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Douglas Dynamics Inc. (NYSE:PLOW)

Q2 2013 Earnings Call

August 6, 2013 11:00 AM ET

Executives

James Janik – President and CEO

Robert McCormick – VP, CFO

Analyst

Jason Ursaner – CJS Securities

Peter Lisnic – Robert W. Baird

Robert Kosowsky – Sidoti

Operator

Good day, ladies and gentlemen, and welcome to the Douglas Dynamics Second Quarter 2013 Earnings Conference. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded. I would now introduce your host, Bob McCormick. Sir, please go ahead.

Robert McCormick

Thank you, welcome everyone and thank you for joining us on the call today. Two quick items as we begin. First, please note that some of the information that you will hear during this call will consist of forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 as amended. Such statements express our expectations, anticipations, beliefs, estimates, intentions, plans and forecasts. Because these forward-looking statements involve risks and uncertainties, our actual results could differ materially from those in the forward-looking statements.

For more information regarding such risks and uncertainties, please see the sections titled Risk Factors, Forward-Looking Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year-ended December 31, 2012, filed with the Securities and Exchange Commission and the updates to these sections in our subsequently filed quarterly reports on Form 10-Q. Second, this call will involve a discussion of adjusted EBITDA and adjusted net income, all non-GAAP financial measures, which under SEC Regulation G we are required to reconcile with GAAP. The reconciliation of these measures to the closest GAAP financial measure is included in today’s earnings press release which is available at douglasdynamics.com.

Joining me on the call this morning is Jim Janik, President and Chief Executive Officer. With these formalities out of the way, I’d like to turn the call over to Jim.

James Janik

Good morning and thank you for joining us on today’s call to discuss our second quarter 2013 performance. I’m going to begin by providing an overview of our performance for the quarter and then Bob will provide a detailed review of our financial results. Finally, I’ll return to discuss the business outlook and provide guidance for the remainder of the year.

Overall, we’re pleased with our second quarter performance. Results were in line with internal expectations, given the shift in pre-season order shipments that we outlined in the press release and the first quarter earnings call. As a reminder, the second and third quarters taken together comprised Douglas pre-season order period. In direct contrast to 2012 pre-season order period in which orders were skewed approximately 65% to 35% for the second and third quarters respectively. The 2013 pre-season order period shipments are expected to be closer to an even split between the two quarters.

A shift towards a more even split between second and third quarter shipment make for a tough comparison given last year the pre-season skewed more heavily to the second quarter. The main reason for the shift was related into the timing of our new product launches. So, of course this is what something we had expected.

For the second quarter 2013, net sales were $55.2 million, hardly driven by 16.9% quarterly increase in parts and accessories sales compared to second quarter 2012. Sales of parts accessories continued to be strong in the quarter as dealers restock inventories after the heavy product use from the late snowfall in February and March. The timing of snowfall late in the season typically results in increased parts and accessories as end-users look to repair rather than replace equipment.

As I briefly mentioned earlier, the timing of new product launches and related shipment mix trends are partly responsible for the shift towards the historical norm of more even split. We introduced a total of eight new products in 2013, with the majority beginning shipment in the third quarter. Product innovation remains the cornerstone of our Company and longer term we’re excited these new products will enhance our market leading position and further cement our reputation to deliver best-in-class products and services to our customers. Our lineup of new products as received strong positive feedback from dealers thus far.

As far as industry trends, we’re generally encouraged by slow but steadily improving market conditions, both in the economy and with respect to dealer sentiment. There is no doubt that terrible snow conditions we experienced from the fall and winter of 2011 through all of 2012 has led dealers to be cautious. Therefore, we expect our 2013 pre-season to be slightly lighter than 2012. However, we have a positive outlook because we believe that the fourth quarter of 2013 will show a significant improvement over the same period of 2012, assuming we achieve more normal snowfall pattern.

Select, pickup truck sales had continued their upward momentum with sales up approximately 20% -- 24% through June. Over the years, we had found that truck sales due positively correlate with cloud sales over the long-term. At the moment, dealer sentiment is best described as cautiously optimistic with optimism more prevalent in the regions with stronger recent snowfall. However, dealers in areas with well below average snowfall this past few years such as New York and Chicago are considerably more cautious. Other positive non-snowfall indicators include an improvement in landscaping business compared to the record summer drought of 2012 in many of the snow-belt regions.

While it was late arriving spring in 2013, the recent warm and wet weather has helped many small landscapers’ businesses, which is very important end-user group for our products. The more revenue the landscapers generate, the greater likelihood that they will convert that additional income to purchase snow and ice products later in the year.

Now, I’d like to provide an update on the TrynEx acquisition that we completed in early May of this year and introduced in our first quarter earnings call. This acquisition provides us with opportunities to carve out new growth channels across market adjacencies, expand our reach to new geographies and expand the depth and breadth of our product offering. We made excellent progress in integrating our core back office operations with the TrynEx and leveraging shared expertise across the business. We will continue to seek opportunities to achieve operational efficiencies, deliver best-in-class service and products to customers, and overall strengthen our market leading position across the snow and ice control business.

I applaud the tireless efforts of employees from both organizations that had made the first three months since the acquisition such a productive time. It is worth reiterating that TrynEx has been impacted by the same market dynamics impacting our business, namely the 2011, 2012 record low snowfall season and drought that followed in the summer of 2012. The drought weighed on results given that TrynEx servers the same landscape contractor market as Douglas Dynamics, but through different distribution channels and product offerings. We are pleased with the acquisition so far and looked to… forward to working with the TrynEx team going forward as we continue to share ideas and leverage our capabilities.

Finally, I’d like to reiterate our dividend policy. We remain committed to returning value to our shareholders for a long term dividend plan. As a reminder, we paid our regular quarterly cash dividend of $20.75 per share of our current stock during the second quarter on just 28th 2013. We continue to focus on paying down our debt and pursue strategic acquisitions with attractive return on invested capital as opportunities arise. With that I’ m going to turn the call back over to Bob to discuss the specifics on our financial results and then I’ll will conclude with comments on our business and outlook for the reminder of the year. Bob.

Robert McCormick

Thanks, Jim. Overall, we remained cautiously optimistic as market conditions continued to improve despite the lingering negative impact from 2012. For the second quarter of 2013, Douglas Dynamics generated sales of $55.2 million compared to $65.5 million in 2012. Shipments of units decreased by 17.1% and parts and accessories sales increased 16.9% for the quarter versus the same period last year. As Jim mentioned earlier, this is a continuation of the theme from the first quarter of 2013 as dealers restock parts and accessories inventories due to late snow fall in February and March 2013.

Cost of sale was $36.3 million or 65.8% of sales for the second quarter compared to $42.4 million or 64.8% of sales in the second quarter of 2012. This year we’re decreasing cost of sale, it was primarily driven by decreases in unit volume given the mixtures in previous season order of various shipments.

SG&A expenses were $6.1 million for the quarter, an increase of $0.4 million compared to second quarter of 2012. Second quarter of 2013 adjusted EBITDA was $14.4 million compared to prior year adjusted EBITDA of $19.6 million. Net income in the second quarter of 2013 was $5.9 million compared to prior year net income of $9 million.

Earnings per share was $0.26 per diluted share during the quarter compared to $0.40 per diluted share for the second quarter of 2012. During the first six months of 2013, net cash used by operating activities was $1.9 million compared to net cash used by operating activities of $17 million in the same period of last year. This decrease was driven largely by a $4.3 million reduction in cash used by accounts receivable as AR grew slower in Q2, 2013 versus the prior year.

Accounts receivable at the end of the second quarter of 2013 was $38.5 million, a decrease of $12.1 million compared to second quarter of 2012. Cash and cash equivalents on hand at the end of Q2 totaled $2.1 million, the unused borrowing capacity on the revolver is $26.7 million with firm liquidity of $28.8 million, we’re well positioned to fund upcoming quarterly cash dividends.

Turning back to the acquisition as discussed in the last quarter’s earnings call, I’ll provide more color on TrynEx earnings in 2013 including the impact of noncash purchase accounting adjustments. To provide some background in a normal economic and snowfall area TrynEx, has historically generated revenue of approximately $20 million with annual EBITDA in the range of $3 million to $4 million. From the date of acquisition on May 6th 2013, through year end we expect TrynEx net sales to be in the range of $12 million to $14 million. Projected adjusted EBITDA for this period is expected to be in the range of $1 million to $1.75 million, with earnings per share in the range of minus $0.80 to minus $0.12. These projected results include certain non-cash purchase accounting adjustments of $4.5 million, which are expected to impact earnings per share negatively by $0.12. The $4.5 million is comprised of two items.

First, a portion of the potential earn out is expected to be spent in 2013 totaling approximately $3.8 million of which approximately $3.7 million will occur in Q3, 2013. The balance of the year and half is expected be expense between 2014 and 2016 totaling approximately $500,000 per year. Second, the impact of an inventory right up the share market value totaled approximately $700,000, $100,000 which has already been expensed in Q2, with the balance expected in Q3, 2013.

Additionally, the preliminary purchase price allocation includes intangible assets which were preliminarily valued at $18.7 million of which approximately $65% are book intangibles. That will be amortized through the income statement over periods ranging from 17 to 25 years. Meanwhile, the remaining approximate 35% to be preliminary intangible assets were allocated to goodwill, which is expected to be amortized for tax purposes over 15 years.

Again in Q3, 2013 the quarterly non-cash expense for book intangibles is expected to be approximately $150,000 per quarter. For this tough period of May 6 to the Q2 book intangible amortization expense totaled just under $100,000 dollars.

Finally, as Jim noted earlier, we’re excited about the long term impact of TrynEx, the acquisition is still expected to be both accretive earnings per share and free cash flow positive on a four year basis beginning the 2014. With that I’ll turn the call back over to Jim for some concluding remarks.

James Janik

Thanks Bob, of course I would like to share a view of current market conditions and provide some insight for expectations in the second half of 2013. The second quarter preseason order period provides an early directional visibility on sales for the reminder of the year but there is still variability in our fourth quarter. As we progress further into the preseason order period we still anticipate a better full year 2013 compared to the very challenging year in 2012. However, the lingering impact of 2012 still exists as evidenced by the cautious approach of our dealers purchasing inventory during the preseason order period. Overall, we do expect the 2013 preseason to be slightly lighter than the 2012 season. However, we believe demand in the fourth quarter will accelerate assuming average snow fall conditions as dealers seemed to be taking wait and see approach to ordering.

Given the very difficult fourth quarter of 2012, as long as we see something close to average snow fall, we expect to show a significant improvement in this year’s fourth quarter. Based on our results from the first two fiscal quarters I’m assuming average snow fall averages in the fourth quarter, we expect net sales for the fiscal 2013 to be in the range of $175 million to $200 million, adjusted EBITDA of $36 million to $46 million and earnings per share of $0.30 per share to $0.60 per share. The projected results for TrynEx are included within the fiscal 2013 company guidance.

In conclusion, we’re encouraged by positive market indicators and the gradual improvements in the market conditions in dealer sentiment. Looking ahead we’re well positioned to capitalize on an improving market environment given our new line of products, our strong financial position and new growth platforms with the addition of TrynEx. Enhancing shareholder value through our robust dividend will continue to be a priority going forward. At this time we’ll now open the call for your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operation Instructions) and our first question comes from the line of (inaudible). Your line is open.

Unidentified Analyst

Thank you. Good morning everyone.

Robert McCormick

Hi, Jim.

Unidentified Analyst

A quick one on the TrynEx acquisition you – thank you, for giving us a dot $14 million, how do you envision that playing out in the second half. I had assumed similar seasonality to Douglas, but I just want to make sure that I’m modeling here appropriately?

Robert McCormick

Yeah, Jim that’s a great one. It’s their seasonality of shipments by quarter is a little bit different than the normal Douglas business because they started the one and got in market and they’ve got some other products et cetera. The way I would I think about that second half revenue projection would be, almost a fifty-fifty split between quarters.

Unidentified Analyst

Okay. That’s all folks. Thanks and another one on – I’ll just – what you’re seeing pricing – I’m curious as to how your new products are impacting pricing and the competitive landscape, if you’re seeing anybody, if it’s rational right now or you seeing any competitor as being a bit more aggressive and attacking to that steel prices coming down the last several quarters, how your price cost equation is looking for the rest of this year.

James Janik

Jim, I’ll answer the first question and let Bob talk about material prices. We’re still seeing pretty – people pretty rational. Again we continue to take price increase, most of our competitors do certainly as they do what most of the industry does is, it's typically not an across-the-board price increase, but there are certain product they will increase prices other products they might not but in general almost everyone is or they make change their discounts in their programming or the volumes but what -- however you look at it, there is generally a price increase in there. So along those lines is pretty rational. I let Bob discuss the -- what’s going on in commodities.

Bob McCormick

Yeah, we’re seeing what most everyone else sees Jim and that is a fairly modest cost inflation environment. As Jim noted, we did take our normal price increase this year. So from that point of view, we would expect margins to be holding in the area that they have been so far year-to-date and then with the possibility for some improvement during the fourth quarter when our price increase really takes on.

Unidentified Analyst

Great, thank you.

Operator

Our next question comes from the line of Jason Ursaner from CJS Securities.

Jason Ursaner

Good morning.

James Janik

Hi, Jason.

Jason Ursaner

You mentioned the expectations for a modest or wider full pre-season relative to last year with the optimism for Q4. So I just like to ask about expectations for the starting inventory level based on full pre-season orders that you’ve gotten as dealers get to that early retail season on Labor Day. How much inventory would you expect them to be starting with relative to last year and versus historical levels?

James Janik

Sure, I’ll have to answer in generalities. My expectation this year again we take inventory four times a year, filed inventory four times a year. In May, the less field inventory, dealer inventories were down about percentage wise high single digits and slightly below the five-year average. So inventories are in check. We’re also getting pretty decent feedback that retail activity is certainly better than it was last year at this particular period of time. Typically, this time the year, there is not a lot of retail takes place just because snowfall is so far away but we are seeing certainly better retail activity. Based on how things are going, I would expect that dealer inventories could be relatively low to where we like them to be going into the fourth quarter. Does that answer your question?

Jason Ursaner

I think so. I mean, if inventory was down in double digit May and the pre-season is less than last year, that is going to get your lower inventory, which I guess, is getting to that Q4. How did that relate really to the weather driven reorders, but then also how do you layer the potential for pent up demand on top of that?

James Janik

Yeah, it's -- that’s always, the fourth quarter as you know Jason is always a challenge for us, we try and really take a look at some of the indicators whether it's truck sales, last year’s weather, current retail activity, the general economy, those things all look certainly more positive they did in 2012 and at the same time we anticipate dealer inventories will be a little bit lower, which is part of the reason we think that the fourth quarter could certainly be better than last year and under the right conditions particularly good weather in the fall, we could see a very decent fourth quarter compared to last year and may be even historically.

Jason Ursaner

Okay, and the pent up demand part of it not those -- the weather driven reorders, but with that be a fourth quarter phenomenon or that be more an expansion of next year’s inventory base that you would get.

James Janik

It could be a fourth quarter. It's truck sales and we talked about within our calls and discussions that a fairly decent percentage of our new ploughs also go on new truck. So, as truck sales -- pent up demand for truck sales comes back I think it would certainly be expected that we’re going to see some of the benefit of that whether it comes lumpy or it comes in fourth quarter, first quarter and into next year that tends to be a wild card for us.

Jason Ursaner

Okay, and then just last question for me. The bulk of that $4.5 million adjustment you mentioned was the earn-out, is that part of the purchase price structure or that’s an accrual on the projected maximum earn-out that was sort of to stretch number?

James Janik

Yeah, that is not part of the purchase price allocation, which are required to do from SEC rules perspective that to get an outside valuation on what that potential earn-out looks like and a portion of which then is expensed in the current year which is the $3.8 million and then there is a second portion which gets expensed evenly from 14 through 16, that’s about $600,000 a year. So those will be expenses that will be booked expenses through the income statement, not part of purchase price allocation which hadn’t find this way through intangible amortization of some kind.

Jason Ursaner

And that’s get put in SG&A or?

James Janik

Yes, and correct.

Jason Ursaner

And there the difference between EPS and EBITDA, you’re pulling it out of EBITDA, but you’re not taking it out of adjusted EPS.

James Janik

Correct, it really isn’t an adjusted net income item, but it is an adjusted EBITDA item correct.

Jason Ursaner

Okay. I think, that’s it from me. Thanks.

James Janik

Thanks, Jason

Operator

Our next question comes from the line of Robert Kosowsky of Sidoti, your line is open.

Robert Kosowsky

I just had a quick clarification question. So the earn-outs, I guess, of the acquisition related expenses, the total amount that are non-recurring is a $3.8 million of the earn-out which the majority is going to hit in Q3 and then another 700,000 of the inventory write-up which you’d assume a lot get in Q3 as well, so it's $4.5 million of one-time non-recurring?

James Janik

Exactly, that $4.5 million it will take in 2013 is one time non-recurring types of expenses, the intangible amortization of approximately $150,000 per quarter that will be with us for a long period of time.

Robert Kosowsky

Okay. And will the most of the inventory write-up occur in the third quarter?

James Janik

Yeah, we took around a $100,000 of that kit in the Q2 and will take the remaining kits likely in Q3.

Robert Kosowsky

Okay. That’s helpful. And then, otherwise, any early thoughts, are you actually going to be selling any ploughs like this year through (inaudible) try a TrynEx dealer network or is that going to be more pushed into next year.

James Janik

Yeah, I think it's little early for us to get that granular, but I think there may be certain opportunities to look at synergies this year but the majority of what we’re going to see will be in 2014 and probably accelerating into 15 and 16.

Robert Kosowsky

Okay, thank you very much and good luck.

James Janik

Thank you.

Operator

Our next question comes from the line Peter Lisnic of Robert W. Baird. Your line is open

Peter Lisnic

Good morning, guys.

James Janik

Good morning.

Peter Lisnic

I guess the first question on the more balanced second and third quarter order pattern, does that have any significant impact on how you’re looking at the production schedules and does that translate into a sort of absorption impact that we might want to consider in the models, we look forward to the third and fourth quarters?

James Janik

Yeah, that’s a good question Pete. I don’t think we adjusted the production plans significantly from what we’ve normally done. Even though we have a little bit of a shift between quarters, we pretty much set the plant on a production pace, so that by the end of pre-season we have certain amount of inventory having into the selling season if you will. So inventories are little higher now at the end of the Q2 and it’ll come down a little bit more during Q3 than it normally does, but we’re not making significant changes to the production plan themselves, thus those significant (inaudible) absorption impact should be fell off.

Peter Lisnic

Okay, all right perfect. And then you’d mentioned a bit Bob on the -- Jim on the inventory perhaps being a bit lower relative to historical levels at the dealer level. Can you may be give us a sense of to, if that indeed is the case and all of a sudden there is some sort of rush to fill that that demand. Are you in a better spot, do you think competitive believe versus some of your competitors to fill that demand may be take some shares or just -- how comfortable do you feel in your ability to respond very quickly if indeed there is a quick snap back?

Robert McCormick

Yes, yes to all your questions. One of the reasons five or six years ago we went to lean manufacturing and sourcing was to be able to provide much, much better services in periods of time where there is this potential serge and I’m going to underline potential because I don’t want anybody to rush to judgment. But if it that occurs, I don’t think there’s any question we’ll be the best in the industry prepared to meet that demand, because I think we constantly are monitoring what’s going on in the market place, we’re checking our supply lines and making sure that even today the kinds of inventory we have are the right kinds of inventory and feel very comfortable, we can respond to almost any eventuality.

Peter Lisnic

Okay. And then a last follow up on the – on your forecast for the year. So the EPS number of 30 to 60 that range that includes the $4.5 million of purchase accounting related item is that correct?

James Janik

Correct Pete that would include the negative $0.8 to negative $0.12 TrynEx EPS number.

Peter Lisnic

Okay, but then when we look at the EBITDA guidance the 36 to 46, we would adjust out the $4.5 million?

James Janik

That is not included in that 36 to 46 correct.

Peter Lisnic

Okay, okay perfect. Thank you very much for your time.

James Janik

You got it.

Operator

It kind of appears we have no further questions. Thank you, sir. I’ll turn this and I’m going back to you, so that you can close the call.

James Janik

All right. Thank you for joining us today and for your continued interest and support for Douglas Dynamics. We look forward to speaking with you again during the third quarter announcement and thanks again and have a terrific day.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.

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