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Douglas Dynamics Inc. (NYSE:PLOW)

Q1 2014 Earnings Conference Call

May 6, 2014 11:00 AM ET

Executives

Robert McCormick – EVP and CFO

Jim Janik – Chairman, President and CEO

Analysts

Jason Ursaner – CJS Securities, Inc.

Robert Kosowsky – Sidoti & Company

Unidentified Company Representative

Jim Walsh [ph] – Deyer [ph]

Jim Giannakouros – Oppenheimer & Company, Inc.

Operator

Good day, ladies and gentlemen, and welcome to Douglas Dynamics’ First Quarter 2014 Earnings Call. At this time, all participant lines are in a listen-only mode. Later, we will be conducting a question-and-answer session and instructions will follow at that time. (Operator instructions)

As a reminder, this conference is being recorded. I would now like to introduce the host for today’s call, Mr. Bob McCormick. Mr. McCormick, you may begin.

Robert McCormick

Thank you. Hello, 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-end of December 31, 2013 filed with the Securities 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, adjusted net income and adjusted earnings per share, 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 are included in today’s earnings press release which is available at douglasdynamics.com.

Also joining me on the call this morning is Jim Janik, Chairman, President and Chief Executive Officer. With these formalities out of the way, I would like to turn the call over to Jim.

Jim Janik

Good morning and thank you for joining us on today’s call. I’m going to begin by providing an overview of our results and then Bob will provide a detailed review of our financials. Finally, I’ll return to discuss current trends and provide additional details on our outlook for 2014.

Before we begin, I’d like to remind everyone that first quarter sales for Douglas Dynamics are historically the lowest – first quarter are typically the lowest, averaging less than 10% of full year sales. As such, we historically generate a net loss in the first quarter.

This was not the case this year. We produced very good results during the first quarter even when compared to the strong first quarter of last year. This was due primarily to the continued strong snowfall across our core markets in the first quarter. And of course, the dedication of our employees who ensured we were able to meet the record first quarter demand for parts and accessories during this high equipment usage environment.

Turning to our results, net sales were $36.4 million in the first quarter of 2014. This represented 158% year-over-year increase. Robust first quarter of 2014 results reflect higher than average snowfall levels across core markets and additional sales of products related to the business of TrynEx which the company acquired in May of 2013.

For the first quarter of 2014, we achieved record parts and accessory shipments and produced a profitable first quarter for the first time in a decade.

We are encouraged by the recently improving market conditions combined with our leadership position in the industry. As I’m sure everyone is aware, after a tough couple of years, snowfall really came back strong this past season. In fact, North America experienced its highest level of snowfall in 18 years this winter, which is very good for our business. Numerous core markets for Douglas received at or near record snowfall for this season.

As we enter our pre-season order period, we are pleased by how positive the non-snowfall business indicators we follow such as the positive trending in light trucks or the quarter sales of select pickup trucks remained positive, growing 4% year-over-year.

Over the years, while there isn’t a direct link, we found truck sales do positively correlate with plow sales over the long-term and we do think that the cold weather negatively impacted truck sales this quarter.

Our dividend remains a focal point as we look to return value to our shareholders and it’s protected in our current model. As a reminder, we paid our regular quarterly cash dividend of $0.02175 per share during the first quarter and made March 31, 2014. We view our cash generation and commitment to paying dividends as a distinguishing characteristic compared to other companies our size.

As we’ve stated since our IPO in 2010, aside from enhancing shareholder value to returning cash through our regular dividend, we’re committed to generating excess cash to reduce the company’s debt and pursue strategic acquisitions at disciplined valuations when the opportunities arise.

One non-operating issue worth mentioning is our ongoing litigation with Buyers Products Corporation in which we were recently awarded patent infringement damages of $9.75 million. We are pleased with the verdict and happy to put this long standing five-year dispute behind us. We can’t comment any further on the litigation until the process is finalized.

Overall, well, we are proud of our patents and more broadly, our innovation which enables us to provide industry-leading products and solutions to our customers. We expect to leverage our industry-leading combination of innovation and execution and superior customer service to drive growth in our business.

With that, I’m going to turn the call back over to Bob to discuss the specifics of our financial results and then I’ll conclude with comments on our business. Bob?

Robert McCormick

Thanks, Jim. For the first quarter of 2014, Douglas Dynamics generated sales of $36.4 million, an increase of 158% compared to $14.1 million in the first quarter 2013.

Shipments of snow and ice equipment units were $6,502, an increase of 206% versus the prior year. Parts and accessories sales climbed to a record $14.2 million in the first quarter of 2014, an increase of $8.2 million compared to the prior year. The increase was driven mainly by the higher than average snowfall across core markets and additional sales of products related to the business of TrynEx which the company acquired May of 2013.

Cost of sales was $22.3 million or 61.2% of sales for the quarter compared to $9.8 million or 69.4% of sales in the first quarter of 2013. The decrease in cost of sales as a percentage of sale is largely due to operating leverage; more specifically, stronger first quarter 2014 sales reduced as a relative impact of fixed cost.

SG&A expenses were $8.3 million for the first quarter compared to $5.9 million in the first quarter of 2013. The increase compared to 2013 was mostly due to ongoing expenses related to TrynEx products of $1.3 million. Additionally, $900,000 of the increase was a result of increased performance based compensation expense as a result of better operating results in 2014.

First quarter of 2014 adjusted EBITDA was $8.3 million compared to prior year adjusted EBITDA of $0.2 million, an increase of $8 million. This increase is primarily attributable to both higher equipment and parts and accessories shipments during the quarter.

Adjusted net income for the first quarter of 2014 was $1.6 million compared to prior year adjusted net loss of $3 million. Adjusted net income per diluted share for the first quarter of 2014 was $0.07 per diluted share compared to adjusted net loss per diluted share of $0.13 loss in the first quarter of 2013. As Jim mentioned earlier, we produced a profitable first quarter for the first time in a decade.

Net cash provided by operating activities for the first quarter of 2014 was $10.2 million compared to the prior year net cash used in operating activities of $7.1 million. This increase was driven largely by improved earnings and the addition of TrynEx.

Cash on hand at the end of the first quarter of 2014 totaled $10.5 million. The unused borrowing capacity on the revolver is $38.9 million. With total liquidity of $49.4 million, we are well positioned to fund our regular quarterly dividend payments and future growth opportunities.

As part of our customary pre-season inventory bill, inventory was $46.9 million at the end of the first quarter of 2014 compared to $28 million of inventory at the end of 2013 and $45.1 million at the end of the first quarter of 2013.

Inventory excluding TrynEx products decreased $3.3 million compared to the end of the first quarter of 2013 as a result of higher sales volumes in 2014. The decrease in inventory during the first quarter of 2014 was partially offset by the $5.1 million worth of additional TrynEx inventory.

Accounts receivable in the first quarter of 2014 was $13.5 million compared to $42.3 million in the fourth quarter of 2013 and $11.3 million at the end of the first quarter 2013. The company historically receives accounts receivables defining [ph] the first quarter as the snow season winds down.

The increase in accounts receivable during the quarter was primarily due to additional sales of product related to TrynEx. Excluding TrynEx, receivables were relatively flat year-over-year. Even though Q1 [ph] sales for the quarter with $22.3 million higher than prior year, most of those shipments occur in January and February and thus are collected prior to the end of the quarter.

With that, I’ll turn the call back over to Jim for some concluding remarks. Jim?

Jim Janik

Let me now take a few moments to share some thoughts on what we’re expecting for the remainder of 2014. As you probably saw on our release based on our first quarter results, dealer sentiment and industry trends, we are updating our 2014 outlook by raising the bottom end of the ranges for all three metrics.

We now expect net sales for the full year 2014 to range from $215 million to $260 million and adjusted EBITDA to range from $45 million to $70 million. And earnings per share are expected to range from $0.75 per share to $1.20 per share. As you may remember, we have just entered our pre-season period which typically runs from April to September and we normally ship 55% to 65% of our annual equipment orders.

Finally, I want to remind everyone that we launched an unprecedented eight new products in 2013, which was a record for the company and that’s something we plan to repeat this year. That launch process impacted the timing of shipments during our 2013 pre-season order period causing shipments to turn closer to a 50-50 split between the second and third quarter. For 2014, we expect to move that towards the recent five-year trend of a 60-40 shipment split.

Overall, we anticipate robust 2014 results due to improved market conditions and favorable non-snowfall indicators. The continued positive momentum in selected pickup truck sales coupled with the positive January field inventory results indicate we’re continuing to see improved sentiment among dealers.

As a reminder, on January 30th, distributed inventories were down double digits year-over-year and retail reorder sales from October through March were up substantially year-over-year. As a result, dealers are likely to be optimistic and as a result, 2014 pre-season orders are likely to be higher than 2013.

With that, we’ll now open the call for your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) One moment please while we wait for participants to queue. And I have a question from the line of Jason Ursaner from CJS Securities. Your line is open.

Jason Ursaner – CJS Securities, Inc.

Good morning. Congratulations on a great start to the year.

Jim Janik

Thank you.

Jason Ursaner – CJS Securities, Inc.

Just first question, you mentioned a significant order activity in February and March, I guess the obvious question is how much do you think that pulled from the pre-season, if at all, and do you have any sense for dealer inventory at the end of March given that last year there was a pretty nice drawdown late in the season?

Jim Janik

Yes. Jason, the second question is a little bit easier to answer. We expect that dealer inventories are at relatively low levels at the end of March. Even though we don’t take a field inventory, I think it’s still a continuation of the retail activity coming off the January field inventory. So our feel is that the distributor inventories are a very nice level, somewhat lower than previous years just – and that will enhance pre-season.

The second one is a little bit harder to answer. I think we get a better feel for whether people are drawing sales from next year into this year. Typically, that’s not the case. Typically, when people are ordering in February or March and have begun, the numbers aren’t generally large numbers. It’s really based on need and I think it creates momentum and I think the momentum that it creates is certainly more positive than any potential sales that are pulled ahead earlier.

Jason Ursaner – CJS Securities, Inc.

Okay. And you mentioned introducing a record number of new products last year. I guess just any sense for how those fully made their way through the channel at this point. Would there be a margin benefit this year more than last year in terms of how those sell through and how we should think about the new products you’re coming out with this year?

Robert McCormick

Yes, Jason, typically what we tell folks is that when we introduce a new product, the goal is for margins to be better than the product that just got replaced and will certainly be the case with the majority of those products that we introduced. I guess from that perspective, you’d expect to see a little bit of a margin lift but I wouldn’t think it would be of any kind of a material amount.

Jason Ursaner – CJS Securities, Inc.

But does it take time for the product to get into the channel in terms of how dealers are selling and reordering?

Robert McCormick

Oh, sure.

Jim Janik

Yes, I think – I thought your question was more about product margins. In terms of getting fully through the channel, absolutely. Many of the products we introduced last year were not even part of the pre-season order program that were introduced later in the year. And I think you do see the first full year of sales you will see a significant benefit from having those products in the marketplace, people understand them and now are prepared to place orders for them.

Jason Ursaner – CJS Securities, Inc.

Okay. And in the full year outlook, I’m assuming the infringement award is excluded from that?

Jim Janik

Correct.

Jason Ursaner – CJS Securities, Inc.

Okay. And the infringement going forward, is there any royalty agreement on SnowDogg plows?

Robert McCormick

Yes. There – Jason, we really can’t comment on at this point. It’s not concluded. So as a result, when we have a conclusion, I think we can perhaps give some more detail.

Jason Ursaner – CJS Securities, Inc.

Okay. Maybe just one more. You didn’t quantify any legal expenses in terms of adjusted EPS. Were there any significant label costs that you incurred in this quarter – in the quarter just reported as you move towards some these court dates?

Jim Janik

No.

Jason Ursaner – CJS Securities, Inc.

Okay. I’ll hop back in the queue and let others have a chance. Thanks.

Operator

Thank you. Our next question comes from the line of Robert Kosowsky from Sidoti. Your line is open.

Robert Kosowsky – Sidoti & Company

Thanks. Good morning, guys. How you doing?

Jim Janik

Hi, Rob.

Robert McCormick

Hi, Rob.

Unidentified Company Representative

Hi, Rob.

Robert Kosowsky – Sidoti & Company

Yes, I was wondering if I guess looking into this year, do you see any increase in plow sales into the lawn and garden channel and vice versa given the TrynEx increased distribution channel?

Robert McCormick

We would anticipate some of that. I think granular with it but we did introduce the Blizzard product line through the SnowEx channel this year in addition to the existing Blizzard channel and we would expect to enjoy some of the benefits of that.

Robert Kosowsky – Sidoti & Company

Okay. So just starting at a slow pace but still pretty good penetration?

Robert McCormick

It’s so early in the pre-season order period, I don’t even know if I can comment.

Robert Kosowsky – Sidoti & Company

Okay. And then, I know you’ve had a couple of good quarters since you bought TrynEx and I’m wondering what normalized SG&A should look like, is it at this $8 million level or should we see it step down to more of kind of $6 million or $7 million?

Jim Janik

No. I think you’re probably closer at $8 million. TrynEx adds about $5.5 million worth of SG&A to the normal baseline structure, if you will. But I think between $7.5 million and $8 million is probably closer.

Robert Kosowsky – Sidoti & Company

Okay. And then also any update or how would you view TrynEx’s ability to capitalize on higher demand within the season and any update on operational integration of TrynEx with your spreader manufacturing?

Jim Janik

Well, from an integration perspective, what we really focused on in 2014 is making sure that TrynEx can meet the increased revenue demand that we see across all of the product lines. As you know, we’re implementing our lead manufacturing processes there.

So that’s the real focal point this year. Jim mentioned that we’ll be selling Blizzard snow plows into that channel, which is another positive. Some of the other revenue synergies are likely to come a little bit further down the road.

Robert Kosowsky – Sidoti & Company

Okay. And then also, was TrynEx able to fully capitalize on the hiring season demand?

Jim Janik

Absolutely.

Robert Kosowsky – Sidoti & Company

All right, cool. Thank you very much.

Jim Janik

Thanks, Rob.

Operator

Thank you. Our next question comes from the line of Jim Walsh [ph] from Deyer [ph], your line is open.

Jim Walsh [ph] – Deyer [ph]

Hey, guys, nice start to the year.

Jim Janik

Thank you, Jim.

Jim Walsh [ph] – Deyer [ph]

I guess just – is there a way to kind of frame – do you think just given your market share and just your production capabilities, is there any sense that you may have gained share just given the abnormal snowfall that we saw this last year, I guess can you maybe talk about the possibility of that?

Jim Janik

That’s a terrific question. In fact, one of the things that we feel very good about is that in the heat of the season, which is typically Q4 and Q1, we were still able to shift the majority of orders within a week. We know just by doing some field surveys, most of our competitors were not able to do that.

Jim Walsh [ph] – Deyer [ph]

Okay.

Jim Janik

And by connecting the dots, that should mean some potential to increase market share. It’s a little bit difficult to measure the course, but our instinct would say that if you have a product available in a snowy year and maybe some of your competitors don’t, you’re going to pick up some business you might not otherwise have had.

Jim Walsh [ph] – Deyer [ph]

Right. Okay. No, that’s helpful, thanks. And I guess just on pricing, have you guys talked about what pricing might look like this year from an ASP prospective and then anything we should think about just in terms raw materials?

Jim Janik

Yes. The pricing, we have not yet had that discussion. Typically, our pricing will come out effective July 1 and so, that’s something we’ll, as we begin to wrap up with pre-season, we’ll begin to talk about the pricing. From a raw materials, I’ll let Bob answer that.

Robert McCormick

Yes, Jim. We’re not seeing anything from a raw material contemplation perspective that gives us any reason for a pause at all. Typically, price increases that we take help to cover off raw material contemplation. I would expect that to be the case, but nothing unusual that’s going to have any impact on our margins from a negative perspective.

Jim Walsh [ph] – Deyer [ph]

Okay. And then just on free cash flow, just given the inventory dealer levels that you characterize as pretty low, should we expect free cash flow maybe in Q2 and Q3 to be a little bit – generate more of a free cash flow negative just given there might be more pre-season orders this year versus years prior?

Robert McCormick

Again, that’s another excellent question. We are hopeful that with the drivers pointing the green for the most part that will see an increase of pre-season orders this year versus a year ago, which would lead you to believe that we would consume more cash and have to borrow deeper into the revolver, that passes the logic test.

Jim Walsh [ph] – Deyer [ph]

Okay.

Robert McCormick

The one thing though that we’re watching here early on is while most of our customers when they take a pre-season order it’s usually extended date, terms have not paid until the fourth quarter. You also have an option of taking a cash discount and paying those pre-season orders off early. And early indications are with courts around early is that we are seeing a greater percentage of people than historically we see taking the cash discount payment terms versus the dating.

So we’re going to see a little bit of a greater inflow of cash than we normally do during the second quarter. So the first part of your question spot on, we should see more of a revolver draw counterbalancing that a little bit. I think it’s going to be a little bit better cash coming in through the cash discount payments.

Jim Walsh [ph] – Deyer [ph]

Okay. So it doesn’t sound like there’s really any inability to be able to invest in some of the growth opportunities that you might see from an M&A perspective because of the cash raw?

Robert McCormick

Cash, no, no. We’ve got even, we’ve got – just to comment on that, we’ve got a number things that are disposal when it comes to being able to finance growth. Number one as you’re alluding is we can draw on to the revolver and we typically recover some environment at $20 to $30 million of drive power there. We also have a $40 million [indiscernible] flex that we can execute on our term level in the existing desk structure as well.

So without even having going to the debt markets, we’ve got access to some capital that can continue to fund our growth initiatives.

Jim Walsh [ph] – Deyer [ph]

Great, thank you.

Operator

Thank you. (Operator instructions) And I am seeing – I have a question just now from the line of Jim Giannakouros from Oppenheimer, your line is open.

Jim Giannakouros – Oppenheimer & Company, Inc.

Good morning, gentlemen. Congrats on the great start to the year.

Jim Janik

Thank you, Jim.

Jim Giannakouros – Oppenheimer & Company, Inc.

Just tagging on to that last question, if you can address how your M&A pipeline is looking, does the current environment affect your approach and is it farfetched to think that something could happen even this year?

Jim Janik

I think from our perspective, we really never talk granularly about M&A and opportunities that are out there. We continue to look for good strategic opportunities at great valuations and from that perspective, I guess that’s all that I’ll say at this particular point.

Robert McCormick

Yes. I guess I would just add, Jim, that there isn’t anything about the year we’re having that would influence the amount of energy that we devote to those growth strategies. And it wasn’t any different during 2012 during the down cycle as well. So we think this business model is built to be able to be very sustainable at all parts of the cycle. And I think the acquisition growth strategy is kind of executed on its own regardless of where you’re at in those cycles.

Jim Giannakouros – Oppenheimer & Company, Inc.

Got it. And one other on margins, I know in the past you said that you’re trying to get your TrynEx margins up to – close to the spread of margins in a two to three-year timeframe. Has – did that have a material impact to this go around or was it – or were your margin performance really had to do with just the incremental volume flow through?

Jim Janik

I think it’s more based upon the incremental volume flow through. There’s a lot of great things going on between core Douglas and the Madison Heights [indiscernible] facility. But those things take some time and to feel the full year affect of those things is largely going to be a second half 2014 proposition and then a 2015, ‘16 proposition as well.

Operator

Thank you. Our next question comes from the line of Jason Ursaner from CJF Securities, your line is open.

Jason Ursaner – CJS Securities, Inc.

Thanks for taking a quick follow-up. Just on the M&A question, give that anyone in the snow industry should probably be having a pretty good year and some pretty high expectations, if you were to find something strategic and at a good price in the shorter term, is it logical to think it would need to be from some of the counter seasonal markets that you’re also looking at?

Jim Janik

No. Again, I think that – we’re looking in a variety of different areas, Jason. And so I wouldn’t necessarily connect those dots. I think, again, a great opportunity is a great opportunity and it could be from our industry, it could be from the truck equipment industry, it could be from the ground security [ph] industry. Because, again, with a seasonal business like ours, we have to put the same amount of effort year in, year out through the M&A type of business. And so, again, I wouldn’t jump to those conclusions.

Jason Ursaner – CJS Securities, Inc.

Okay. That was it for me. Thanks.

Jim Janik

Okay. Thanks, Jason.

Operator

Thank you. (Operator instructions) And I’m seeing no other questioners in the queue at this time.

Jim Janik

Okay. Operator, then, thank you everyone for your interest in Douglas Dynamics. We look forward to speaking with you again early August for our second quarter earnings announcement. Thanks and have a great day.

Operator

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

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