to introduce Jeff Leonard. Jeff, please go ahead.

[Jeffery Leonard, Chief Executive Officer and President]

Thank you Ed. We want to thank all of you for joining us today. Richard will begin our call with a review of our financial results for the fourth quarter and year-end 2022, I will then provide additional comments on the results. Following our formal remarks, we will look forward to taking your questions.

So Richard, please go ahead.

[Richard Wehrle]

Thanks Jeff and good morning, everyone. Alamo group's fourth quarter 2022 closed with a solid performance that produced record net sales and net income driven by strong demand for our products, despite persistent supply chain and labor shortage headwinds.

Fourth quarter consolidated net sales for 2022 were $386.6 million, an increase of 15% compared to $337.2 million in the fourth quarter of last year. Fourth quarter net sales were negatively impacted just over 3% by currency translation compared to the fourth quarter of 2021 as the U.S. dollar continued to strengthen.

Gross margin dollars in the quarter improves compared to the fourth quarter of 2021 by $14.1 million, as did gross margin percent, which was up 50 basis points due to both price initiatives, take it earlier in the year, as well as improved manufacturing efficiencies. Both margin dollars and percentage were negatively impacted by supply chain issues, labor shortages, and freight costs on inbound inventory as surcharges continue to be added to already significantly higher freight invoices.

Consolidated net income for the fourth quarter of 2022 was $29.2 million for $2.44 per diluted share, an increase of 52% versus net income of $19.2 million for one point -- or $1.62 per diluted share for the fourth quarter of 2021. Our continued efforts to control both costs and expenses help support the increase in the profitability.

Vegetation Management division delivered a solid fourth quarter for 2022 as markets remain strong. Fourth quarter 2022 net sales were $232.5 million, an increase of 14% compared to $204.3 million for the fourth quarter of 2021. Strong demand for forestry tree care and agricultural and governmental mowing products in both North America and Europe led the way for this division. Despite labor shortages and supply chain disruptions, margins improved primarily due to increase in net price realization and improved operating efficiency. Operating income for the fourth quarter of 2022 was $30.2 million, up 67% versus $18.1 million for the same period in 2021.

Industrial Equipment division net sales in the fourth quarter of 2022 were $154.1 million, up 16% compared to $132.8 million for the fourth quarter of 2021. This is due to a solid performance of snow removal products and to a lesser extent improved net sales in the division's excavator and vacuum truck and sweeper product lines. While truck chassis delivery showed improvement this quarter, other component parts shortages continued to impact this division's operations, which in turn drove unfavorable manufacturing efficiencies, although not as significant as in previous quarters.

Operating income in the fourth quarter of 2022 was $12.5 million compared to $8.7 million for the fourth quarter of 2021, an increase of 28%. Consolidated debt sales were a record for the full year 2022 coming in at $1.5 billion, up 13% compared to $1.3 billion for the full year of 2021. A strong demand for our products in both company's divisions along with positive impact, the price initiatives were the main drivers of the increase.

Full year gross margin for 2022 was up over $42 million versus the full year of 2021. Margin percentage was down about 20 basis points as we experienced inflation and material costs, purchase components, and higher inbound freight costs, all of which resulted in higher absorption costs. Net income for the full year of 2022 was $101.9 million or $8.54 per diluted share, also a record versus net income of $80.2 million or $6.75 per diluted share for the full year of 2021, an increase of 27%.

Full year 2022 net sales for the Vegetation Management division were $937.1 million compared to $812.7 million for 2021, up 15%. The division experienced robust demand in all product categories, particularly in forestry, tree care and in both North American and European agricultural and governmental mowing. Full year 2022, operating income was $108.5 million, up 37% versus $78.9 million for the prior year.

For the full year 2022 net sales for the Industrial Equipment division were $576.6 million compared to $521.5 million for 2021, an 11% increase. Sales of excavators and vacuum trucks led the way, but all product lines contributed in 2022.

Full year 2022 operating income was $40.1 million versus $38 million for the full year of 2021, an increase of 5%. This division's results were negatively impacted by constrained chassis deliveries, supply chain disruptions, manufacturing inefficiencies, and higher input costs in both material and inbound freight costs.

The company's backlog at the end of 2022 came in just over $1 billion. This was an increase of 26% compared to backlog for the full year of 2021. This positions the company up for an excellent start for 2023.

Turning to a few additional financial items for the year-end 2022. Our balance sheet continues to remain strong. Working capital increased $117 million to $537 million from $420 million at the end of 2021. The increase in working capital results from higher accounts receivable and inventory. Accounts receivable were up $318 million, up 33% from a year ago and solid sales volume. We continued to be really pleased with receivables and no major issues on collections and incoming cash remains very steady.

Inventory is up almost $32 million compared to the end of 2021. This is a reflection from higher work in process, although down from the last two quarters, material cost inflation, as well as our efforts to support growing demand for our products by purchasing higher levels of key components and service parts for our customers during this time of constraint supplies. The increase has also reflected our modestly higher debt levels. And finally, the company's trailing 12-month EBITDA is a record $196 million, that's up 21% compared to 2021.

For 2023, incoming cash flow should remain strong as our focus on the balance sheet will be to reduce both inventory and debt levels. Increasing consolidated profits for 2023 will be extremely important as we will continue to be disciplined in controlling costs and expenses, as inflation is expected to continue to put pressure on our margins. We will also adjust prices as needed based on changes in material and transportation costs in order to maintain our target margins.

We're also focusing on future -- on further improvements supply chain performance to help reduce the amount of inventory we hold in work in process. Our biggest challenge will be in needing the heightened demand for our products throughout the company, given current supply chain constraints and labor shortages.

We're pleased that our Board recently approved a 22% increase in our regular quarter dividend of $0.22 per share for the first quarter of 2023.

With that I will turn the call back over to Jeff.

[Jeffery Leonard, Chief Executive Officer and President]

Thank you, Richard. I'd also like to, again, thank everyone who's joined our conference call today. We were very pleased that the company was able to leverage positive and sustained market momentum to set new records for sales and earnings for our fourth quarter and the cap off 2022 with the best full year financial results in company history.

Sales in both of our operating divisions were up by double-digits as our markets continued to display the significant strength that we experienced throughout 2022. Net sales increased by 15% compared to the fourth quarter of 2021, despite currency translation effects the reduced sales by more than 3% or $10.5 million during the period. For the full year 2022, sales more than 13% with a currency translation having a negative impact of 2.4% or $32 million.

The Vegetation Management division net sales in the fourth quarter rose 14%, led by a nearly 20% increase in sales of forestry and tree care equipment and a more than 20% increase in sales of governmental mowing equipment in North America. Sales of this division's products in South America also more than 20%, while sales to the Agricultural segment and European sales of governmental mowers were seasonally softer, but still showed nice growth.

Industrial Equipment division's fourth quarter net sales were up 16%, led by a 26% increase in sales of street sweepers into pre-collection equipment, while sales of its excavators and vacuum trucks were up by nearly 15%. The cold weather experienced in many parts of North America during the quarter also drove sales of the division snow removal equipment and related spare parts up by 12%.

Supply chain performance also continued to improve in the fourth quarter. Compared to the prior year, Class 8 truck chassis receipts were approximately 40% higher in the fourth quarter of 2022, while receipts of Class 6 and 7 chassis declined modestly during the same period. Although, we remain constrained by chassis capacity allocations from the major manufacturers, this improvement in Class 8 chassis receipts supported nicely improved sales of our larger vocational trucks within the Industrial Equipment division. Supplies of other critical industrial components, such as hydraulics and wiring harnesses, automation equipment remained in shortage and continued to impair our operating efficiencies and constrained further sales growth. Manpower availability remained concerning to us, and we ended the quarter with more job openings than we anticipated.

As we've reported throughout the year, the margin in our backlog remains excellent, and this was evident in our results for the quarter. Fourth quarter gross margin of 25.3% was the highest of the year. Our teams also did an excellent job of managing controllable costs. Fourth quarter operating expenses were almost 2% lower than the prior year, reflecting our focus on streamlining our cost structure and increasing operating flexibility. We also ceased operations at one of our U.S. snow removal manufacturing facilities and consolidated these activities into one of our larger plants during the fourth quarter. Higher top line sales [technical difficulty] expenses drove our fourth quarter operating income to 11%, a level last achieved in the third quarter of 2018.

Our markets continue to demonstrate strength and provided us with excellent opportunities during the final months of the year. Order bookings of nearly $474 million in the fourth quarter were down less than 2% from the record established in the fourth quarter of 2021. Despite this modest decline, year-end order backlog of flat to more than $1 billion was nearly 26% higher than prior year and almost 11% higher than at the end of the third quarter.

The rebound in our Industrial Equipment division was noteworthy as order bookings were 20% higher than the fourth quarter of 2021. Orders in the Vegetation Management division declined 15% relative to the prior year fourth quarter. This was partly due to our decision to conduct only a limited preseason program in the North American agricultural mowing businesses, given the very high order backlog in this segment.

Activity in our governmental markets at the state, county and municipal levels remained robust during the fourth quarter. According to the National Association of State Budget Officers, state agencies recorded spending growth of more than 18% during 2022, the highest increase in spending since the association again keeping records in 1979. In aggregate, states general fund revenue grew 14.5% year-over-year to total $1.17 trillion in fiscal 2022, following a 16.6% increase in fiscal 2021. Most county and municipal governments also reported higher receipts and increased spending during 2022.

Our industrial customers also continue to invest in upgraded equipment for facilities and right-of-way maintenance at a very healthy pace. Activity in our forestry and tree care segment remained strong. And demand from the agricultural sector was very good, especially for fourth quarter.

As we look ahead, we continue to be encouraged by the positive trends visible in our markets, and we remain optimistic about the company's outlook for the coming months. While we remain vigilant for signs of a potential recession, we've not yet witnessed any trends that are a cause for concern for at least the first half of 2023. Our large and healthy backlog provides several quarters of excellent forward visibility. Our focus for the next several quarters therefore, remains on achieving further improvements in the performance of our supply chain, driving our internal efficiencies higher, still accelerated recruitment of skilled employees and continuing to optimize our manufacturing capabilities and footprint. We're also excited to introduce several hybrid and fully electric versions of our core products at the upcoming CONEXPO show next month in Las Vegas.

This concludes our prepared remarks. We're now ready to take your questions. So, operator, please go ahead.

[Operator]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]

Your first question comes from Chris Moore with CJS Securities. Please go ahead.

[Chris Moore, CJS Securities]

Hey, good morning guys. Congrats on a terrific quarter.

[Jeffery Leonard, Chief Executive Officer and President]

Thank you.

[Chris Moore, CJS Securities]

Right. So, revenue growth for the year was 13%. Consensus for 2023 before Q4 was a little bit north of 5%. And understanding you guys don't guide, but what would be the puts and takes for Alamo to come in significantly above or below the 5% level in 2023?

[Jeffery Leonard, Chief Executive Officer and President]

Okay. Chris, great question. For the last couple of quarters on these calls, I made a fairly consistent remark that just a little bit of supply chain improvement would quickly lever itself in terms of our sales and profitability. And I think we saw that start to happen now in Q4. I mentioned the big increase in receipts of Class 8 trucks. We still need more. The bookings are growing faster than the increase in the receipts of the chassis, but that's a very, very nice position to be in.

So, the only thing it would really take to answer your question is for that trend to continue, for the supply chain to continue to improve its performance, for supplies to be a little bit more readily available and for us to continue doing what we're doing, which is to get our people and drive our capacity is higher as well. I wish I could tell you there was some magic in the formula, but there really isn't. It's just doing the basics and doing them well.

[Chris Moore, CJS Securities]

And that visibility from where you sit now in late February versus late -- or mid-November. Has it changed much? I mean, were you surprised at the level of chassis availability in Q4? Or you could see that in November?

[Jeffery Leonard, Chief Executive Officer and President]

Chris, you got to go back actually to Q3. If you recall, we had a fairly poor Q3 because some of the chassis we expected that quarter will push back into Q4. So, we got a boost. That's part of it. But also the long haul over-the-road truckers that operate large fleets are slowing their spend on trucks now. So, there's a few more plants safe chassis coming available from our traditional suppliers, which is starting to improve our position. I think that's going to continue for a bit from what we're hearing. We're fresh off meetings with all the major truck OEMs and the picture is sounding much better than it was a few months back.

[Chris Moore, CJS Securities]

Got it. That's very helpful. 12% operating margin medium term goal. We've talked about that a few times. Now that Q4 is done. You had a record 11% on almost two months in. Any updated thoughts in terms of that 12% visibility? Is that just a pure supply chain conversation also? Or anything else we should be thinking about?

[Jeffery Leonard, Chief Executive Officer and President]

No, I think it's just more of us doing what we do, Chris. Supply chain, for sure. I've said that several quarters in a row. Now that's the biggest driver. But continuing to consolidate our operations and really doing a good job executing this make and market strategy that we've talked about a few times, producing products closer to the point of consumption, so that we don't have inventory and time lags associated with shipping products across the Atlantic Ocean primarily is a fact and in continuing the consolidation of our footprint.

At the same time, we're accelerating our investments in our manufacturing capability, buying new machine tools, getting more automation and more robotics because we recognize we're going to be in this labor constraint for some time to come. In fact, none of us can really yet see an answer to that, to be candid.

[Chris Moore, CJS Securities]

Got it. That's helpful. And just last one for me on some of Richard's comments on cash flow. So, obviously, you had a good Q4 after you had a lot of working capital build in the first nine months. You still -- AR is still up quite a bit. So, just in terms of 2023 thoughts, it should be pretty strong, certainly the beginning of the year, is that kind of what I heard?

[Richard Wehrle]

Yeah. Chris, I don't think that's going to change at all. I think our accounts receivable going to be very strong. If we continue to do the sales levels that we're expecting to do here, it's going to stay up. Our DSOs are in excellent shape. So, I don't -- I'm not worried about a collection issue here. So, I think incoming cash is going to remain strong first, second and third quarter from keeps we're doing right now.

[Chris Moore, CJS Securities]

Perfect. I will leave it there. Thanks guys.

[Jeffery Leonard, Chief Executive Officer and President]

Thanks Chris.

[Operator]

Next question, Greg Burns with Sidoti & Company. Please go ahead.

[Gregory Burns, Sidoti & Company]

Morning. What is the outlook -- your outlook here for the ag business? Have you seen any change in the demand trends there? I know in the past, you've talked about dealer inventories as a maybe something you look at, but has there been any change in that market at all?

[Jeffery Leonard, Chief Executive Officer and President]

Dealer inventories are rising slightly, but I think most of us that serve the industry think that's a pretty good thing, not a bad thing at the moment. I mean, where it sits right now, it's a good thing.

The trend in ag has been surprisingly strong to be candid with you. I think that we were seeing some signs of weakness back in the first quarter of last year. But it's been a good pay. The bookings have remained good. And honestly, the activity level seems just fine right now. It's surprising. It's -- I'm surprised that the cycle has lasted as long as it has to be candid with you, but it still shows excellent legs for the foreseeable future.

[Gregory Burns, Sidoti & Company]

Okay. Great. And then, on the industrial side, the strong order growth that you saw this quarter, was that any product line in particular? Or is it more across the board? Any color there.

[Jeffery Leonard, Chief Executive Officer and President]

I think it's been pretty much across the board. We had changed our strategy at snow removal a couple of quarters ago. We have traditionally been a supplier of attachments for snowplow trucks and the like. So, we made the plows. We made the salt spreaders, but we didn't build the trucks themselves. And we shifted our strategy to produce the complete product and deliver a complete product onto the state, county and municipal operators, large contractors and the like. That increased our demand for chassis. That's part of what you saw and what we're referring to this persistent constraint on the chassis supply. So that part of the business has picked up very nicely. That strategy has been very appreciated by the large operators of snowplow equipment.

On the balance of the Industrial division, street sweepers have been rebounding very nicely, have been strong, and our vacuum truck business has remained strong all the way through. It's been robust. Our rental fleet utilization is sky high. I don't want to cite a number for obvious reasons, but it's at a very, very high level. In fact, I'd like to get some more trucks into that rental fleet pretty soon. So, no, it's pretty much across the board. Everything was good in industrial. They've just been waiting for chassis and those chassis are beginning to finally flow through now.

[Gregory Burns, Sidoti & Company]

Okay. And then, lastly, where are you in terms of price cost? Have you been able to completely offset inflation at this point? Do you feel like the pricing you have in the market now is, I guess, sufficient to accomplish that?

[Jeffery Leonard, Chief Executive Officer and President]

Yeah. We have. I mean, we raised prices every year at the start of the year. We have in 2023 as well. That's just part of our discipline as a company. I do think we're in front of it, Greg. Our margins have been expanding only offset by our operating efficiencies as we've commented the last couple of quarters, but operating efficiency did improve in Q4 as the supply chain began to stabilize.

So, yes, I give you a clear answer. I think we are out in front of it. And I think we're in a very nice position. We actually moved out some of the weaker backlog we had in Q4. So, we're in a very nice position now as we head into the early months of this year.

[Gregory Burns, Sidoti & Company]

Great. Thank you.

[Jeffery Leonard, Chief Executive Officer and President]

Thanks Greg. Appreciate it.

[Operator]

Next question, Tim Moore with EF Hutton. Please go ahead.

[Tim Moore, EF Hutton]

Thanks and congratulations on the strong sales growth and impressive new orders increased. If I'm looking at your backlog, which is a record number, I'm just trying to get a sense of how much higher maybe that gross margin could be compared to a year ago. I think one difference might be full net price realization this time around compared to orders more than a year ago. And I'm just trying to think, if you don't do another preseason program and you don't have to back out maybe some of the freight surcharges by the summer, mean could the gross margin on your backlog be about 100 basis points better than a year ago?

[Richard Wehrle]

It's hard to say. I would say it would be better. I mean, our backlog right now has got all that pricing in there that we've been doing for all of 2022. So, we feel very comfortable with that. And I think as Jeff had mentioned, the key here is to have a consistent flow through the manufacturing plants. We do that. We're going to actually have the margins exactly where we want them to be.

[Jeffery Leonard, Chief Executive Officer and President]

And Tim, this is Jeff. One other thing I would say to you about that is that on the governmental side of our business, it's more difficult to reprice backlog. We had some success, but not nearly as much as we've had with our Vegetation Management division. So, some of those older contracts that were taken at the start of the supply chain crunch moved out in Q4, and those were the lower margin ones. So, we actually had better pricing profile and backlog now than we've had the last couple of quarters.

[Tim Moore, EF Hutton]

That's great. That's good to hear that that's rolled off recently. No, that makes sense. And just related to some comments you made earlier and something that's been going on for mostly the last year. You've had an absorption headwind when you go back to the unfinished final assembly stage after incurring an extra expense to reset that for a couple of parts that arrive a few months later. How much better is that improved in the last few months? Or is it about the same as it might have been last summer and fall?

[Richard Wehrle]

The last couple of quarters, Tim, we were probably $30 million or so, maybe even a little bit more in our work in process and we ended the year at $22 million. So, I think some of that supply chain move through has really pushed the area where we need to go and get that number down. We still have more room to growth, I mean, to reduce that. And if we can continue to keep the supply chain moving through the system the way it is, I think that number is going to keep coming down, which is what we want.

[Jeffery Leonard, Chief Executive Officer and President]

And Tim, it's Jeff. I'll add a little bit more color to that for you in the way the facilities are operating right now. While the supply chain is improving and more material is flowing through, it tends to flow through in the last month of the quarter. That's just the behavior of manufacturing, I guess. And so, we get a surge of equipment coming in the final week. So, we're still having to burn a pretty good bit over time to push products out in the final weeks of the month. We don't like that. That's not our tradition, but that's kind of where we are, frankly. So, there's nice room to move to get the efficiency rising higher. We've only improved them, about one-third of where I think they ought to go. There's still a lot of room for improvement.

[Richard Wehrle]

I think the other key here too, Tim, is just consistency from the suppliers. We can hit that a little bit more -- flowing a little bit more equally each individual month inside the quarter and then it would be great.

[Tim Moore, EF Hutton]

No, thanks for the color and quantifying that. It's nice to hear that it's going in the right direction. Was there any uptick? Or do you think there'll be uptick in demand for forestry and tree care from the recent Texas ice storms? And on the flip side, is there probably maybe any demand loss if it's not a great snowy winter in parts of the U.S.?

[Jeffery Leonard, Chief Executive Officer and President]

Give you my first comment. On the Texas winter and forestry, probably not much because that takes the low-end of the product range more than the high-end. And if you don't have that shipper on the shelf, you don't sell it. So, mostly it's contractors operating the current fleet. The market doesn't react that quickly, I guess is what I'm trying to say. It does help our parts business for sure in the short run.

And I would tell you, this winter has always -- already been excellent for snow removal. The early snowfall is what really helps us when it starts to snow in October and November as it did this year, people start putting new blades, wear tips on the plows and really working. So, our parts business picks up. We already have an all-time record backlog in snow. I mean, snow is just selling really, really nicely right now, particularly since this change in our strategy. And I think we've got a reputation to be a good builder of snow plow trucks. We produce a quality product, and we feel we've been gaining market share in that space. So, I think that we've already seen that uptick. The backlog is high enough now. It will be hard for you to measure it from here to be candid with you, because it's going to kind of take out the cyclicality of the business.

[Tim Moore, EF Hutton]

Great. So, two more quick questions. The first one is around SG&A. It was nice to see that as a percentage of sales, it declined to 14% compared to 15% to 16% the prior two years. Richard, do you think that's sustainable for 2023? Or do you think it will tick back up a bit if there's any travel costs or one-time costs to come back?

[Richard Wehrle]

Tim, you could have some movement a little bit in there. But I think overall, for full year, there's no reason why that number can't stay in that same range. Our job is to make sure that we continue to keep those in check and control, and we've done a great job. We were a little bit aggressive after the first quarter this past year because of the inflation that was going on and the pricing that we had to keep putting in place for all of our products. So, I mean, if we're going to do that and we were having that heavy cost, we had to do something and controlling expenses was where we needed to be. We'll keep that in check. It doesn't mean we're not going to spend money on SG&A. It just means we just need to keep an eye on it. And yeah, you could have a few bumps here and there just depending on how the shipments go out. But overall, the numbers should stay relatively the percentage-wise should stay relatively close to the total sales.

[Jeffery Leonard, Chief Executive Officer and President]

Yeah. I would emphasize on the percentage side because we've made our first round of significant investments in electrification of our equipment. We have a second round now to move from prototypes to production machines that will flow through largely in the back half of 2023. So, I think it will edge up throughout the year in dollars, not necessarily in percentages.

[Tim Moore, EF Hutton]

No, that makes sense. Good. I always think about it in terms of percentages. And then my last question is related to one that I asked last quarter. If I recall, you were doing a study or a policy that was underway for maybe accelerating your in-country made production, Brazil, Australia, maybe U.K. and France to really save on transportation costs and improving the lead times for delivery to customers. How big of action plan is at this year and when do you think you might start seeing gross margin improvement? Is that more of a fourth quarter story for timing?

[Jeffery Leonard, Chief Executive Officer and President]

Yeah. It is. It takes a while. We have to do some groundwork within the legal structure of our company. We have to move intellectual property around to facilitate that, then we have to change tooling in some of our facilities, but we're actively into that. We've already seen some benefit from it, but we're still in the very early stages of that. And I think you'll start to see meaningful progress on it in Q4 and then much more so as we head into next year.

[Richard Wehrle]

Add to that, two division heads, Rick Raborn and Mike Haberman have done an excellent job working their groups together to work with each other on this because this is what's going to make the difference as we go forward, as we've said before, Tim, the cost of moving things is just ridiculous. Having that opportunity where these guys are working with their groups is huge. It makes a big difference and allows us to be able to build this product worldwide, which is exactly what our intent is.

[Tim Moore, EF Hutton]

Great. No, that's helpful. I think that's a big catalyst that you get benefit for starting later this year. So, thanks a lot. That's it for my questions.

[Richard Wehrle]

You bet.

[Jeffery Leonard, Chief Executive Officer and President]

Okay. Thank you.

[Operator]

[Operator Instructions]

Your next question comes from Mike Shlisky with D.A. Davidson. Please go ahead.

[David Johnson, D.A. Davidson]

Good morning. This is David Johnson on for Mike.

[Jeffery Leonard, Chief Executive Officer and President]

Hi, good morning.

[Richard Wehrle]

Good morning.

[David Johnson, D.A. Davidson]

Hey, there. Morning. Morning. I was wondering with operating margins and potentially free cash flow taking a step up in 2023, what's your appetite for M&A from here? Given the growth of the company and the low leverage on the balance sheet at the current time, are you looking at larger deals that we've seen in the past?

[Jeffery Leonard, Chief Executive Officer and President]

Yes.

[David Johnson, D.A. Davidson]

Okay. Great.

[Jeffery Leonard, Chief Executive Officer and President]

I don't want to give you examples for obvious reasons. But yes, we are looking at larger deals, and we've said that for some time. Particularly in Europe, the market in Europe looks good to us, right? Now we've always wanted to balance our portfolio a little bit more between North America and Europe. And to grow our forestry and tree care business in Europe, we've stated those things several times. So, yes, we are very actively looking for larger deals at the moment. And I think that the timing is good for companies like us right now.

[David Johnson, D.A. Davidson]

All right. That's great to hear. And lastly, you mentioned labor availability, especially in manufacturing. Can you take us through any initiatives you're working on to get those positions filled?

[Jeffery Leonard, Chief Executive Officer and President]

Yeah. We've been increasing our apprenticeship programs, looking at certain operations that we can fully automate, not just partially automated, but fully automated and just increasing outreach in the communities where we operate. And then lastly, through this manufacturing footprint reengineering, we're able to liberate labor. So, we made people side up in low volume production in one country where we're shipping the product to another destination, we can get better utilization of our bigger factories if we consolidate that closer to the point-of-sale. So that also helps us from a manpower point of view. But it's going to take a lot of work through those things. We're still down several hundred employees from where we would like to be and that's a tough fight right now.

[David Johnson, D.A. Davidson]

Understood. Thank you for taking my questions.

[Jeffery Leonard, Chief Executive Officer and President]

Thank you.

[Richard Wehrle]

Thank you.

[Operator]

Thank you. I will now turn the floor over to management for closing remarks.

[Jeffery Leonard, Chief Executive Officer and President]

Okay. Thank you that concludes our remarks for this conference call. We look forward to speaking with you again at our May call for the second quarter of 2022 – 2023, I apologize.

[Operator]

This concludes today's teleconference. You may disconnect your lines at this time. And thank you for your participation.