Douglas Dynamics, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Douglas Dynamics third quarter 2020 earnings conference call. At this time, all participant lines are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's call is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Sarah Lauber, CFO. Thank you, and please go ahead, Madam.

Thank you. Welcome, everyone, and thank you for joining us on today's call. Before we begin, I'd like to remind you that some of the comments that will be made during this conference call, including answers to your questions, will constitute forward-looking statements. These forward-looking statements are subject to risks that could cause actual results to be materially different. Those risks include, among others, matters that we have described in yesterday's press release and in our filings with the SEC. Joining me on the call today is Bob McCormick, our President and Chief Executive Officer. In a moment, Bob will provide an overview of our performance, then I'll review our financial results. After that, we'll open the call for your questions. With that, I'll hand the call over to Bob.

Thanks, Sarah. Good morning, everyone. Before I discuss our quarterly performance, I wanted to highlight two important topics. First, we are very pleased that the vast majority of Douglas' employees have remained healthy since we came back to work in May. We've had a handful of isolated cases at some locations, and people who have tested positive have contracted COVID outside the workplace. In all cases, we have responded quickly, and we've avoided any large outbreaks at this point. Heading into the winter months, we're likely to have more positive tests, especially as cases expand across the country. We do remain vigilant, working to ensure no one lets their guard down. Our protocols are effective, and we're ready to handle any outbreaks that occur. Additionally, I'd like to take this opportunity to welcome Lisa Rojas-Bacchus to our board. Lisa has a proven track record of leadership with greater than 30 years of experience across a diverse set of industries. She focuses on marketing, strategic planning and data analytics at Cigna, American Family Insurance and Ford Motor Company, bringing invaluable experience in the years ahead. We're looking forward to having her as part of our team. At the same time, we'd like to recognize Jim Packard for his numerous contributions to Douglas Dynamics. Jim will retire from the Board at the end of his current term at the 2021 Annual Meeting. We are grateful for his contributions and guidance over the past decade and wish him all the best for the future. Okay, turning to the results for the quarter. In short, we are pleased with our results. All of our facilities operated throughout the quarter, albeit under pandemic conditions, Attachments performed well, with a strong finish to the preseason. Solutions rebounded from the second quarter shutdowns and executed well, all things considered. Let's talk about the segments in more detail. First, attachments. We had a solid quarter, actually outperforming third quarter 2019, with revenue EBITDA and EBITDA margin all increasing. If you recall, We saw a late start to preseason, and dealers were understandably conservative with their orders given the uncertainty that existed in April and May and the below-average snowfall in recent winters. We hope to see dealer orders strengthen as we got closer to the end of Q3 and the beginning of the retail selling season, and that's exactly what happened. This led to an approximate 50-50 ratio between second and third quarter preseason shipments compared to previous expectations of a 55-45 split and the prior year split of 60-40. Even with the uptick in Q3 orders, field inventories are down to prior year at the end of September, another positive that will influence demand as the retail season begins. It is worthy to note that landscapers are in a relatively strong financial position right now because they were able to work all spring and summer, and this may translate into early retail activity as well. On the product front, the half-done B-plow we launched this spring has been well-received. We are optimistic about the long-term potential for this product. In other positive news, the health of our dealer credit remains in good shape. Collections are coming in as expected and we are pleased that the financial health of our dealer network remains on par with previous years. Overall, we are encouraged by the trends and are well positioned heading into the snow season. Of course, we are now keeping a close eye on the weather channel and our ability to deliver products during the snow season remains as strong as ever. In short, our attachment segment continues to prove its resilience once again and our team is executing its operational plan flawlessly as we've come to expect. Turning to solutions. As we discussed during our call last quarter, many of our Dejana facilities are in the East Coast and Mid-Atlantic, areas that were particularly hard hit early during the pandemic. After a difficult second quarter, we saw Q3 quoting and order activity increase across the board. In fact, Incoming orders October year-to-date 2020 at Dejana have just surpassed the same period in 2019, which was a record year. Considering everything that has happened this year, we are very encouraged by this development, and I want to commend the Dejana sales team that has worked strategically to adapt and engineer this dramatic rebound in a very challenging market environment. So on the demand side, we feel much better today than we did a few months ago. However, the ramp-up of OEMs and component suppliers will still be unpredictable in the near term, especially as we see a second wave of COVID cases across the country. This is certainly true with chassis availability for Class 4 through 6 trucks. While OEM production continues to ramp up, we do believe chassis availability for Class 4 through 6 trucks will be a challenge for the balance of the year. However, it is worth remembering that we have a long track record of being the number one recipient of pool chassis from our largest OEM partner. Additionally, the number of chassis received has almost doubled since our acquisition of the Janna, confirming that our OEM partners have been supporting our growth plans. I'll close with this statement on chassis. Our competitors would give anything to be in the same position as the Janna. Moving on to Henderson's municipal snow and ice control business, where our team turned in a good quarter. As expected, availability for Class 7 and 8 chassis is much improved, with lead times declining to just 9 to 12 weeks at the moment, after being closer to 9 to 12 months in recent years. This is certainly great news. On the incoming order front, we are clearly paying attention to how the municipal customers are dealing with tax revenue challenges. to date we haven't seen and don't expect to see orders being canceled. It is important to note that Henderson has built a strong backlog over the past two years as we set new records for incoming orders in both 2018 and 2019. We'll be working our way through a portion of that backlog and we'll continue to monitor the sales cycle and commentary from our municipal customers. As a reminder, historically, snow and ice control budgets are the last thing to be cut to ensure public safety and to ensure commerce can continue. We'll keep you posted on the municipal order trends as we turn the corner into 2021. All in all, we are continuing to make our way back from a difficult second quarter and remain confident in the long-term future growth prospects at Work Truck Solutions. Looking ahead, despite the challenges that we've encountered in 2020, our commitment to return in value to our shareholders has not wavered. We remain fully committed to our dividend, which was paid as usual at the end of the quarter. We have increased our dividend many times over the past decade, during good times and bad, and I envision this being true for many years to come. When it comes to M&A, We know the limited list of blue chip companies that we would talk to if they became available, and we receive information on other deals on a regular basis, although far fewer this year because of the pandemic. We will continue to build relationships and will conduct due diligence on the logical opportunities that are presented, but don't see major deals on the horizon. You've heard me say on many occasions, we will exit stronger than we entered. As we near the end of the year, it's worth taking a moment to reflect on that statement and call off some of the successes in 2020 which helped position Douglas to achieve its long-term profitable growth objectives. There are certain areas we were able to excel. First, as we mentioned last quarter, Sarah and her team were able to secure an excellent new debt deal in June, providing us the financial flexibility to support and grow the dividend, invest in future growth initiatives, all while creating enough dry powder to execute strategic acquisitions down the road. Next, while March and April were tough, we are extremely proud of our response to the pandemic, from the rapid decisions we made in March to the planning and execution of our safe return to work plan. If there was a silver lining to this situation, it was that we were able to demonstrate our commitment to our people by looking after them before, during, and after the shutdowns, which helped accelerate our cultural transformation in solutions. Also, investments in vertical integration remained on track and were not slowed down significantly by the pandemic. These investments will support key long-term growth initiatives in a post-pandemic environment. Finally, as I mentioned earlier, we are very pleased that the order PACE at the JANA has already met and will surpass the prior record year. Given this took place on the eastern seaboard in what was a major pandemic hotspot region, the turnaround has been nothing short of remarkable. However, because of the pandemic and other factors out of our control, there were also areas we weren't able to address as thoroughly as we originally planned. For example, following our success at the Rhode Island facility last year, We had plans in 2020 to significantly expand our DDMS efforts in solutions to several other facilities. Obviously, these plans were curtailed due to COVID travel restrictions on the East Coast. We are poised and ready to execute these plans as soon as business travel restrictions are lifted. Overall, I couldn't be more pleased with the way we are executing in an uncertain environment. Our teams are doing an outstanding job and will continue to do so. At its core, our business model is built to adapt to dynamic external conditions, make the necessary adjustments to overcome these challenges, and utilize our continuous improvement mindset to get better every day. Will we exit the pandemic stronger than we entered? Absolutely. There's no doubt about it. There are a lot of reasons to be excited for our growth prospects over the long run, and we continue to push toward our long-term goals to deliver shareholder value in the years to come. Now I'd like to pass the call to Sarah.

Thanks, Bob. Overall, our financial performance for the quarter reflects the sequential improvement in general business conditions as people got back to work following shutdowns in the spring. Both our customers and suppliers are gradually ramping up production and continue to adapt their operations to the new confines associated with the pandemic. While we continue to provide comparisons on a year-over-year basis, given the dramatic changes over the past year, the sequential changes from the second quarter are perhaps more important. All things considered, we're generally pleased with the resilience of our performance this quarter. From a consolidated perspective, we generated third quarter net sales of $133.8 million and gross profit of $36.7 million, compared to net sales of $141.9 million and gross profit of $39.9 million during the third quarter of 2019. We recorded GAAP net income of $9.2 million, or 39 cents per diluted share, compared to 12.4 million and 53 cents respectively in 2019. On an adjusted basis, we generated net income of 9.8 million and 42 cents per diluted share compared to adjusted net income of 12.8 million and 55 cents per diluted share. Similarly, we generated consolidated adjusted EBITDA of 23.1 million compared to $25.1 million in the corresponding period of the prior year. SG&A expenses, including amortization expense, were $19.2 million, approximately $800,000 lower than the third quarter of 2019. The decline in SG&A was due to lower discretionary spending, including travel, advertising, and promotions, all as a result of our income protection plan. Interest expense was $5 million for the quarter, which was higher than the $4.3 million incurred in the same period in the prior year. The increase is primarily due to higher interest paid on our term loan due to the increase in principal balance from our June refinancing. This was somewhat offset by lower revolver interest of $300,000 as a result of decreased short-term borrowings when compared to the prior year. The effective tax rate was 26% for the quarter, higher than the 20% rate for the third quarter of 2019 due to the release of reserves for uncertain tax positions last year. Now let's turn to the earnings information for the two segments. Within our work truck attachment segment, we generated net sales of 76.9 million compared to net sales of 75.6 million. The 2% increase was primarily attributable to a strong end to the preseason period. Adjusted EBITDA was $20.2 million during the third quarter, higher when compared to adjusted EBITDA of $18.7 million recorded the prior year, due to the slightly higher volume. When we last spoke in August, we anticipated that our preseason orders would be approximately $55 million are all listed on the list. With the preseason now concluded, we were closer to a 50-50 overall between the two periods as those late orders came in. This compares to a 60-40 split between the second and third quarters in 2019. While dealer inventory remains relatively low and in line with our expectations, the We believe that some of the order activity we've already seen has pulled from the fourth quarter, as dealers felt more comfortable about the economy in September compared to the spring. That brings us to Work Truck Solutions, where we reported net sales of $56.9 million and adjusted EBITDA of $2.9 million. compared to net sales of $66.2 million and adjusted EBITDA of $6.4 million in the same period last year. The decline in both net sales and adjusted EBITDA is primarily due to lower volumes tied to the gradual operational ramp-up of customers and suppliers following pandemic-related shutdowns, combined with the ongoing Class IV-VI chassis supply constraints. Turning to the balance sheet and liquidity figures. Net cash used in operating activities during the first nine months of 2020 was $27.1 million compared to $21.2 million for the same period in the prior year. Free cash flow for the first nine months of 2020 was negative $36.5 million compared to negative $29 million during the same period in 2019, in line with our expectations. These changes are both primarily attributable to less favorable operating results, partially offset by favorable changes in working capital of $26.1 million. The largest favorable change in working capital was a decrease in accounts receivable, mainly driven by a higher AR balance at the start of the year, combined with relatively lower sales through the first nine months of 2020 when compared to last year. As expected, we saw a $3.3 million increase in inventory to $93.7 million at the end of the quarter when compared to the third quarter of last year as we built inventory in anticipation of potential supply chain constraints related to the pandemic. Accounts receivable at the end of the quarter were $123.2 million compared to $153.2 million at the end of the third quarter last year. due to the aforementioned lower sales so far this year when compared to last year. Capital expenditures for the first nine months of 2020 totaled $9.5 million, higher than the $7.8 million incurred in the first nine months of 2019, but in line with expectations as we continue to invest in long-term growth projects. Despite the pandemic, the long-term strategy we outlined last year remains intact, We've been able to make good progress during 2020. Our vertical integration initiatives remain on track and we should be in a position to talk about these projects more specifically as we progress through 2021. Total liquidity, which is comprised of $14.3 million in cash and $79.6 million in borrowing capacity under our revolver, was approximately $93.9 million at the end of the third quarter, compared to $47.3 million at the end of the third quarter 2019. Our higher liquidity relates to the June refinancing of our $375 million credit facility, which fortified our financial position and provides ample flexibility going forward. We are comfortable with our current debt levels, maintaining a net debt leverage ratio of 3.7 times in comparison to 2.5 times at the same point last year. The increase in the ratio is due to the impact of the pandemic on our financial results. Paying down our debt continues to be a priority, and we will assess and make a decision on additional payments as usual during the first quarter of next year. As we are now more than six months into the pandemic, we can reflect and say we've done a good job of curbing discretionary spending where appropriate. Nonetheless, I want to reiterate our commitment to funding our long-term growth projects. Despite the challenges that we've encountered throughout the year, our capital allocation priorities remain consistent. In addition to returning cash to shareholders via our dividends, and Paying Down Debt, we will continue to invest in the business while keeping a close eye on the market should one of our blue chip acquisition targets become available. Finally, as you probably saw in our earnings release, we are not providing quantitative guidance this quarter. However, we can confirm the following. Free cash flow is still expected to exceed the amount necessary to fund the dividend. In attachments, The timing, location, and amount of snowfall will influence results in that segment, as it does every year. And in the fourth quarter, we expect to produce a similar performance to the third quarter, given some sales were already pulled into the third quarter. Solutions results will be impacted by customer confidence. and the ability to operate with varying pandemic restrictions in addition to chassis supply trends. We expect the gradual recovery to continue and produce a sequential improvement from third quarter results, partly because the fourth quarter is traditionally Solutions' largest quarter. Of course, these qualitative comments also assume that current macroeconomic conditions remain relatively stable in the coming months. Given how rapidly the economic outlook is changing, there are too many unknown factors today to predict how 2021 will unfold with any sense of accuracy. At this point, we are not expecting an immediate return to the type of environment that allowed us to produce our record 2019 results. However, We do know that as the situation improves in the years ahead, we will be ready to take advantage of the conditions and deliver our growth potential. Over the years, we have proven our ability to adapt our business in many different economic environments. As we move into the last two months of 2020, we're focused on adapting to the changing environment, executing on our near-term plans, and investing for the long term. Also, while 2020 has presented unique challenges, we have adapted quickly and are pleased with recent performance improvements. In short, we're well positioned for the long term and expect to emerge from the situation stronger. With that, I'd like to open the call for questions. Operators?

As a reminder, ladies and gentlemen, if you would like to ask a question, please press star 1 on your telephone. Your first question is from Tim Woj from Bayard.

Hey, everybody. Good morning. Nice results.

Good morning, Tim.

Maybe just first question. Just on September, just wondering if you could add maybe a little bit of color on what you saw in terms of the order activity and attachments and maybe what drove that. Just stronger light truck sales or did the cash flow improve at the dealers and so they just kind of pre-ordered a little more closer to the season? Just trying to understand kind of the drivers and based on your intel, what kind of drove that? I don't want to call it pull forward, but better numbers in September. Sure.

Yeah, again, going back to the preseason order period, which was right in the early stages of the pandemic, we expected dealers to be conservative in their ordering, and they were. And again, as I said earlier, what we hoped would happen, when you get to the last half of the third quarter, orders... typically are their lightest that they are at any point during the preseason because everybody's already placed their stocking order in April, May, and the first part of June. And so we typically don't expect a lot of activity during that period of time, Tim. But as I said, we hoped that we'd see some increased stocking order activity late because dealers were conservative early on, and that's what we saw. So we actually started fielding dealer calls at various points over the summer. Remember, the preseason period closes middle of June from an order perspective, and people would call and say, is it too late to add dealers? 100 plows to my order. And we absolutely let them do that. So there was some momentum building later in the quarter. At that point, not yet driven yet by retail activity, Tim, because we're still in the green season to a large degree. It's just more dealers feeling more and more comfortable about their lot in life and wanting to bring those inventory levels back up to a decent place. Having said that, Retail inventories are still on the plow side 10%, 15% below a year ago. And we feel good about that as well. So, you know, everything's lining up for our dealers to be well positioned to start the season and for us to be well positioned to respond to it.

Okay. Okay. I appreciate all that. That sounds great. Okay. And then basically just switching over to the solutions, on the supply chain pressures, it doesn't really sound like anything's changed. I mean, if anything, seven to eight chassis have really improved. Where else are you, you know, outside of four to six, where else are you seeing kind of acute supply chain pressure in that business?

You know, it's knock on wood if you have any wood near you, right? Right. We have been pleased with the component suppliers up to this point. Not to say that we don't have a few challenges here and there, but by and large, we have not had significant constraints that have held back our ability to build and ship work trucks. Now, I put a big caution flag around that because As we enter the winter and we're seeing, you know, COVID cases increase, we have no idea what the future holds from a shutdown perspective or from a supply chain perspective. But up to this point, I think it speaks to the strength of our relationships with those suppliers and that they, by and large, are holding up their end of the bargain.

Yeah, Tim, I would add to that. You know, we do have backlog in those businesses. So for us, We can safely add to our inventory levels, which we have been doing just because of the uncertainty of, you know, what could happen to the supply chain here in the fall and the winter.

Okay. Okay. That sounds good. And then the last question I had, just... On your vertical integration initiatives, I think you said in your prepared remarks you'll talk a little bit more about that next year, but any sort of preview you could give us just in terms of maybe how meaningful a contribution those initiatives could be to 2021?

Yeah, the way to think about this project, group of projects, which we've been speaking about now for the better part of a year. 2020 was really the year of product design and capital investment to get the Greenfield facility to a point where it can be producing product. And you're right, we will speak to it in more depth as we round the corner into 2021. I would suggest that this is a long-term play. and that while there will be some impact in 2021, the greater impact will be certainly down the road in 2022 and beyond.

Okay. Okay, great. Well, I'll hop back in queue and good luck on the rest of the year.

Thanks, Tim.

Your next question comes from Ryan Sigdahl from Craig Hallam Capital.

Good morning. Congrats on the results and thanks for taking our questions. I just want to dig in a little bit on Dajana. So you've mentioned in your prepared remarks that chassis are, I believe you said double the supply from when you acquired that business a few years ago. You also mentioned year-to-date orders are record. Yet it seems like 2021 expectations are still for some softness kind of across the business and down from 2019 level. So I guess Help me understand the supply dynamics given those two comments, given the constraints you also mentioned in that segment.

Yeah, a couple of things. When you think about 2021 for DeJana, obviously we went out of our way to send a signal about the strength of orders and what a terrific job that that team has done in this environment. Similar to Henderson, during the years of chassis constraints in 2018 and 19, Henderson was building record order books every year. Shannan is in the process of starting to do a similar thing. That means that long-term, we've got nothing to worry about. Shorter term, we do have some inconsistent supply with those chassis, but I wanted to remind people, I'm actually glad that that stuck with you, You know, it isn't that our OEM partners haven't been paying attention or are not supporting the Janna and our growth initiatives. They have. We're just growing at a pace that is faster than their ability to supply. Now, obviously, the pandemic doesn't help that at all, right, because everybody's going through various stages of startups. So I think it's prudent, as we look at 2021, We're going to keep the foot on the gas out in the marketplace in terms of getting new orders. It's prudent for us to plan for some inconsistency in chassis supply until we see a change. And likely, we're going to have some of these challenges certainly through the remainder of the pandemic, whatever that turns out to be. But longer term, we're going to be just fine.

Gotcha. And then We saw you guys enter into a distribution agreement with John Deere to support, sell, attach their utility vehicles. Any call you can provide on that relationship and maybe what you guys, if anything, were doing before versus going forward?

Yeah, actually, thanks for noticing that. We're excited about this opportunity. I'll say two things. It is evidence... of the success of our non-truck strategy on the attachment side. As you know, we've got market-leading 50% to 60% share in that space, and so growth is difficult to come by on traditional pickup-mounted snow and ice control products. So most of the growth in the industry is occurring in this non-truck segment, and this John Deere partnership is evidence that that non-truck segment for us is working. Having said that, I will tell you that this agreement just got finalized. It's very early, and we will have much more to say on this topic as we get into the first half of 2021.

Just one follow-up on that without getting too specific. Do you think the utility segment can be a material contributor and or this specific agreement as you get into 2021 and beyond?

In 2021, I don't think we should think about it that way. Keep in mind that when you sell a plow for a UTV, ATV, It is a much smaller piece of equipment, nowhere near as complicated, nowhere near as profitable. So even as we sell units, we're going to see revenue and margin improvements, but it isn't the same as selling one of our traditional units. That doesn't mean we're not excited about it. I think the way that we're looking at this heading into 2021 is let's make sure we get the partnership kicked off appropriately. Let's make sure that we're bringing the new dealers on in a fashion where we're accustomed to treating them like they ought to be treated. And at some point in 2021, we'll have a better perspective of what 2022 and beyond could look like. I would summarize it this way. It's a tremendous addition to an already extremely successful business. But given the revenue and profitability of that business to begin with, it's likely not to have a material impact longer term.

Great. That's it for me. Thanks, guys.

Good luck. Thanks, Ryan. Your next question comes from Chris McGinnis with Sidoti.

Good morning. Thanks for taking my questions. Good morning, Bob and Sarah. I just wanted to do, talking about market share, like you just were, Bob, in this environment with your ability to replenish quickly and meet that dealer demand, I know there's not a lot of room, but in a difficult environment like this, is this helping you in any way maybe gain smaller market share, at least in the snow and ice, and then Maybe if you take that same question and apply it to the attachments or the solutions business as well, what you're seeing on competitive dynamics there, giving you a strong ability to get the product from OEMs. Thanks.

Yeah, Chris, thank you. Certainly, you know Douglas' business pretty well. We look at any... Uncertain economic environment, whether it's snowfall-driven or whether it's economic-driven, obviously in 2020, pandemic-driven, they are all opportunities for us. Sarah mentioned the fact that we've been prudent about cutting our costs and those sorts of things. We absolutely scale the businesses back, but boy, we look at these situations as an opportunity for us to not just exit stronger, but but that when everybody else is batting down the hatches and kind of hiding in the corner waiting for the headwind to pass, we look at it as an opportunity to better serve our customers and to be more responsive. So is there a possibility we could grab a little market share on the attachment side? Possible. I hope so. It has happened before. Solution side, I think similar opportunities exist. Obviously we've got a few chassis challenges with class four through six, but again, our teams there are learning from the attachments group, right? And they are focused on being more responsive in this environment so that our end user customers just get a reinforcement of the value proposition from Douglas Dynamics.

Great. I appreciate that. And then just one quick one just on the cash flow, you know, you're targeting for year-end. I guess what could you see improvement from that? Is that really just around stronger kind of end market demand or is there other, I guess, working capital abilities you have to maybe beat that number? Thanks.

Yeah, we mentioned our free cash flow being greater than the dividend. I would say that opportunity in the free cash flow for the year is twofold. It'll be, one, just improved earnings, so a strong fourth quarter finish, which, you know, for us has a lot to do with snowfall. I am expecting working capital to be relatively flat for the year. That would be the second area of opportunity just if we are able to reduce our working capital. It's not been something that we've been pushing hard because we want the inventory levels to be there for us when the chassis are here and the ability to get those trucks out the door quicker. But there's always some opportunity that we may be able to execute on and receivables.

I appreciate that. Thanks and do up in Q4. Hopefully you'll see a lot of snow this year.

Thanks, Chris. Thanks.

Ladies and gentlemen, if you would like to ask a question at this time, please press star, then the number one on your touchtone telephone. There are no further questions at this time. I would like to turn the call back to Mr. Bob McCormack, President and CEO.

Thank you for your time today. As always, we appreciate your ongoing interest in Douglas Dynamics. We hope that you and your families are staying healthy, and we look forward to talking to some of you at the virtual Baird Conference next week. Have a terrific day.

This does conclude today's conference call. Thank you for participating. You may now disconnect.