Douglas Dynamics, Inc. (NYSE:PLOW) Q2 2019 Results Conference Call August 6, 2019 10:00 AM ET
Sarah Lauber - CFO
Bob McCormick - President and CEO
Conference Call Participants
Josh Chan - Baird
Ryan Sigdahl - Craig-Hallum Capital
Chris McGinnis - Sidoti & Company
Good morning, ladies and gentlemen, and welcome to the Douglas Dynamics Second Quarter 2019 Earnings Conference Call. 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 will now like to turn the conference over to your host, Ms. Sarah Lauber, CFO. You may begin your conference.
Thank you. Welcome, everyone, and thank you for joining us on today's call. Before we begin, I'd like to remind you that some of the comments that will be made during this conference call, including answers to your questions, will constitute forward-looking statements. These forward-looking statements are subject to risks that could cause actual results to be materially different.
Those risks include, among others, matters that we have described in yesterday's press release and in our filings with the SEC. Joining me on the call today is Bob McCormick, our president and chief executive officer. In a moment, Bob will provide an overview of our performance. Then I'll review our financial results 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.
Thanks, Sarah. Good morning, everyone. Thanks for the first-class execution from everyone at Douglas Dynamics, we generated record second-quarter net sales of $176 million, and record net income of $25 million during the quarter. The strength in our performance this quarter was driven by ongoing positive demand trends, coupled with strong operational performance, particularly within the work truck solutions segment.
In Work Truck Attachments, we are very encouraged by the start of our commercial snow and ice preseason, especially given the fact that this year's snowfall was generally less favorable when compared to 2018. And while below-average snowfall normally results in lower preseason orders, our demand has proven more resilient than expected. While macroeconomic concerns exist, other demand drivers, such as truck sales and dealer sentiment are generally positive. We also saw an encouraging contribution from non-truck snow and ice control equipment sales and our expanded parts and accessories offering.
Similar to 2018, we expected approximately 60% to 40% split between the second quarter and third quarter for shipment of our preseason orders. While ongoing uncertainty exists around tariffs, our team has a great track record of recouping this inflation in the form of price increases, giving me confidence that we can navigate the challenges ahead. In the work truck solutions, we produced strong top and bottom line performance during the second quarter. The key drivers are higher revenue and improved margins through the impact of DDMS and other cost-savings initiatives.
The teams at both Dejana and Henderson have gone a long way to unlocking the formula for incorporating DDMS continuous improvement concepts in a custom up-fit environment, which will ultimately lead to long-term margin expansion.
Moving on to chassis. Class 7 and 8 chassis lead times have generally remained long at six to nine months, but we are starting to see light at the end of the tunnel. While chassis supply will still be a headwind in the back half of 2019, we believe that our conditions will normalize during 2020.
As we stated in the past, the chassis supply for Class 4 through 6 trucks is less constrained, but also more unpredictable, primarily due to supply line issues and component shortages at all major OEMs. Overall, we continue to be pleased with the positive momentum of demand and order trends, and the long-term growth prospects for the Solutions segment continue to be a source of excitement for our team. Over the years, most of you have heard me speak to competitive advantages that separate us in the marketplace, namely industry-leading lead times and world-class quality. It's simply what we do.
But you've also heard me say, it's not just what we do, but how we do it and who we do it with. The how we do it and who we do it with are centered around our people. At Douglas Dynamics, the quality and commitment of our people are another real competitive advantage. While we have always prided ourselves on investing in our people, which is shown by our long-average tenure and workplace awards, we've recently embarked on a journey to build a more robust organizational development function at Douglas.
We are now providing cutting-edge learning experiences and providing clear visibility to talent and succession planning throughout all divisions to support our long-term growth initiatives. Even though, we are early in the next chapter of our talent journey, we are already seeing great results. In the first half of 2019, the team developed and launched eight new course topics, delivered 25 total learnings sessions to more than 300 people in nine different locations. Initial feedback for all of our programs has been incredibly positive, with over 75% indicating they would recommend the experience to a colleague.
These ratings are trending toward world-class levels, and are substantially higher than the national average for this type of training. While we are still early in this journey, we are excited about what we have accomplished and what is on the horizon as we move toward becoming a premier developer of talent. To close, I am pleased by our first half performance, a strong backlog and the solid order patterns are projected to continue in the near term. Robust demand, combined with improving operating performance, give us confidence in our ability to sustain this momentum into the second half of the year.
Now I'll hand the call to Sarah to discuss our financial results and guidance.
Thanks, Bob. I'll begin with our consolidated earnings for the quarter, followed by a look at the results for each segment before providing commentary on our balance sheet, liquidity and the updated guidance. As Bob noted, we're pleased with our performance during the quarter, and for the first half of 2019, especially the demand strength across both segments and improved operational performance in the solutions segment. We achieved record second-quarter net sales of $176.4 million, an 8% increase over the same period last year, with gross profit for the second quarter increasing to $59.6 million compared to $55.8 million in the same quarter last year.
Gross margin held up well despite the higher inflation due to margin improvement initiatives within the solutions segment. The slight decrease in our gross margin as a percentage of sales is mainly due to the dollar-per-dollar impact of material cost inflation. SG&A expenses were $18.8 million, $1.7 million lower than the second quarter of 2018 and reduced as a percentage of sales by approximately 2% to 10.6% this year. The decrease in SG&A expenses resulted from a onetime stock-based compensation charge due to planned design changes in the prior year.
Both higher volumes at all of our businesses and the margin improvement in solutions helped to produce record adjusted EBITDA of $44.1 million for the second quarter compared to $40.1 million for the second quarter of last year. For the same reasons, both net income and adjusted net income increased over prior year to record levels. For the second quarter of 2019, we generated net income of $25.5 million or $1.10 per diluted share, an approximately 20% increase compared to net income of $21.2 million or $0.91 per diluted share in the same period of 2018. On an adjusted basis, net income was $26.5 million or $1.14 per diluted share compared to adjusted net income of $23.5 million or $1.02 per diluted share for the second quarter of 2018.
Interest expense was $4.2 million for the quarter, which was slightly higher than the $4.1 million incurred in the same period in the prior year. The slight increase is due to a less favorable variable rate during the quarter and was slightly offset by the reduction to the principal balance of the term loan credit agreement, which resulted from the $30 million voluntary prepayment that we made in February of this year. In addition, the effective tax rate for the second quarter of 2019 was 24.6%, the same as last year. Now let's turn to the earnings information for the two segments, and let me add color to the results.
As a reminder, the Work Truck Attachments segment now includes our commercial snow and ice operations and an allocation of corporate overhead, following the change we made earlier this year. As Bob mentioned, we anticipate an approximate 60% to 40% split of preseason ordering between the second and third quarters of 2019. For the second quarter, Attachments recorded revenue of $112.2 million and adjusted EBITDA of $38.5 million. In the same period last year, the segment's revenue and adjusted EBITDA were $103.5 million and $37.1 million, respectively. The increases in net sales and adjusted EBITDA compared to the second quarter of 2018 are both attributable to the strong start to the preseason shipments. Adjusted EBITDA margins within the segment were negatively impacted by material cost inflation. Next, work truck solutions, which comprises the Dejana and Henderson businesses and applicable corporate overhead. Solutions reported net sales of $64.1 million and adjusted EBITDA of $5.6 million.
In the same period last year, the segment's net sales and adjusted EBITDA were $59.9 million and $3 million, respectively. Net sales and adjusted EBITDA benefited from higher volumes, driven by increased demand, price recovery on higher material costs and continued improvements in chassis predictability compared to the same period last year. The adjusted EBITDA margin improvement is mainly attributable to operational efficiencies, driven by DDMS initiatives and cost reductions. Turning to the balance sheet and liquidity figures.
Net cash used in operating activities during the first six months of 2019 was $300,000 compared to cash provided of $11 million during the same period in the prior year. The decrease in cash provided by operating activities is attributable to a higher receivable balance on strong second-quarter 2019 results. As we've stated in the past, the change in cash on a quarterly basis is very much impacted by the swings we experienced in our seasonal business, and is not necessarily reflective of cash generation for the full year. Free cash flow for the first six months of 2019 was negative $5.8 million compared to positive $6.9 million during the same period in 2018. The decrease in free cash flow is similarly attributable to timing of working capital invested and accounts receivable.
Accounts receivable at the end of the quarter were $114.7 million compared to $95 million at the same point last year, primarily due to higher sales in both segments this year relative to the same period last year. Increase in sales of Attachments was driven by timing and favorable preseason orders, while the increase in solutions was driven by demand and chassis becoming more predictable. We continue to navigate through both material inflation and the tightening of supply chains and have temporarily increased inventory levels to help ensure delivery times to our customers and lock in lower prices when we are given the opportunity. Accordingly, inventory was $93.9 million at the end of the second quarter compared to $84.6 million for the same period last year.
In turn, total liquidity, which is comprised of $5 million in cash and $72.4 million in borrowing capacity under our revolver, was approximately $77.4 million at the end of the second quarter compared to liquidity of $82.8 million at the end of the second quarter of last year. This lower liquidity is primarily due to the timing of higher working capital as we've discussed.
Turning to our cash usage priorities. We increased our dividend for the 11th time in the past nine years, also made an additional $30 million payment on our debt during the first quarter, meaning our net debt leverage ratio has declined to 2.6 times today. In addition to the dividend and paying down debt, we do remain open to considering potential acquisitions. Capital expenditures for the first half of 2019 totaled $5.5 million higher when compared to $4.1 million during the second half of 2018. This is due to ongoing investments in the business.
Next, I'd like to discuss our updated guidance. Based on our strong operational performance during the first half of this year, coupled with visibility regarding positive demand trends, we're narrowing our overall outlook for the year, and raising our adjusted earnings per share and outlook. We now expect to deliver net sales between $520 million and $560 million; adjusted EBITDA in the range of $95 million to $115 million; adjusted earnings per share target to between $2 and $2.40. Additionally, we anticipate our effective tax rate to be approximately 25% on the low end of our previously stated 25% to 26% range.
This outlook assumes that the economy remains generally stable, the chassis supply situation continues its predictability and our core markets will experience average snowfall levels. We believe that the update for our 2019 guidance reflects both the positive momentum generated during the first half of the year, as well as, the positive long-term outlook for the company. We remain focused on the factors within our control, such as the continued expansion of DDMS in the solutions segment, improving operational efficiency and executing effectively. Now I'll turn the call back over to Bob for closing remarks.
Thanks, Sarah. In summary, as I've said earlier, we're very encouraged with first half results, and we're well-positioned for the second half of 2019. I have to say that I'm very proud of our teams and they are laser-focused, not only on to customer, but on improving the business and getting better every day. At Douglas Dynamics, the future is bright, and we're excited about 2019 and beyond. With our prepared remarks complete, we would now like to open the call for questions. Operator?
[Operator instructions]And your first question comes from the line of Josh Chan with Baird.
Hi, morning. I just wanted to get your thoughts on the strengths in the preseason orders. Wonder, what you think the drivers of those might be? And whether you've seen kind of any geographic differences between sort of the preseason dynamics?
Yeah. Let me answer the second part of that question first. As we spoke about in our last call, there was a significant variation in snowfall based upon geography. The Midwest had very much above-average snow while the East and Northeast had a below-average snowfall season.
So we are seeing some anticipated variations in preseason orders, given those regional fluctuations. But having said that, as we said earlier, we are very encouraged by the overall preseason order book. And what I would point to is something that we said earlier in this call, take a look at the secondary drivers. Truck sales, pickup truck sales have been at near-record levels for multiple years now.
So the strength of pickup sales, certainly, helps in terms of some of those folks replacing plows when they replace trucks. Dealer sentiment, I know you guys have done a few dealer checks, remains positive, which is a good thing. And the other thing that I would point to is, we have such tremendous market share in that big amount of snow and ice control equipment. Our team's focus on nontruck plow offerings, and on building a more robust parts and accessories product line have really paid off nicely, and are showing themselves in those preseason orders.
So I think those would be the main drivers, Josh.
All right. Yeah. Thanks for that color. And then on raw materials, I guess you mentioned steel.
I assume it's steel inflation. And then also, you mentioned tariffs. So I just wanted to see, in terms of your income statement, when you will start to realize sort of the lower spot steel prices that we've seen in the recent weeks and months. And then how you expect the tariff impact to kind of influence you over the coming couple of quarters here?
Yeah. We really navigated through the tariffs and the inflation last year going into the beginning of this year. If you think about the steel inflation we really had steep trough here, and now we're more at normalized level. As I've stated in the past, we always cover our inflation dollar-for-dollar. Because that inflation was so high, our margin percentages are impacted by that negatively. When you look at the second quarter, it is a quarter that we’ve covered everything dollar-for-dollar, but comparatively to last year, there’s two impacts, one, just the math, the dollar-for-dollar; and then the second being, we did not experience the much higher steel price for the entire second quarter last year. So the comp was a little bit more challenged. We are experiencing lower steel now, but I would say it’s more just normalized, not dramatically lower.
Okay. Great. And then lastly on the solutions business. Is there any color you can give us relative to that overall segment growth? How each of the two businesses performed relative to the overall growth rate in the quarter?
Yeah. So I’ll chime in here, and if there’s anything Bob wants to add. I think from a growth perspective, solutions is seeing a high growth rate, I mean and the expectation would be continuing through the remainder of the year. We’ve been talking now for several quarters about very high backlog and the order rates, and those have continued, we’ve really seen strength in demand across our Class four to six trucks. And then with the fact that we have a strong order book at Henderson and the Class 8 chassis is becoming more predictable, we’re able to get more throughput and shipments out the door. So our expectation is what we’ve seen thus far in the first half of the year, will continue through the second half as long as the chassis predictability remains the same.
All right. Great. Thanks for the color. And thanks for the time.
And your next question comes from the line of Steve Dyer with Craig-Hallum Capital.
Good morning. Ryan Sigdahl on for Steve Dyer.
First off, so given the strong results and preseason commentary, it seems like there would have been a narrowing of revenue toward the higher end similar to EPS and EBITDA. I guess what are the puts and takes there that give you some caution in the second half of the year?
Yeah. As you know, we’ve always had a wider range across the board for our guidance. From a sales perspective, there’s still the wild card of the fourth quarter and the seasonality of the fourth quarter around snowfall. I would say that always tempers our sales guidance to some extent and that’s what you’re seeing.
So presumably, cadence would be solid growth here again in Q3, given that 60-40 split, and then Q4 putting some extra conservatism there?
Yeah. I would say, I mean, when we look at preseason, you’ve got that right, 60-40. When we look at the fourth quarter, we do our best to predict average snowfall. The challenge being how much of that is in the preseason. So, I would expect growth, but I would say, yes tempered, just because of that unknown.
Great. And then the work truck solutions, it was up nicely year over year, but it took a step down sequentially, both on revenue and EBITDA margin. What is that a function of?
We've talked about the fact that we expect linear improvement in solutions. We still expect that from 2018 to 2019. Quarter to quarter, there are more dynamics that just make it a little bit more mixed. It's not confirming that it's gone down sequentially, a lot of that could be based on the product mix that we have within those businesses. So from a quarter-to-quarter perspective, I wouldn't focus too much on that. I'd focus more on what we can accomplish from a linear perspective year after year, and we still expect that improvement for full year.
I would add to that. One of the things that I'm most excited about is the ongoing DDMS implementation that we have across all 16 locations in the work truck solutions segment. We are seeing improved margins. As I said earlier, we've unlocked some of the magic formula there for implementing these concepts in a custom environment. And as those things continue to get rolled out across all of our facilities over the next three, six, 12, 18 months, and we start seeing some of that backlog shake loose when chassis begin to make themselves more available, those are some of the key drivers that give us reason to believe that you will see the sequential margin improvement Sarah spoke to.
Last one for me, then I'll turn it over. You briefly mentioned tariffs and being able to mitigate any cost there. But do you guys have any exposure to the proposed 10% tariff on the $300 billion of Chinese imports that will be effective here September 1?
We do not.
And your next question comes from the line of Chris McGinnis with Sidoti & Company.
I just wanted to ask about the recent Class 8 sales and with the decline in that order pattern, will that help you in the Henderson business at all?
Absolutely. We've been watching the same data points you've been watching. For those who don't pay a very close attention to it, the industry has been projecting a return to some semblance of normal demand sometime in 2020. And for that to occur, you need to start to see some signals of it. And we have seen signals of the over-the-road demand softening, which essentially frees up capacity at those OEMs to allocate more chassis toward the municipal side of the market, which is where Henderson competes. Now having said that, backlogs -- or lead times are still in the six-plus month range. So the impact on 2019, likely not to be very much, okay? But heading into 2020 and throughout 2020, we're getting excited about the prospects of having more chassis hit the ground, and giving us a chance to work through some of that robust backlog that we've built.
Okay. With no more questions, thank you for your time today, and your ongoing interest in Douglas Dynamics. I have some good news, Douglas will be hosting an investor event at the NYSE in early October, and we hope to see many of you there. More information will be forthcoming. Thank you, and have a terrific day.
Ladies and gentleman this does concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.