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Douglas Dynamics Inc. (NYSE:PLOW)

Q2 2014 Earnings Conference Call

August 5, 2014 11:00 AM ET

Executives

Bob McCormick - EVP and CFO

Jim Janik - President and CEO

Analysts

Robert Kosowsky - Sidoti

Jason Ursaner - CJS Securities

Flavio Campos - Credit Suisse

Operator

Good day, ladies and gentlemen, and welcome to Douglas Dynamics’ Second Quarter 2014 Earnings Results. 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 your host for today’s program, Bob McCormick, Executive Vice President and Chief Executive Officer of Douglas Dynamics. Sir, you may begin.

Bob 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. These 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, 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, 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 to discuss our second quarter 2014 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 financials. Finally, I’ll return to discuss the business outlook and provide guidance for the remainder of the year.

We achieved record second quarter financial results with both record quarterly net sales and record quarterly earnings per share while also returning cash to shareholders through our robust dividend. The strong second quarter results exceeded our expectations and reflected the improved market environment, driven by higher than average snowfall across core markets this part year and the impact of our ongoing continuous improvement initiatives which allowed us to leverage our improved sales and to even greater earnings growth.

For the second quarter 2014, net sales were $88.2 million, partly driven by a 51.3% quarterly increase in equipment sales and a 63.6% quarterly increase in service parts and accessory sales compared to the second quarter of 2013. As a reminder, the second and third quarters taken together comprise Douglas pre-season period.

Last year pre-season sales were relatively evenly distributed between the second and third quarters, which was quite different when compared to the average split over the past 10 years of 55-45. For 2014, the Company anticipates to return to the historical averages. We expect shipments for the pre-season order period will be more heavily weighted towards the second quarter and closer to the 10 year split.

While we excited by the strong momentum and our strong performance so far, it’s important to remember that the year-over-year improvements in results this quarter were partially the results of the shift in the shipment mix.

Overall, the non-snowfall indicators within our business including truck sales, dealer sentiment and end user businesses are all encouraging. Positive dealer sentiment is driven by the renewed confidence from the strong snowfall levels across the majority of our core markets this past year. This was highlighted by many dealers taking advantage of our best pre-season order program terms early in the season. Another favorable indicator is that dealer inventory levels are slightly below historical averages and in it in excellent shape.

Both of these items are in contrast to 2013 when dealers took a cautious approach to inventory due to the lingering effect of the 2012 low snowfall. In addition, select pickup truck sales are enjoying year-over-year increases. Over the years, while there isn’t a direct link, we found truck sales do positively correlate with plow sales over the long term.

Finally, it’s also worth nothing that there is favorable business environment for professional landscapers across many of our core markets. The late arriving and cool wet summer weather means there is more work, which should translate into revenue streams benefiting many landscaping businesses. This is a very important end user group for our products and the more summer revenue landscape we generate, the greater the likelihood that they will convert that additional income to purchase snow and ice control products later this year.

Aside from an improved market environment, a sharp focus on continuous improvement and effective execution was very important to producing our record financial results. The improvement in profitability highlights the actions taken in prior years to manage the factors within our control and to position the business for success.

Now conditions have improved, it is very pleasing to see our efforts paying off. At Douglas our ingrained culture and steadfast focus on identifying and executing continuous improvement initiatives underscores our commitment to drive significant value for our customers and shareholders.

Turning to the TrynEx business, which we have owned for just over a year now, I'm pleased to report that the business is performing well and we continued to seize opportunities to increase productivity, leverage expertise and implement improvements across the business. TryneEx had solid results this quarter as we continue the successful integration into Douglas. Both in our legacy core businesses and businesses that we acquire, we will continue to strive for greater operational excellence to improve efficiency, optimize cost and deliver better customer service, while at the same time we will invest our resources in those activities that deliver the highest returns for the long term benefit of our shareholders.

We continue to generate significant cash flows and are well positioned to execute on our capital allocation strategy. We remain committed to returning value for our shareholders through a long term dividend plan and as a reminder we paid our regular quarterly cash dividend of $0.2175 per share on our common stock during the second quarter on June 30, 2014. In addition, we continue to focus on paying down our debt and pursue strategic acquisitions with attractive return on invested capital as the opportunities arise.

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

Bob McCormick

Thanks Jim. For the second quarter 2014, Douglas Dynamics generated record sales of $88.2 million compared to $55.2 million in 2013, an increase of $33 million or 60%. Shipments of snow and ice equipment units were 20,679, an increase of 51.3% compared to the prior year. Parts and accessory sales climbed to $10.8 million, a second quarter record, and an increase of 63.6% compared to the prior year. As Jim mentioned earlier, a robust snowfall this past season is the main driver of these revenue increases.

Sales of TrynEx products were $4.3 million in the second quarter of 2014 compared to $0.8 million in the second quarter of 2013. Year-to-date, TrynEx sales totaled $8.7 million. Please remember that TrynEx sales are historically stronger in the second half of the year when they typically generate 60% to 70% of their revenue.

Cost of sales was $53.8 million or 61% of sales for the second quarter, compared to $36.3 million or 65.8% of sales in the second quarter of 2013. This year-over-year decrease in cost of sales percentage was primarily driven by operating leverage, specifically strong second quarter 2014 sales reducing the relative impact of fixed cost.

Looking ahead, it is worth noting that historically Q3 cost of sales as a percentage of sales are higher than Q2, driven largely by the under absorption from our normal two week planned shutdown in early July. To a lesser degree, Q3 cost of sales is also negatively impacted by higher shipments of spreader products, as cost of sales as a percentage of sales is higher on spreaders than plows.

SG&A expenses were $8.4 million for the quarter, an increase of $2.3 million compared to the second quarter 2013. The increase was mostly due to a full quarter of ongoing expenses related to TrynEx products of $1.5 million for the second quarter 2014, compared to $0.4 million in the same period in 2013. Additionally, $1.2 million of the increase was a result of increased performance based compensation expense as a result of better operating results in 2014.

Second quarter 2014 adjusted EBITDA was $27.8 million, compared to prior year adjusted EBITDA of $14.4 million. Net income in the second quarter of 2014 was $14.6 million, compared to prior year net income of $5.9 million. Earnings per share were $0.64 per diluted share during the quarter, compared to $0.26 per diluted share for the second quarter of 2013.

During the first six months of 2014, the Company recorded net cash provided by operating activities of $12.3 million, compared to net cash used in operating activities of $11.8 million in the same period last year. This increase was driven primarily by the increase in net income and favorable working capital changes.

Accounts receivable at the end of the second quarter 2014 were $51.3 million, an increase of $12.8 million compared to the second quarter 2013. Cash and cash equivalents on hand at the end of Q2 totaled $7.1 million. The unused borrowing capacity on the revolver is $62.4 million. With total liquidity of $69.5 million we are well positioned to fund upcoming quarterly cash dividends.

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

Jim Janik

Thanks Bob. To close, I’d like to share our view of the current market conditions and provide some insight for our expectations in the second half of 2014.

Overall, we’re very pleased with continued growth in revenues and profitability, we were able to achieve for the first half of 2014. We have great confidence in our business and the strategies we are implementing across the business to bolster our industry leading product portfolio, strengthen our manufacturing performance and deliver best in class service and capabilities to customers.

The strong start to the pre-season order period provides early directional visibility on sales for the remainder of the year. But there is still is variability in the fourth quarter. As we stated many times, fourth quarter results were impacted by the weather, which has fluctuated more than normal the past few years. More specifically results are impacted by the timing, location and amount of snowfall along with other macroeconomic trends. However, we remain encouraged by a continuation of positive market indicators within our business such as dealer inventory levels below historical averages, continued strength in light truck sales and positive overall dealer sentiment that all influence and contribute to our business.

All of this combined provides us the confidence to raise our guidance for the full year 2014. Based on our results for the first two quarters and assuming average snowfall in the fourth quarter and a stable economic environment, we expect net sales for the fiscal 2014 to be in the range of $245 million to $275 million and adjusted EBITDA of $60 million to $72 million and earnings per share of $1 per share to $1.35 per share. Looking ahead, we remain committed to driving profitability through continued focus on operational efficiencies and investing in our business to achieve long term growth.

At this time, we’ll open the call for your questions. Operator?

Question-and-Answer Session

Operator

Thank you (Operator Instructions) And our first question comes from the line of Robert Kosowsky from Sidoti. Your line is open.

Robert Kosowsky - Sidoti

I was just curious in your conversations with dealers, are dealers interested in taking on I guess materially or significantly more inventory heading into next season from what you’re hearing right now?

Jim Janik

That’s a terrific question. We’re seeing certainly the willingness to take more inventory than last year. But I think it would be a leap to say that it would be significantly more. We’re certainly seeing good retail activity but I think our dealers still continue to be somewhat cautious about how much inventory they carry. But to this point it’s not impacting retail activity at any level.

Robert Kosowsky - Sidoti & Company

Okay perfect. And then also first half of this year was pretty fantastic from the parts side of the business. Can you give any thoughts on how we should think about this level of parts sales I guess translating through the entire year or what we should be thinking about kind of embedded in your guidance or parts sales assumptions?

Jim Janik

Sure. From the 20,000 foot level Robert, I think that the part sales really are a reflection of the snow last year and how hard and continual the product has gotten used as well as the general age of the product out there. We've talked many years about people holding their product a little bit longer. I think what we’re seeing now is certainly a reflection of that. I also believe that should we get descent snow in the fall, we could still see a fairly strong fall --late third quarter early fourth quarter sales of parts and accessories as well. I don’t know Bob do you have any other comments?

Bob McCormick

Well I guess I would just to add to what Jim said. First quarter we had record parts of accessory sales Rob that was driven entirely by the heavy snowfall. Second quarter’s record shipments really are more about restocking viewer shelves from that very strong first quarter. So, I wouldn’t anticipate parts and accessory sales necessarily continue at record paces for the balance of the year. But as Jim indicated, there is every reason to think that they still should be strong.

Robert Kosowsky - Sidoti & Company

Okay, that’s helpful. And then one other thought about SG&A expenses, I think you mentioned about $1 million or $1.2 million of higher incentive expenses. So, if we think about next year if we do get kind of more normal year from snowfall standpoint and early unit sales standpoint, you' probably see SG&A go down by level?

Bob McCormick

Absolutely.

Robert Kosowsky - Sidoti & Company

Okay, so that’s a better indication through SG&A.

Bob McCormick

Correct.

Operator

Thank you. Our next question comes from the line of Jason Ursaner from CJS Securities. Your line is open.

Jason Ursaner - CJS Securities

Just looking at the Q2 to Q3 shift that you mentioned, was last's year shift back towards or shift to a 50-50 kind of split; was that just related to the new products you came out with last year that would have changed manufacturing timing?

Bob McCormick

I think that had a significant impact on that. As you recall we had record introduction of new products. And as a result to do it in an orderly process we had to feather in during the quarter when we actually began shipping each of the products and many of it was heavily skewed towards Q3 and Q4. So I think that was one of the factors certainly that sort of had a structural impact, yes.

Jason Ursaner - CJS Securities

Okay. And the cash discount versus financing, looking at the cash flow statement and I realized it’s not a cash generation quarter for you guys in general but is it a stretch and take away that there might be a slight shift back towards taking the finance terms versus the discount with cash upfront?

Bob McCormick

Yes, I think actually Jason, by the times the pre-season period ended there was a slight increase in the cash discount terms. There was certainly a lot of early April and May shipment requests when cash discounts are at their highest. So I think that was the largest driver of that but by the time the pre-season orders balanced out and came in through the middle of June when more people end up taking the extended dating terms, it was relatively close to historical norms, a little bit of a slight increase in the cash terms.

Jason Ursaner - CJS Securities

Okay. And TrynEx you mentioned performing well. Is there any numbers you can put-on on, on how that did or just how spreaders did in general as a percent of revenue or growth?

Bob McCormick

No, I mean I don’t think we plan on getting that granular. What I would suggest is that TrynEx’s unit volumes are seeing every bit the kind of uptick in this environment, given the positive drivers Jim mentioned as the core Douglas business.

Jason Ursaner - CJS Securities

Okay. And is that business benefiting from the Douglas structure for the pre-season order period or it had its own sales model that as a standalone that was -- that ended up being pretty similar?

Bob McCormick

Yes, it has its own programming and typically because most of their products go through lawn and garden dealers, it runs a little bit later than the historical Douglas model. There are some aspects of it that we're blending. But from a timing perspective, the shipments tend to be a little bit later in the year. And that’s really because this is a very, very busy time of the year for lawn and garden dealers. And this is the last time -- it's very difficult for them to be thinking about pre-season orders and actually taking a lot of inventory because they've still got a lot of grass cutting inventory.

Operator

Thank you. Our next question comes from the line of Flavio Campos from Credit Suisse. Your line is open.

Flavio Campos - Credit Suisse

So quick question on landscaper budgets? Have you guys got any visibility into that and if the strong first half of the year has helped that at all and the expense should drive replacement of falls specially towards the end of the year?

Jim Janik

Sure. Our information Flavio is only anecdotal. What we do know for sure is people who moved snow last winter for living did very well financially. We have very good indication that this year because -- even though the season started later because of the cool wet weather it’s been a longer season than people would normally see. So what we’re seeing is that landscapers in general have had a lot of success in the past two seasons, the last snow season and the current lawn and garden season. So, that bodes well for us.

Flavio Campos - Credit Suisse

And just quick follow up, do you guys have any updates on the lifecycle of a plow post this unusual snow season that we’ve had before? Before the strong ’13, ’14 season you guys have given some updated ways of thinking about how long the landscapers are holding on to their equipment. Just wondering if you have any updates on that.

Jim Janik

No material updates. We would say during the really poor economic cycle that we’ve gone through that people probably extended the life a year or two. Although I think as the economy is coming back and we had the snowfall that we had last year, I think we are beginning to see some of the return of pent up demand as we speak. But we’re really going to have to get through another snow cycle before we really get a better handle on is the replacement cycle stabilized. So we’ll have to see.

Operator

Thank you. (Operator Instructions).

Jim Janik

Okay, operator if there is no more questions, I’d like to thank everybody for joining us today and continued interest and support for Douglas. We look forward to speaking with you again during the third quarter announcement. And thanks again. Have a terrific day.

Operator

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

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