Douglas Dynamics, Inc Q3 FY2024 Earnings Call

Good day, and welcome to the Douglas Dynamics Third Quarter 2024 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Nathan Elwell, VP of Investor Relations. Please go ahead.

Thank you, Nick. Welcome, everyone, and thank you for joining us on today's call. Before we begin, I would 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 Jim Janik, Chairman and Interim President and CEO; Sarah Lauber, Executive Vice President and CFO; and Mark Van Genderen, Chief Operating Officer and President of Work Truck Attachments. Jim will provide an overview of our performance, followed by Sarah reviewing our financial results and guidance. After that, we'll open the call for questions. With that, I'll hand the call over to Jim. Please go ahead.

Thank you, Nathan. Douglas Dynamics has a 75-year history of adapting and improving our operations. For our Attachment segment, this has been a year of adapting to very unusual weather conditions that we've seen. For our Solutions segment, it has been a year of delivering improvements following the challenging work put in over the past few years that is now paying off. This was a positive quarter for the company and I'm very impressed with the operational improvements that have been made. I want to recognize the dedication and resilience of our team which continually allows us to maximize our potential in all market conditions. With that said, let's talk about what happened in the third quarter. First, we saw an impressive performance from Work Truck Solutions, which is becoming a very nice trend. Our Henderson operations are outperforming expectations this year, helping to drive record double-digit adjusted EBITDA margins for the quarter in Solutions. Second, our results at Work Truck Attachments were more or less in line with our expectations. The other key factor this quarter was the 2024 cost savings program. As you may remember, earlier this year the team made difficult decisions to align our cost structure at Attachments and our corporate team in light of the demand outlook. The actions taken mean that Attachments is well positioned to succeed over the medium to long term in all market conditions. The program was implemented in the first quarter and expanded in the second quarter. It is expected to deliver $11 million to $12 million in sustainable annualized savings starting next year. Importantly, we remain on pace to deliver $9 million of savings this year. Now, turning to results in each segment, starting with Attachments. As we noted, preseason orders were softer than previous years with demand continuing to be impacted by two years in a row of significantly below average snowfall in our core markets, particularly on the East Coast. However, taken as a whole, our preseason results were slightly below our overall predictions. The ratio of preseason shipments in 2024 came in at a 65-35 split between the second and third quarters rather than the more traditional 55-45. The lengthening equipment replacement cycle will continue to be a near-term factor and we will carefully track retail activity and dealer inventory trends. Margins were also impacted by the mix of products this quarter, with more of our most profitable products being shipped in the second quarter this year. It's important to point out that the 2024 cost savings program has really helped preserve profitability. In fact, our adjusted EBITDA margins are a respectable 19.5% on a year-to-date basis. Rest assured, we are talking with our dealers and monitoring order patterns and will be ready to ramp up production if needed as we work through the elongated equipment replacement cycle. Our recent dealer checks indicate inventory levels continue to come down but remain elevated and less than ideal compared to previous years. Also, reorder activity at the end of the third quarter was lower than expected. While these reorder numbers in September are relatively small, they are directionally important as we head into the retail season for snow and ice control equipment. The financial health of our dealer network remains strong and the sentiment is positive under the circumstances. While it's been longer than we like, we know that the impact of low snowfall is temporary and we have adjusted our operations to match today's market conditions. We will continue to prudently invest in upgrading our manufacturing capabilities in 2025 and beyond to maintain our operational competitive advantages. As we enter winter, we are ready for whatever mother nature throws at us, and we'll use our continuous improvement mindset to adjust as the snow season progresses. Okay, let's talk about Work Truck Solutions. I'm pleased to confirm that Dejana and Henderson teams delivered record third quarter results. The profitability shown this quarter exceeded our internal expectations. The volumes were down slightly, but the improved efficiency plus the price realization were the primary driver of record results. Performance was also strong on a year-to-date basis with adjusted EBITDA margins more than doubling to 9.5% when compared to the previous year. This performance demonstrates that our long-term goals are very achievable when external circumstances allow. At Dejana, the team continues to focus more of their attention on the fleet business where the supply of chassis is currently the strongest. Some customers are less urgent about their buying decisions today and more price conscious with some signs of softening demand for certain products. We believe there is an impact from high interest rates in some local markets; customers are hesitating with their spending decisions due to the upcoming election. However, in other areas, demand remains generally stable and we're working to position ourselves to drive sustainable long-term growth. For example, we're just starting to see the positive impact of the infrastructure bills with interest in sectors related to utilities, sewage, waste, as well as telecom. While the situation isn't perfect, chassis availability has improved, especially for fleet customers, and we're starting to eat into our backlog a little bit more. At Henderson, the team is having a great year and we're well on its path to long-term profitability goals. Chassis and component supply are more closely aligned with our needs, and stable supply of labor coupled with our operational improvements of recent years are delivering stronger results. Municipal demand remains positive and the backlog remains much higher than historical levels. We do believe some of our outperformance at Henderson this quarter was due to business mix and we predict some softness in the coming quarter. Overall, our results at Solutions bode well for the future and it's important to remember that demand remains positive with municipal customers and most solid with commercial customers. Near-term chassis supply is as good as we've seen in recent years. The improved chassis availability has helped our teams drive great efficiency, which has led to improved profitability. While we aren't counting on it, market commentators are indicating that OEM production levels are increasing over the medium term. From an operational standpoint, we executed effectively across the board and we still have a solid backlog to work through and in some parts of the business it is growing. We are on track to deliver on our goal of improved performance for the third straight year in solutions. So in summary, it's great to see Solutions hit their stride this year and hats off to those teams for continuing to push forward. We've seen in recent years that the diversity of our operations has helped us to manage through tough times, as one segment has performed well while the other was impacted by market conditions. After the turbulent conditions we've faced in recent years, with various unpredictable external headwinds, we believe the years ahead will produce more stable conditions that will allow us to deliver on our potential. We will continue to manage through the short-term challenges while investing in the long-term future to ensure we remain the clear leader in our markets. Okay, before I hand the call over to Sarah, I want to discuss our leadership team. We have a terrific group of people in place today, and we recently announced a few changes in our senior team, promoting the next generation of leaders. As Nathan mentioned, we have Mark Van Genderen on the call with us today. Mark was recently promoted to Chief Operating Officer of Douglas Dynamics. Since he joined Douglas four years ago, he's established himself as an important leader within our organization and in his new role he will be overseeing both Attachments and Solutions. Mark has a broad operational background and demonstrated sales and marketing expertise and most importantly he shares our values and is a great fit with our culture. I look forward to working with him and Sarah as we lead the company into 2025. Also, our Chief Human Resource Officer, Linda Evans, is retiring at the end of the year as planned after 16 years at Douglas. Linda has played a pivotal role in many aspects of the company's growth. She has helped shape our culture and her passion and enthusiasm will be greatly missed by all. A silver lining to Linda retiring is the strength of her successor, Shannan Vlieger, who Linda has been mentoring. Her dynamic leadership will prove important to our success in the years ahead. Finally, I've been back in the CEO role for five months now. I'm in Milwaukee and I stay committed to stay on as interim CEO into 2025. The primary objective of the CEO search process is to take the time to ensure we appoint the right person. Our intention is to have a new CEO in place in the first half of 2025. With that, I'll pass the call on to Sarah.

Thank you, Jim. Our performance this quarter can be explained quite simply. The Attachment segment's results were somewhat below our expectations due to the extended replacement cycle. However, the Solution segment delivered a record third-quarter performance that exceeded our expectations, leading to a significant improvement in profitability. The sale leaseback transaction added a layer of complexity to our financials. As you may know, we completed this transaction in September, resulting in growth proceeds of $64.2 million. The cash taxes related to the deal amounted to $12.7 million, and transaction expenses totaled $5.3 million. We utilized $42 million of the proceeds to reduce our term loan debt, which enhances our flexibility and supports our long-term growth strategy. The additional rent expense from this transaction, when compared to the reduced interest expense following the debt repayment, will have a negligible effect on our earnings per share annually. This transaction was an excellent way to optimize our balance sheet, positioning us well to invest in the business. It included seven facilities with 780,000 square feet of manufacturing and upfitting space, featuring leases for 15 years with two 10-year renewal options. All seven facilities are vital to our operations, and these long-term leases demonstrate our commitment to operate in these communities for many years to come. Now, moving on to the quarter, despite a decline in demand and attachments, our profitability remained stable owing to strong performance in Solutions and the contributions of our 2024 cost savings program. For the third quarter, our consolidated net sales were $129.4 million compared to $144.1 million during the same period last year. Gross profit fell slightly to $30.9 million, but gross profit margin increased by 160 basis points to 23.9% thanks to higher price realization, efficiency improvements from the 2024 cost savings program, and better results at Solutions. SG&A expenses for the quarter were $20.4 million, excluding the sale leaseback transaction costs of $5.3 million, up from the $18 million reported in the third quarter of last year. The $2.4 million increase is mainly due to CEO transition costs and higher incentive-based compensation. Recall that the 2024 cost savings program is projected to yield between $11 million and $12 million in sustainable annual savings, with about $9 million expected to be realized in 2024. Interest expense was $4.5 million, consistent with the $4.6 million from the previous year. The effective tax rate was 22.7% for the third quarter of 2024, up from 16.4% in the same period last year, which had benefited from a tax advantage related to investment tax credits. Our GAAP net income for the third quarter was $32.3 million, or $1.36 per diluted share. Adjusted net income was $5.9 million, roughly in line with last year's third quarter figure of $6 million. Adjusted EBITDA decreased to $15.3 million compared to $17.3 million from the same quarter last year, driven by lower Attachments volume, though partially mitigated by better pricing and efficiency at Solutions. Now, let’s delve into each segment. Starting with Attachments, we are still affected by the previous two winters with significantly below-average snowfalls in our primary markets, leading to a prolonged equipment replacement cycle and reduced order volume. This quarter's net sales were $60.2 million, slightly below expectations due to lower reorder volumes in September and product mix, resulting in adjusted EBITDA of $8.1 million. The preseason shipment ratio this year was 65-35 between the second and third quarters, similar to last year but skewed more towards the second quarter compared to our long-term average of 55-45. The 2024 cost savings program has helped maintain profitability, with year-to-date adjusted EBITDA margins close to 20%, in line with our expectations. Turning now to Solutions, which achieved record third-quarter sales and earnings as we continue to advance our growth and profitability goals. Net sales were $69.1 million, slightly above last year, with lower volumes offset by higher prices. Adjusted EBITDA increased by 44% to $7.2 million, with margins reaching 10.4%, a 310 basis point improvement. The profitability achieved in this quarter surpassed our expectations due to improved pricing and efficiency gains led by Henderson. Strong year-to-date results show adjusted EBITDA margins more than doubling to 9.5% compared to the previous year. However, it's important to note that while we have seen excellent progress this year, we do not anticipate linear improvements moving forward. Variability in business mix, delivery timings, and contract profitability will lead to fluctuations in our overall results from quarter to quarter, but we expect to achieve annual improvements in EBITDA for the third consecutive year, with high single-digit adjusted EBITDA margins projected for the segment this year. Now, regarding our balance sheet and liquidity, as of September 30th, we had a total liquidity of $90.9 million, which included $8.4 million in cash and cash equivalents along with $82.5 million available under our revolving credit facility. Year-to-date comparisons show a significant improvement of $30.9 million in net cash used in operating activities and a $34.6 million improvement in free cash flow, moving from negative $71.9 million to negative $37.3 million. This improvement is linked to favorable changes in working capital, including reductions in cash utilized in accounts payable, accounts receivable, and inventory. The proceeds from the sale leaseback positively affected cash from investing activities by $64.2 million. As mentioned earlier, $42 million of these proceeds went towards voluntarily prepaying long-term debt. Consequently, by the end of the quarter, our leverage ratio stood at 2.6 times, well within our target range of 1.5 to 3 times. Inventory was recorded at $145.4 million at quarter-end, slightly down from $147.2 million in the third quarter of 2023. Accounts receivable were $153.1 million at quarter-end, compared to $165.3 million at the same point last year. Year-to-date capital expenditures of about $4 million were significantly lower than the $7.7 million from the same period last year. Based on the current year-to-date figures, we expect CapEx for the year to be below the typical low end of our usual 2% to 3% of net sales range. We distributed our quarterly cash dividend of $29.5 per share at the end of the quarter, and maintaining the dividend remains our top priority. Looking ahead to the end of the year, the exceptional performance recently observed in Solutions positions them for improved full-year results for the third consecutive year. However, the fourth quarter will present a tougher comparison for Solutions, and we anticipate that Attachments shipments will continue to be limited due to the prolonged recycling cycle. We are preparing for average snowfall in the fourth quarter and will monitor reorders as dealers work to adjust their inventory levels. Consequently, we are revising our net sales guidance and lowering the upper end of the adjusted EBITDA and adjusted EBITDA margin forecasts. Net sales are now projected to range from $570 million to $600 million, down from the previous range of $600 million to $640 million. Adjusted EBITDA is now expected to be between $70 million and $80 million, as opposed to the earlier range of $70 million to $90 million. Adjusted earnings per share is now forecasted to be between $1.20 and $1.60, previously estimated at $1.20 to $1.70. The effective tax rate is anticipated to be roughly 24% to 25%. Our outlook is based on the assumption of relatively stable economic conditions, sufficient supply of chassis and components, and expectations for average snowfall in our core markets in the fourth quarter. Operationally, we executed well across the company this quarter. As external conditions improve, we are well-equipped to leverage our operations and enhance our long-term earnings potential. Now, we would like to open the call for questions.

We'll now begin the question-and-answer session. And our first question today comes from Michael Shlisky of D.A. Davidson. Please go ahead.

Hi, good morning. This is Linda on for Mike Shlisky. Thank you for letting us ask questions. So my first question for you is on the Attachments segment. Can you update us on your off-highway Attachments business, such as your wheel loader and tractor-based products? Has this meaningfully contributed to growth in 2024?

Let me make sure that I understand your question. You're talking about the non-truck market. Is that accurate?

Yes, so it's the off-highway Attachments. So like the wheel loaders and tractor-based products. Yes.

Yes. They continue to have a very nice spot in the market. I would say some of the newer products are having some impact, but at this particular point, it's not material. But as we get into 2025 and beyond, we expect them to have a very good role within our profitability and our marketplace.

Yes, I can add a little bit of color to that. So for the third quarter, we were relatively flat when you look at non-truck sales. For the year, we are down similar to what we're down in preseason. So it just kind of follows the trend. And non-truck sales still represent less than 5%. But it is a large, growing segment for us and Attachments.

Yes. This is Mark. I would add that from a product development standpoint some of the products that we brought to market over the last year or 18 months are really starting to get into the groove right now. I was down in Louisville at a big show three weeks ago and our pusher plows, the big ones that go on skid-steers and front-end loaders, are getting a lot of attention; they have some great features, so we're pretty excited about that product in the future.

Oh, great. That's great color. Thank you. And then my next question would be, can you detail for us what you're doing for your dealers to help them until the winter starts? Are you offering to move inventories around to the dealers or even take back inventories if they ask for it?

Yes, this is Jim. I think for the dealers, most of them are typically have the equipment that they need. They're just waiting for the snow season to come around. It's not a mix issue for most of our dealers. It's a demand issue. So moving inventory around is a nice thought, but it doesn't add a lot of value or relief to any of our dealers. We do feel as if with any decent snow this coming year, inventory is going to be normalized by 2025.

Got it. Thank you for your time.

Thank you.

And our next question today comes from Tim Wise with Baird. Please go ahead.

Hey everybody. Good morning.

Hi Tim.

Hey. Maybe just in the Attachment segment, I guess you're expecting to have average snowfall in December. But I guess what is your expectation for reorder activity relative to average snowfall? I guess are you expecting reorders to be normal, or are you still expecting to see weaker reorders just as your dealer kind of starts to flush inventory for any sort of initial orders?

Tim, I think you've hit the nail on the head. Your comment is that, with some elevated levels of inventory, many of the dealers will work down that inventory as they see retail activity, and probably we won't see retail or reorder activity as you might otherwise see just because they're working down that inventory. So I think your point is a good one; they're going to work down the inventory first and then reorder. So with average snowfall, we expect reorders to be, as we've indicated here, probably a little softer than we would normally expect under the circumstances.

Our guidance has been fine. Even though we talk about average snowfall expected for now for a couple of quarters, we don't expect that to equate to average volume. So that's been embedded in our fourth quarter the way we're thinking about it.

Okay, that's helpful. From a production standpoint, you've always emphasized your ability to quickly respond to changes in in-season demand. With the cost savings implemented throughout the organization, has anything changed in your production processes that could affect your ability to meet demand if it exceeds expectations?

Yes, Tim, this is Mark. I can address that. This year, we've enhanced our response capabilities. The unusual snowfall over the past 18 months has prompted us to evaluate operations across all our facilities, resulting in better overall flexibility in our production. This includes the ability to lower production to align internal inventories with dealer inventories or to ramp up as needed. I believe we're in a strong position right now.

Okay, good. And then just on Solutions, I guess I was surprised that volume was down in the quarter. I guess I thought you guys still had a fair amount of backlog to work through. So I guess, is there a way to kind of break out price versus volume and then just kind of update us on where the backlog is? Because I guess the top line seems a little more variable now relative to maybe the backlog driven demand we've seen in the last couple quarters.

Yes, so it really is kind of a tale of two cities here when you look at the two businesses. So price for the quarter for Solutions is really in the low single digits. The volume, it's up a little bit at Henderson, but more of the volume decline has been at Dejana. When you look at the backlog, in total, our backlog is still up from the end of last year. But we saw Dejana kind of eat into some of their backlogs, and Henderson's backlog has grown. I would say on the Dejana side, we have experienced some softness that we talked to a bit in the script from the standpoint of quarter volumes in the quarter.

Okay. And then I'm going to squeeze one last one in. Just what are your free cash flow expectations for the year in Q4?

Yes, our free cash flow expectations don't change a lot from what we walked through last quarter other than the impact of the sale leaseback. So our cash taxes will still be in that 24% to 25% effective tax rate. But that has kind of doubled because of the gain that we experienced on the sale leaseback. And then we have experienced already in our results some positive flow through on working capital. So I used to think working capital was flat for the year and now I expect that to be slightly favorable. So the total free cash flow for the year after the sale leaseback with all of that will still well exceed our dividend level.

Okay. Great. Thanks for the time.

Thank you, Tim.

And our next question today comes from Greg Burns with Sidoti & Co. Please go ahead.

Good morning. Just to follow up on the Dejana demand environment, what are you hearing or seeing in the market? Is it just maybe a pause because of election uncertainty or maybe some other short-term drivers? Or is there anything maybe more structural where you're seeing demand soften? Just trying to get a sense of where you feel that business might be in 2025 if you expect that maybe a rebound as interest rates come down and we get past the election?

Yes, terrific question. Thank you. I think as we look at it, it's a little bit difficult to determine what specifically the impact of interest rates and the election are. We know it has some impact, and we're seeing it particularly in the local commercial businesses. Businesses like plumbing contractors, electrical contractors who are local to our businesses. I think they're just being very reluctant to pull the trigger on orders at this particular point. Our hope is that it rebounds after the election and the impact of the reduction in interest rates starts to work through the channels. Overall, I think we're optimistic with the business. We're also seeing more of a shift towards weak business and a little less of the local market business. So there's some puts and takes, and I think as we go into 2025, we're optimistic, but we're not entirely sure which of these factors are playing the greatest role.

Okay, thanks. And then maybe in terms of expected cash generation in the fourth quarter and where you expect leverage to exit the year?

Yes, so we are at 2.6 times at the end of the third quarter, and I expect that to continue to decline through the end of the year. And as you know, the fourth quarter is by far the highest free cash flow generating quarter for us. And I expect it to go strong, to end strong.

Okay. I understand you're working with the assumption of average snowfall. However, if we experience another year of below-average snowfall, do you have any plans or alternative measures, such as additional cost reductions or potential sale leaseback opportunities, that could help sustain the business if snowfall remains low this upcoming year?

When we put together the 2024 cost savings program, we really spent a lot of time on optimizing the business for the run rate that we've seen over the last several years. The sale leaseback did the same with optimizing the balance sheet. I really feel like at this point in time, we have a runway of some lower snowfall from here and/or higher snowfall from here. I think the business is well set to deliver, depending on what the snow brings up. So I guess my answer to that is, at this point in time, no, not additional action.

Okay. Thank you.

Seeing no further questions, this will conclude our question and answer session. I would like to turn the conference back over to Jim Janik, Chairman, Interim President, and CEO, for any closing remarks.

Thank you for your time today. And going forward, our consistent focus on continuous improvement will help ensure we maximize the potential of any situation we are faced with. Our attachments team is ready for winter and right-sized for the current environment. If the weather cooperates and we see decent snowfall in the coming winters, we will be in a very good position to drive profits. Our Solutions team is now reaping the benefits of efficiency improvements implemented in recent years. Our company has a 75-year history of adapting and managing through uncertainty. The only constraints are that situations will arise and change will occur. We know how to manage through both the short term and the long term, and recent results show when headwinds subside we deliver. Thank you, and we look forward to seeing some of you at the Baird Conference in Chicago on November 12th. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.