Douglas Dynamics (PLOW) Q3 2019 Earnings Call Transcript

Douglas Dynamics (PLOW 1.18%)
Q3 2019 Earnings Call
Nov 05, 2019, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to the Douglas Dynamics third-quarter 2019 earnings conference call. [Operator instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Ms. Sarah Lauber, chief financial officer.

Sarah Lauber -- Chief Financial Officer

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 are 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 and guidance before turning it back to Bob for final comments. After that, we'll open the call for your questions.

With that, I'll hand the call over to Bob.

Bob McCormick -- President and Chief Executive Officer

Thanks, Sarah. Good morning, everyone. Due in large part to the continued commitment and execution from the entire team here at Douglas Dynamics, we were able to sustain our positive momentum and produced strong third-quarter results. Our team delivered record third-quarter net sales of $142 million and improved net income of $12.4 million and adjusted EBITDA of $25.1 million, both considerably higher when compared to the same quarter last year.

These strong financial results reflect the ongoing positive demand trends that we are seeing across both segments and the tangible progress that we are making with our DDMS initiatives. Throughout the first three quarters of 2019, we have been impressed with the progress and accomplishments both segments have achieved. First, I'll highlight Work Truck Attachments. The preseason for commercial snow and ice control products ended well and right in line with our expectations.

We experienced an approximate 60% to 40% split of preseason shipments between the second and third quarters, in line with 2018. Despite this past winter snowfall being generally less favorable compared to the previous year, net sales increased 8% in our Attachment segment. This confirmed that end-user demand is resilient and matches the cautiously optimistic tone we are hearing from both our dealers and end users. When you include the fact that inventory levels and truck sales are in good shape, we are well positioned to execute effectively when the snow starts to fly.

It is worth noting that nontruck snow and ice control equipment sales and our expanded parts and accessories offering continued to grow, albeit off a small base and at lower margins. And I'm excited to see incremental improvements in the years ahead. While tariffs continue to result in material cost inflation, we are covering the costs dollar-for-dollar and continue to utilize our global sourcing office to mitigate the tariff impact where possible. Transitioning to work truck solutions where we generated record performance for the quarter.

Our strong top and bottom-line growth were driven by a combination of increased volumes and pricing, improved operational performance, price recovery on higher material costs and greater predictability of Class 8 chassis supply. We continue to be very impressed by the solutions team's commitment and ownership of their continuous improvement journey. They've developed solutions that reduce costs, optimize floor space and significantly improve velocity and throughput. Not only will these initiatives translate into world-class quality and decreased lead times for our customers, but I'm confident that these improvements will lead to long-term margin expansion.

Just to touch on the chassis situation, we continue to expect lead times to slowly improve. We are seeing demand for over-the-road chassis falling off and aligning with available capacity, which means more production should be allocated to the Class 8 work chassis we need. We continue to anticipate that Class 8 chassis lead times will begin to normalize over the course of the next year. On the Class 4 through six chassis front, chassis supply continues to be less constrained overall, still somewhat unpredictable as a result of supply line issues and component shortages at all major OEMs.

At this point, I'd categorize the situation as slightly improving overall. We do believe that we will see less volatility in 2020, although, again, not starting immediately on January 1. So that's where we are today. But I also want to talk about where we are going, a conversation we began about a month ago at our Investor event in New York.

We talked about how we win today and how we will continue to win in the future. I often remind our team that long-term profitable growth is possible only through delivering meaningful, demonstrable competitive advantages in the marketplace. Our core competitive advantages being a total custom solutions provider, delivering industry-leading lead times and world-class quality have been the centerpieces of our business model and have driven our profitable growth to date. Our long-term commitment to continuous improvement through DDMS is the fuel that drives these competitive advantages.

For example, being flexible and nimble on the shop floor allows us to customize our products to meet our customer-specific end-use requirements. Constant improvement in velocity and throughput drive down lead times. And world-class quality is a result of empowering all shop floor associates to make improvements to product and processes on a daily basis. Our people truly set us apart at Douglas Dynamics, where we create a culture where all employees are an important part of creating and driving our competitive advantages.

And we are committed to growing our people, both personally and professionally, which is even more critical today in this very competitive labor market. In the past year, we've doubled down on our commitment to growing our people by investing and building an organizational development program with the long-term objective of making Douglas Dynamics the employer of choice for top level talent in the working -- in the truck equipment industry. It's not just what we do in leveraging competitive advantages or how we do it through DDMS, but who we do it with. So when combined these three factors are how we continue to win at Douglas Dynamics.

Speaking of winning, a few days ago, Douglas received the 2019 Supply Chain Risk Management Program of the Year Award, which recognizes our commitment to our supply chain partners. We realized a long time ago that the success of our supply partners in turn helps us succeed, and so we truly collaborate with our partners to help them manage risk and foster improvements. This award highlights the great work of Jim Klotz, our senior vice president of global sourcing, as well as everyone involved with our global sourcing and DDMS programs. If you look at who else received these awards, which includes industry-leading companies such as General Dynamics, it shows that Douglas continues to punch above its weight when it comes to our expertise and approach to the business.

Now as we look to the next five years, our first priority is to strengthen our market position by leveraging our competitive advantages and creating new points of difference in the market. One such opportunity includes exploring the possibilities for vertical integration, leveraging the operations expertise of our Attachments group to broaden its product offering. Of course, through DDMS, we will execute effectively and take advantage of the growth opportunities we see. And finally, we will focus on investing strategically.

Balancing our investment strategy to support our growth initiatives, maintain and growing the dividend, yet keeping considerable capital available to pursue the right strategic acquisitions across both segments is the key to our future success. When all is said and done, I want you to know that we're laser-focused on being the best at everything we do and will not try to grow for growth's sake. By being the best at what we do, the growth will follow. We firmly believe that when you give the customer a high-performance, high-quality custom product in the shortest lead times, you will win.

Ultimately, we believe this approach will continue to create shareholder value over the long term. To conclude, I'm pleased with our robust year-to-date performance and I'm encouraged that the strong backlog and positive demand trends will continue to trend favorably in the near term. Based on our visibility through the end of the year, coupled with the improvements we're driving through DDMS, I'm confident in our team's ability to sustain the positive momentum achieved so far in 2019. Now I'll hand the call to Sarah to discuss our financial results and guidance.

Sarah Lauber -- Chief Financial Officer

Thanks, Bob. I'll follow the usual routine, beginning with our consolidated earnings for the quarter, followed by a look at the results for each segment and lastly, comment on our balance sheet, liquidity and guidance. As Bob discussed in his opening comments, we are pleased with our performance during the quarter, due in large part to higher sales from continued positive demand trends across both segments. In addition, we are continuing to see the year-over-year improved operating performance in our solutions segment.

We achieved record third-quarter net sales of $141.9 million, a 14% increase over the same period last year, with gross profit increasing to $39.9 million when compared to $34.9 million in the same quarter last year. Our gross margins are up year over year due to improved solutions performance, but they were muted by the impact of material cost inflation. SG&A expenses were $17.3 million, slightly higher when compared to the third quarter of 2018. The increase related to higher performance-based stock compensation driven by improved operating results.

However, SG&A expenses as a percentage of sales declined by approximately 1% to 12.2% this year. The strength and demand across the businesses and our improved performance that I've already mentioned drove adjusted EBITDA up approximately 22% to $25.1 million for the third quarter, compared to $20.5 million for the third quarter of last year. Adjusted EBITDA margins increased to 17.7% this year, compared to 16.4% last year. Both net income and adjusted net income also increased over prior year.

For the third quarter of 2019, we generated net income of $12.4 million or $0.53 per diluted share, an approximate 25% increase, compared to net income of $9.9 million or $0.43 per diluted share in the same period last year. On an adjusted basis, net income was $12.8 million or $0.55 per diluted share, compared to adjusted net income of $10.1 million or $0.44 per diluted share for the third quarter of 2018. Interest expense was $4.3 million for the quarter, which was slightly lower than the $4.4 million incurred in the same period last year, primarily due to the reduction of the principal balance of our term loan credit. The effective tax rate for the third quarter of 2019 was 20%, higher compared to 10.4% for the same period last year.

The current effective tax rate was higher due to a decrease in the release of reserves for uncertain tax positions of $500,000. Additionally, the company made a voluntary pension funding payment during the third quarter of 2018 of $7 million that reduced taxable income for that year. That increased pension funding deduction in turn resulted in a tax benefit of $700,000, further decreasing the tax rate for the third quarter of 2018. Now let's transition to review results for the two segments.

For the third quarter, Attachments recorded revenue of $75.6 million and adjusted EBITDA of $18.7 million. In the same period last year, the segment's revenue and adjusted EBITDA were $69.8 million and $18.8 million, respectively. The increase in net sales compared to the third quarter of 2018 is mainly attributable to a strong conclusion of the preseason shipments and price recovery on higher material costs. Adjusted EBITDA in Attachments was relatively flat for the prior year; however, margins were negatively impacted due to the impacts of material cost inflation, increased investments in the business and a shift in product mix as we expanded sales of our nontruck snow and ice control products, which typically sell at lower margins than our truck-mounted products this quarter.

Turning to work truck solutions. We reported net sales of $66.2 million and adjusted EBITDA of $6.4 million for the third quarter. In the same period last year, the segment's net sales and adjusted EBITDA were $55 million and $1.7 million, respectively. The improved results relate to ongoing strength and demand, resulting in higher volumes, price recovery on higher material costs and greater predictability of Class 8 chassis supply, which is helping the operations to operate more efficiently.

The adjusted EBITDA margin growth in solutions is primarily a result of the success of our DDMS initiatives and global sourcing efforts and continued lower spending. With that said, I'll now turn to the balance sheet and liquidity. Net cash used in operating activities during the first nine months of 2019 was $21.2 million, compared to cash used of $17.9 million during the same period in the prior year. The increase relates to higher receivables balance as a direct result of our robust preseason results this year.

As a reminder, the change in cash on a quarterly basis is highly correlated to our seasonal business and is not necessarily indicative of cash generation for the full year. Free cash flow for the first 9 months of 2019 was negative $29 million, compared to negative $24.2 million during the same period in 2018. Similarly, the decrease in free cash flow is driven by the timing of working capital invested in accounts receivable, which were $153.2 million at the end of the quarter, compared to $128.2 million at the same period last year. Inventory was $90.4 million at the end of the third quarter of 2019, similar to $89.4 million at the end of the third quarter of 2018.

While relatively flat to last year, we are still experiencing higher inventory levels than historically to ensure timely delivery to our customers in light of tightening of supply chain. In turn, total liquidity, which is comprised of $4.9 million in cash and $42.4 million in borrowing capacity under our revolver, was approximately $47.3 million at the end of the third quarter, compared to liquidity of $57.7 million at the end of the third quarter of last year. This lower liquidity again relates to the timing of the increased working capital around accounts receivable. Although we covered this topic extensively at our recent investor day, I'll just reiterate our cash usage priorities.

As you already know, during the first quarter, we increased our dividend for the 11th time in the past nine years, and also made an additional $30 million payment on our debt. Today, our net debt/leverage ratio has declined to 2.5 times, down from 2.9 times at this point last year. In addition to methodically growing our dividends and paying down debt, we are focused on investing in our businesses growth projects, and we plan to continue to look at potential strategic acquisitions. With this focus, capital expenditures of $7.8 million for the first nine months of 2019 are higher when compared to $6.3 million during the first nine months of 2018 due to the mentioned ongoing investments in the business.

Based on our strong year-to-date operational performance, combined with ongoing positive demand trends in both of our segments, we are again reaffirming our outlook for the year. While this isn't really new, given we already did so at our Investor event in early October, let me walk through the details quickly. We continue to expect net sales between $520 million and $560 million. Adjusted EBITDA in the range of $95 million to $115 million.

And adjusted earnings per share between $2.00 and $2.40. A couple other items to consider. First, we anticipate our effective tax rate to be approximately 25%. And second, in the fourth quarter, we expect to incur onetime expense related to the termination process for our pension plans.

This will impact GAAP earnings per share by approximately $0.25, but will have no impact on adjusted earnings per share. The finalization of this activity will not have a material impact on our free cash flow for the year. At this point in the year, we still have a wide range because of the wildcard in the fourth quarter, notably snowfall. However, it's fair to say that if we experience average or above-average snowfall in core markets and chassis availability does not deteriorate, we believe we will end the year on the high end of our sales guidance and at the middle to upper end of our earnings guidance ranges.

The success of implementing price in this inflationary market throughout the year is driving our sales higher without significant impact to EBITDA or earnings per share. We have sustained a positive momentum throughout this point in 2019, which fully supports our guidance. We will continue to focus on the factors within our control and on executing our long-term strategy. With that, I'll turn the call back to Bob.

Bob McCormick -- President and Chief Executive Officer

Thanks, Sarah. In summary, I couldn't be more pleased with our year-to-date results, and we are well positioned to close out 2019. Our teams in both segments continue to execute, and the focus on continuous improvement is consistent throughout the organization. At Douglas Dynamics, the future continues to be bright.

I'm excited about the rest of 2019, the next five years and beyond. With our prepared remarks complete, we would now like to open the call for questions. Operator?

Questions & Answers:

Operator

[Operator instructions] Your first question comes from the line of Steve Dyer from Craig-Hallum Capital Group. Your line is now open.

Ryan Sigdahl -- Craig-Hallum Capital Group LLC -- Analyst

Congrats on the quarter. Ryan on for Steve here.

Bob McCormick -- President and Chief Executive Officer

Thanks, Ryan.

Sarah Lauber -- Chief Financial Officer

Thanks, Ryan.

Ryan Sigdahl -- Craig-Hallum Capital Group LLC -- Analyst

So it sounds like everything is going well. Chassis supply is incrementally getting a little bit better. And Sarah, you made some comments on the Q4 guide, basically the uncertainty with snowfall, but besides that uncertainty, I mean the implied guidance is for a 2% sales decline at the very high end of the range and then getting worse as you go down. But are you seeing anything else, I guess, that's given you caution to expect a sales decline in Q4 besides the snowfall uncertainty?

Sarah Lauber -- Chief Financial Officer

Actually, Ryan, no. I mean when -- we honestly expect growth in both of our segments. But when looking to the full year, there was just really caution around one snowfall, which is always important for the fourth quarter. But general other news, OEM strikes that are in the news and those types of things just made the chassis a little bit more of a question for us.

So the expectation, like I said, would be high end from a volume perspective. I wouldn't read anything into the -- not changing of the guidance for the year.

Ryan Sigdahl -- Craig-Hallum Capital Group LLC -- Analyst

Great. That's helpful. Then as we move over to margins, so there were some margin headwinds related to investments in the business. And you mentioned at your Analyst Day, this increased focus on this nonsnow truck attachments.

Can you elaborate a little bit, I guess, on how much was spent on new product development in the quarter and then maybe how that compares to prior quarters? And then any expectation, I guess, over the next several quarters of how that spend as well as kind of the future revenue contribution looks like from a cadence standpoint?

Sarah Lauber -- Chief Financial Officer

Sure, sure. I mean let me talk to the Attachments overall. I mean let's focus just on Attachments. I want to set the stage there.

I mean we're almost at 25% EBITDA. So still awesome earnings profile for the business. There were three things that happened this quarter that we talked about. But essentially, although they lowered the margins, they were all positive.

One, being the fact that price is covering inflation. However, that just from a mathematical standpoint, the dollar-for-dollar is impacting the margins. Two, the increased sales in our nontruck -- or truck -- nontruck products. So we're growing there.

It's just the fact that it's not going to carry the same margin profile of our truck-mounted products. And then third, investments in the business, which is also a positive for long term. It did show up somewhat in the third quarter compared to last year, although still high margins for the business. I expect in the fourth quarter that fourth-quarter attachments margins will improve.

We will have more of the pricing and material equilibrium happening in the fourth quarter. So I expect going forward those will improve.

Bob McCormick -- President and Chief Executive Officer

Yes. Let me add on a couple of extra comments to that. I want to be clear. The base margin profile of this highly profitable business, the truck-mounted snow and ice control portion of this business is not deteriorating, OK? We are focused on that, laser-focused on that, profit grows every year on that core product line, and there's nothing to be concerned about there.

So is other comment, which I think is worthy of expanding on, when you've got a business with 50% to 60% market share in that core product category, you are challenged to find new opportunities for growth. And our focus in the nontruck market and in the parts and accessories area is absolutely the right place to be. I'm thrilled to death with the top-line revenue growth opportunities that we have there. And if that comes at more normal industry margins, we should be high-fiving in the hallway.

This is a great business that continues to not only grow the top line in these areas, but also protect and grow the bottom line.

Ryan Sigdahl -- Craig-Hallum Capital Group LLC -- Analyst

And then just one quick follow-up, Sarah, on what you mentioned on expecting Q4 Attachments margins to improve, is that on a year-over-year basis or a sequential basis versus Q3?

Sarah Lauber -- Chief Financial Officer

Year over year and sequential.

Ryan Sigdahl -- Craig-Hallum Capital Group LLC -- Analyst

Great. Last one for me, and then I'll turn it over. So free cash flow burn, you commented on some of the moving parts there, and a lot of that is seasonality and working capital changes, but EBITDA is nicely higher year over year, year to date as well as the guide implies. Is it reasonable to assume free cash flow will be up year over year for the entire year when all is said and done?

Sarah Lauber -- Chief Financial Officer

Yes. Our expectation is that it would be up. And looking to the EBITDA is probably the right approach.

Operator

Your next question comes from the line of Chris McGinnis from Sidoti. Your line is now open.

Chris McGinnis -- Sidoti and Company, LLC -- Analyst

Good morning. Thanks for taking my questions and nice quarter. If we can just maybe touch on some of the growth on the Attachments side. Was there any reason they were stronger than others offhand?

Bob McCormick -- President and Chief Executive Officer

Yes. I would point to one. I was hoping somebody would ask about this. At our industry trade show in March, we introduced what we considered to be revolutionary, industry-leading new LED headlights that go on the front of our plow trucks.

Second to none in terms of visibility, in terms of the profile that they cast across the areas that you are plowing, and we've received nothing but tremendous response to that product introduction and essentially, the first round of orders of those products shipped during the third quarter. So that was the largest driver, something we're excited about. And clearly, again, continues to position that business as somebody whose products outperform competitors' products, thus justifying our price leadership position out in the marketplace.

Chris McGinnis -- Sidoti and Company, LLC -- Analyst

Great. I appreciate that. And any regions offhand now? Or, a, on a geographical basis, was there anything stronger anywhere else? Or is it just kind of normal course so far for the year?

Bob McCormick -- President and Chief Executive Officer

I would say it's pretty normal course. We are getting some, not significant, but we are getting some early snowfall across parts of the snowbelt at this point. And -- but we -- what we say at this point is that's called psychological snow, which doesn't really necessarily mean that there's a lot of plowing taking place, but it gives the landscapers a chance to contemplate whether this is going to be a long, heavy season and most times leads people to stock up on equipment and get ready earlier. So we are looking forward to that positive momentum from this early snow.

Chris McGinnis -- Sidoti and Company, LLC -- Analyst

Great. And then just moving to the solutions business, just the growth there. Is there any way to parse it out between maybe Henderson performing a lot better versus the kind of the traditional Dejana business offhand?

Sarah Lauber -- Chief Financial Officer

Yes. When you look at solutions growth for the quarter, very good growth for both businesses. They were both pretty much in line with strong demand across the Class 4 all the way to Class 8.

Chris McGinnis -- Sidoti and Company, LLC -- Analyst

Was there anything special? I guess just a pretty strong number, obviously. Anything special there in terms of the growth that helped to fuel that growth?

Bob McCormick -- President and Chief Executive Officer

I might just add that while we are seeing chassis trends on the Class 8 side start to fall in line with expectations that we think will impact 2020, we are still seeing pretty long lead times for those chassis. The reason the Henderson business is up is because order intake continues to be robust. And if you go back a year, the order patterns at Henderson were strong a year ago, six months ago and nine months ago, and those orders got into the OEM systems with plenty of time for delivery yet into the third quarter. So we can see increased revenue on the Henderson side, even though lead times remained fairly long just because we're able to get those orders into the system six, nine and 12 months ago.

So I'm expecting even better things once we start to see the chassis lead times actually start to come down in 2020.

Chris McGinnis -- Sidoti and Company, LLC -- Analyst

Great. Okay. And just last question. I think you referenced within the solutions business supplier rationalization.

Obviously, at the Analyst Day, you highlighted on the Attachments business what you've done there. Can you just maybe talk about that opportunity and maybe where it's at today and where you think it could go over time?

Bob McCormick -- President and Chief Executive Officer

Yes. I would state -- that's an excellent question. I would state that most of the opportunity still lies ahead of us. The excellent results that you've seen in our core business on that front that was probably a five- to seven-year initiative led by Jim Klotz, and Jim is just now beginning to lead both of these solutions group businesses down that path.

So we are just scratching the surface on that side. I would expect to see positive things over the next couple of years as we embark on not just trimming some suppliers that just can't meet Douglas' performance expectations, but more importantly, as we strengthen partnerships with the right suppliers for our long-term growth.

Chris McGinnis -- Sidoti and Company, LLC -- Analyst

Thanks very much and good luck in Q4. Appreciate it. Thank you again.

Operator

[Operator instructions] I'm showing no further questions at this time. I would now like to turn the conference back to Mr. Bob McCormick, president and CEO.

Bob McCormick -- President and Chief Executive Officer

Thank you for your time today and your ongoing interest in Douglas Dynamics. We look forward to seeing some of you at the Baird conference tomorrow in Chicago. Thank you.

Operator

[Operator signoff]

Duration: 36 minutes

Call participants:

Sarah Lauber -- Chief Financial Officer

Bob McCormick -- President and Chief Executive Officer

Ryan Sigdahl -- Craig-Hallum Capital Group LLC -- Analyst

Chris McGinnis -- Sidoti and Company, LLC -- Analyst

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