Douglas Dynamics Inc (PLOW) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Douglas Dynamics third quarter 2011 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 be given at that time. (Operator Instructions.) As a reminder, this conference call is being recorded.

I would now like to turn the call over to your host, Mr. Bob McCormick. Sir, you may begin.

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 Form 10-K for the year ended December 31, 2010, filed with the Securities and Exchange Commission, and the updates to those 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 is included in today's earnings press release.

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

Good morning and thank you for joining us on today's call to discuss our third quarter 2011 performance. I'm going to begin by providing an overview of our performance for the quarter, and then Bob will provide a detailed review of our financial results. Finally, I'll be back to discuss current trends and provide additional details on the remainder of the year.

To begin, we are pleased to report a strong third quarter performance and a nice finish to our preseason order period. Overall, net sales increased 12.7% year over year, driven by a 6% increase in equipment shipments and a 34% increase in service, parts, and accessories. This growth reflected stronger preseason orders compared to the same period last year and the timing of preseason shipments shifting slightly towards the second quarter versus the third quarter.

You may recall we experienced the same trend during the third quarter last year. Although over the long term, our preseason orders have been split approximately 50-50 between the second and third quarters each year, in recent years we have seen a shift towards the second quarter.

One important change that occurred during the quarter which we are very excited about was the initial rollout of our new snowplow preassembly and packaging system or, as we call it, P&P. This new process has been well received by our distributors and provides four distinct benefits.

First, a significantly larger portion of the plow is preassembled, enabling the distributor to materially reduce installation time and therefore install more plows per day, which is particularly important during the busy winter snow season.

Second, more factory preassembly significantly reduces the chances of distributor installation errors. This is important, as installation errors can significantly impact product performance and subsequent warranty costs.

Third, the new packaging is weatherproof, which allows our distributors to store more inventory outdoors, freeing up valuable indoor floor space and overall handling efficiency.

And finally, an enhanced electrical system enables fleet users to marry any fleet truck to virtually any of our plow models. This significantly enhances plowers' truck and plow scheduling options. Previously, each truck was confined to using a specific plow and could not easily be switched, which limited flexibility.

I also want to mention that as a key part of the P&P initiative, we have also installed three new automated assembly lines in our Rockland and Milwaukee facilities. As we work through the rollout of the P&P system, we anticipate slightly reduced productivity during the transition and a short-term increase in our per-unit manufacturing cost. This is a temporary impact and is far outweighed by the long-term benefits to Douglas and our distributors. Overall, we are pleased that both the rollout is progressing in line with expectations, and the reactions from the distributors has been very positive.

Turning to our preseason results, we normally ship 60% to 65% of our annual equipment shipments and orders during the second and third quarter timeframes. This period is defined as April through September, when the snow is not falling. In order to encourage distributors to place and receive orders prior to the fourth quarter retail selling season, Douglas offers special pricing, payment, and freight incentives. These orders are then shipped to our distributors at their request during the April and September timeframe, and revenues are recognized when an order is shipped.

While the combination of our preseason order program and an average snowfall in any given year typically results in relatively equal shipments across the second and third quarter, there can be swings in revenue based on whether more of these orders are shipped in the second versus the third quarter. The factors that cause these shifts are fairly tactical in nature and can include simple storage space issues at our distributor locations. Given we view the preseason as one time period, we don't over-analyze the shift between quarters.

We are encouraged by what appears to be an increasing appetite for new equipment purchases. However, our distributors still remain cautious on the sustainability and pace of the overall economic recovery. Our results are a reflection of the continually improving drivers of our business. As you recall, previous year's snowfall is the primary driver of our business; the more the products are used, the faster the replacement cycle. In the winter of 2010 and 2011, equipment was used extensively. Additionally, select pickup truck sales remain positive, at 11% year-over-year improvement through September.

And finally, the results of our September field inventory indicates distributor retail activity between June and September was nicely above the same period last year. As we've said in the past, a certain amount of pent-up demand likely exists in the industry, as professional snowplowers continue to delay some purchases. We expect that demand to materialize over a several-year period rather than one particular quarter or season.

Finally, I want to briefly mention our dividend policy. As previously reported, on September 9 the Company declared quarterly cash dividends of $0.20 per share on its common stock, which was paid September 30 to stockholders of record as of the close of business on September 20.

As further evidence of our year-to-date results and confirming our stated use of cash priorities, the Board of Directors has approved an increase in the Company's quarterly cash dividend to $0.205, which will be effected in the fourth quarter of 2011. The Board's decision reflects our continued confidence in the Company's financial strength and future cash flows.

With that, I'm going to turn the call back over to Bob to discuss our financial results in more detail. Bob?

Thanks, Jim. While some caution still exists, we are pleased that 2011 is progressing as planned. For the third quarter 2011, Douglas Dynamics generated sales of $53.5 million compared to $47.4 million in 2010, an increase of 12.7% year over year.

Shipments of equipment units increased 6% versus the prior year. This was driven largely by stronger preseason orders versus the prior year, despite the timing of preseason shipments shifting more toward the second quarter than the third quarter. Parts and accessories sales increased $1.5 million, or 34%, versus the prior year, driven largely by the heavy snowfall last season.

Cost of sales was $37 million, or 69.2% of sales for the third quarter compared to $32.2 million, or 67.9% of sales in the third quarter of 2010. This year-over-year increase in cost of sales was driven by the volume increases in target market programming and the increasing raw material costs, namely steel.

If you recall, we implemented a 1% steel surcharge in April 2011, expecting steel inflation to peak during the summer and to recede by the end of the third quarter. Although steel costs have been softening recently, they did not decline as quickly as we had anticipated; thus we expect a similar impact on our fourth quarter results.

SG&A was $6.5 million for the quarter, a decrease of $300,000 over the prior year. Current quarter SG&A includes $876,000 for acquisition-related legal and consulting fees. In a unique situation, we explored two large potential acquisitions during the quarter, but ultimately decided to walk away from both deals based on valuation. As we've said in the past, we believe strategic acquisitions will be a part of our long-term growth strategy, but we will remain disciplined in our approach to these acquisitions.

Prior year SG&A expense included a one-time stock compensation charge which totaled $1.2 million, which relates to executive stock option expense exercised in 2010. Excluding the impact of the nonrecurring cost, normal SG&A expenses were essentially even with the prior year.

Third quarter 2011 adjusted EBITDA was $12.1 million compared to prior year adjusted EBITDA of $11.6 million, an increase of $500,000. Adjusted net income in the third quarter of 2011 was $4.5 million compared to prior year adjusted net income of $3 million. Adjusted earnings per share was $0.21 per share for the third quarter 2011 compared to $0.14 per share in the prior year, an increase of 50%.

Net cash used in operating activities September year to date 2011 was $18.9 million compared to prior year net cash used in operating activities of $38.4 million. This improvement was driven by working capital changes and nonrecurring cash costs incurred at the time of the Company's initial public offering in the second quarter 2010.

Cash on hand at the end of the third quarter totaled $3.1 million. The unused borrowing capacity on the revolver is $46 million. With total liquidity of $49.1 million, we are well positioned to fund upcoming dividend payments.

Accounts receivable levels of $83 million are slightly higher than a year ago through nine months. Inventory levels of $27.1 million are $2.6 million higher than the prior year third quarter. Inventory levels in 2010 were lower due to reduced production levels during the Johnson City plant closure. Current year levels of inventory more appropriately reflect a normal inventory position heading into the fourth quarter.

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

Thanks, Bob. To close, I'd like to share our review of the current market conditions as well as what we are expecting for the remaining portion of 2011.

Throughout the third quarter, we focused on executing against our preseason sale objectives. As we enter the beginning of our winter retail season, we remain positive. While we believe the overall economy will continue to have a dampening effect on the regular replacement cycle, we are encouraged to see a slow return to a more normal environment.

Retail equipment sales activity is beginning to show improvement. At the same time, sales of parts and accessories continue to be very strong, trending higher than the average when compared to the preceding 10 years, which we believe is largely the result of the heavy product use during the past winter. While we believe there will be a gradual unwinding of pent-up demand over the next several years, we do remain cautious about the pace of the economic recovery.

Finally, based on our year-to-date results, positive industry drivers, and dealer mindset, we are confident our results for 2011 will be in line with our previously issued guidance. We expect sales for the full year 2011 to range from $185 million to $215 million and adjusted EBITDA of $48 million to $58 million and adjusted earnings per share of $0.76 per share to $1.04 per share.

As we've said in the past, the biggest variable factor in determining our fourth quarter results is the timing and location of snowfall. The earlier and larger amount of snow that falls in our core markets is a good indicator that we will see increased fourth quarter sales, and the opposite is also true.

While the unusual recent East Coast storms were difficult for those affected, it is certainly positive for our business. Early snowfall makes businesses and homeowners more likely to contract for plowing services, and subsequently, plowers are more confident in their income outlook for the season, and therefore, they're likely to consider new equipment purchases versus repair. So each year, we always hope to see a white Thanksgiving as well as a white Christmas.

We will now open the call for your questions. Operator?

(Operator Instructions.) Jason Ursaner, CJS Securities.

I guess I'm just trying to get a snapshot of the end of September. You mentioned your inventory check, that there was activity that you saw, but right at the end of September, where were inventories to where they were last year? And the 10% growth in preseason orders, was that just to get guys back to where they were at pre-recession levels, or is it still that post-recession inventory level?

Actually, I guess a couple of questions there. Inventory levels over the past four or five years haven't really changed much over the last four or five years. Our distributors, in general, manage inventory levels throughout the year, I think, very effectively and very efficiently. So many other industries may have gone through some pretty significant inventory spikes. We haven't really experienced that.

Now, having said that, while I don't give detailed specifics on where inventory is at the end of September, field inventory was down slightly, and retail activity was up quite nicely. So basically, what that indicates for us is that there is some pull going on in the marketplace, which is a very positive driver for us, but our distributors to this point are still trying to sell down inventory. They're going to watch inventory very closely. But that chain of events is very positive for our business.

So is the right way to be thinking about it that so far, based on marketing activities, the retail's been strong, and now we're getting to that point where we're waiting for the weather-driven demand?

Yes, I think that's pretty fair. I think, again, the last couple of years, we've been saying that product is being used pretty hard. We've had great snow last winter, which is a good setup for our business. The real issue is, what is the impact of the economy, and that's difficult for us to really lay over this. And it is a little bit challenging to forecast, but the good news is I believe that there's some enthusiasm on the retail side that certainly is higher than it has been the last couple of years, at least at this particular period of time.

Now, you don't want to draw the straight line and say you had a good inventory retail period of time, so let's straight-line it. But I think it's a good trend, and we put that in the bucket and say we'd like to see this continue. But fourth quarters, to your point, really is driven based on snowfall -- where it falls, when it falls, how much falls.

I guess I was more asking, are you looking for it in Q4, or if you really draw down those inventory levels with a strong snow season, that you're talking more about next year's preseason? Or does it flow through pretty immediately if you have low inventory levels?

You'll have to ask the question again. I want to make sure that I understand. Bob, do you --

Yes, I think what Jason's trying to figure out is if there's some retail pull and that type of thing. Are we going to see a positive impact of that in Q4, or will it flow into next year's preseason order period?

Yes, if that's your question, the answer is, again, if you have good snow and you have good weather in the fourth quarter, you will see it in the fourth quarter. If the weather and the conditions continue -- positive truck sales and those kinds of things -- you may also see it flow into the first quarter.

Okay. And then just the last question for me, and I'll let some others go. The shift in preseason -- how much of it do you think is now permanent, given your changes in manufacturing? You mentioned storage is a factor, this new packaging you have. Is it a permanent shift to Q2 that people should be assuming, or is there still room to shift back?

Yes, that's a great question, and it's one that we do think about it as it impacts manufacturing. I don't think that we have enough data at this particular point to make any conclusions, but I think it's certainly something we'll talk about.

Again, from my perspective, we don't over-analyze it, because we have always looked at preseason as an entire period, and it typically hasn't really mattered to us very much whether it came in the second quarter or third quarter.

Got it. Okay, I'll let some others go. Thanks.

Robert Kosowsky, Sidoti and Company.

I was wondering if you could maybe go through the gross margin impact this year versus last year, maybe separate it into buckets -- raw materials versus this in-target market program, just define what that is a little bit more -- and then also talk about the productivity impact. I'm sure that that had an impact on the gross margin as well.

Okay, let me start answering that, Rob, and I'll let Jim talk about some of our customer programming efforts. When you look at the margin change in the quarter year over year, about half of that is on the steel side. And just to cover that quickly again, our steel pricing is based upon a 90-day lag. So what the actual CRU index pricing is for steel in the third quarter is what we'll pay in the fourth quarter.

So when steel stayed up a little longer than we thought, during the second quarter it went a little higher than we thought, the price we paid for steel is higher in the third quarter than we anticipated. And again, it's about half of that margin degradation. We do expect a similar position in the fourth quarter, because again, we are paying third quarter steel prices in the fourth quarter.

Now, the good news is that steel has come down to a point, and it looks like it's going to stay at a reasonable level. And by the time we turn the calendar, we should be fine. So that leaves the other half of the margin change year to year --

As far as the margin change, like that was half of the margin degradation, I guess? That with the markup?

The variance year to year, yes. The other half would be in these two areas where we're positioning ourselves to take advantage of some market growth opportunities, and I'll let Jim discuss them a little bit.

Sure. The other two areas you touched on were the prepackaging system and target market activities, both of which we look at as being hugely opportunistic. The packaging first, as we talk about that, is that over the last few years, we recognized that there's some pent-up demand out there. And as pent-up demand comes back, we wanted to position ourselves where we thought we could pick up some market share by allowing our distributors to make more installations in less time.

Typically, when pent-up demand comes back, you'll see it in the fourth quarter. Everyone's busy. But if you do the math and determine that you can take an installation that might have averaged 5.5 hours and now make it 3.5 hours, you can install a lot more plows per day as a distributor.

And the other thing that we recognize is a lot of these people have laid off technicians over the last few years, and they're very reluctant to hire people back on. So until they hire people back on, we're trying to determine ways that they can do more installations in less time. We think we can pick up market share with this packaging.

As far as target market, along the same lines, as we see pent-up demand at least initially starting to come back, we think there are opportunities, certain opportunities, in the marketplace to pick up market share by proactively targeting some specific types of customers, some specific geographies. So as things come back and people who have not been in the market for four or five years, or six years, for a plow, we want to make sure that as they're deciding what kinds of products they want, that we're top of mind in taking advantage of the scenario.

So I don't go into too much detail because, frankly, I think what customers and where we're doing this, I'd rather our competition not know.

Okay, now, the second initiative -- does it take the form of discount pricing? Is that why it shows up on the gross margin the way it does?

Yes, it can be a variety of things. It could be advertising. It isn't one size fits all. So it's advertising in some situations, it could be pricing to distributors, and it could be some retail incentives as well.

Okay. And then what is the capital cost on this new prepackaging system? Is there a payback that you guys have in mind on it? And just thinking back on CapEx, too.

The capital for this equipment that we ran into at both of our plants was fairly nominal. I think it was around $200,000. We don't, essentially, do many capital projects that don't have a one-year payback or less, Rob. But this one, if you will, it's hard to compute the payback because, as Jim mentioned, the payback is really protecting/gaining market share. So it paid itself back fairly quickly.

It will result, if you think about what we're doing, Jim made a comment about short-term increase in our unit cost. We are doing a lot of the preassembly of our product that our distributors used to do in their own shop. So obviously, our costs are going to go up. Over time, we will mitigate that through some automation because quality gets better because you're doing some of the preassembly. We'll see some reduced warranty costs. So short term, it's going to have a standard cost impact. Longer term, we ought to be able to neutralize that. But throughout the entire process, it really should be something that helps us increase revenue.

Okay, but longer term, if everything goes according to plan, you see it as being margin neutral, but you've added in on the top line?

Right, longer term. It will probably take us 12 months to get to that point. It's something that we'll be working on next year in 2012.

Okay, and then one final question. I think you mentioned that pricing, you guys took a 1% price increase this year. Did I catch that right?

Actually, we took a 2% price increase in our normal July 1 pricing timeframe. We took a 1% surcharge back in April, solely to try and anticipate what we needed to do to cover the cost of steel inflation.

Okay, thank you very much.

(Operator Instructions.) Hamzah Mazari, Credit Suisse.

This is Chris Parkinson on behalf of Hamzah. A very brief question. You mentioned you walked away from two deals during the quarter due to valuations. Can you broadly comment about your overall opportunities there? And is it more of a focused area of the market, or are you exploring several different verticals to enhance your overall platform?

Yes, I'll talk a little bit from 20,000 feet, and then I'll let Bob comment a little bit on some of the things that we look at. From 20,000 feet, which we've mentioned to people all along that we want to be opportunistic with acquisitions. The places that we're likely to look are probably, at this point, in three areas. One is, clearly, snow and ice removal, something that we're in today. We're looking for opportunities there. The second place that we would also look would be in the attachment space, which is an adjacent space. And the third place we would look is truck equipment, which really utilizes much of the same distribution that our current product line looks at. Those would probably be the three primary areas that we would look at.

Bob, I'll let you comment on the other question.

Sure. Again, as we've said many times, when we look at acquisitions financially, they certainly need to be accretive, and not just a little bit. They have to be nicely accretive. They have to stand alone on a free cash flow basis, because remember, this is a free cash flow, dividend-paying business model.

And we also watch leverage ratios fairly closely. Again, remember that this dividend is sized to be comfortably payable when the snow part of our business is in its trough, so making sure that our leverage ratios stay in a reasonable neighborhood of not to exceed 4 for any permanent length of time. Those are the legs of the stool that we look at financially.

And as Jim said, a couple of opportunities came up in these target areas that were fairly sizable. We chased them hard, and we chased them up to a point where they just didn't make financial sense for us anymore. As we've said many times, we're not in this business to grow the business for the sake of growing it. We've got a great business model, and we will be opportunistic, we will be disciplined, and so we took a pass when all the dust settled.

Perfect. Thank you. And just a quick follow-up. You also briefly touched on this earlier, but can you quickly update us on what you're hearing from your distributors based on geography? And do you think there are any notable differences, based on last year's snow season?

Just to make sure that I understand, just generally, what are you hearing from distribution and is there anything that is unusual? Is that what you're --

Yes, essentially there, and if you're seeing any notable differences based on geography, if you think some certain geographies would be more optimistic, based on the last snow season?

Okay. It is interesting. Most truck equipment distributors are a little bit like people in the agricultural business. They're generally pessimistic people by their nature, which is okay. You just have to understand it. We are seeing some level of optimism, and I don't want to overplay this. But there is some optimism in areas that, frankly, hasn't existed for a little while. And it's making people feel good, but they're very careful. They're not hiring more people. They're not hiring more technicians. They're cautious about bringing inventory in, but they are selling more at retail this year, which is a good thing.

So I think there's general optimism, and it's pretty broad. The areas where there might be a little less optimism were the areas that didn't get much snow last year, and that would really be the mid-Atlantic and probably the Toronto-Montreal area of Canada. I think they really had somewhat below-average snowfall. But everywhere else, I think we're seeing just general cautious optimism, which can be interpreted as a potentially good sign, as long as weather and the economy just stay in check and nothing unusual happens.

Perfect. Thanks, guys.

Robert Kosowsky, Sidoti and Company.

Hey, Jim, I just wonder if you can go over the electronics, the new electronics on the new prepackaged system?

Sure, sure. Understand I'm not an engineer, and I'm not going to pretend to be one. But I'll tell you what the system does do, and I'm glad you asked, because this is a feature that is probably overlooked by the general public. But if you are a large fleet distributor, this is hugely important. And the reason it's important is historically there was only, really, one kind of plow, and that was a straight plow. It angled left, angled right. Today, because of productivity demands, we're introducing a lot more kinds of products, like V-plows, power plows, that have much different electronic hydraulic requirements, much more sophisticated.

What's happened in the past is if an end user bought a straight blade, he couldn't put a hinged plow on it. He had to, he basically married that plow to that truck which, from a fleets perspective, if I have 30 trucks and I have 30 plows, I want to have the ability to take any one of those trucks and any one of those plows and put them together for different applications. And so I think this will have a tremendous advantage to very large fleet customers, where we're providing flexibility now where they can schedule vehicles for maintenance and not lose the productivity of a certain plow. Does that help?

Yes. So basically, previously, you needed an individual plow for an F150, 250, or 350, but now you might be able to use the same plow?

Yes. You still do need, for an F150, you probably still need a certain type of plow based on its weight. But if you take a 250 or a 350, now, because I have a common electrical system, I could probably take a Pro-Plow, which is our largest-selling straight plow, I could put that on a 250, or I could put our smaller V-Plow on that 250.

So it gives a lot more flexibility as to what an end user can do with his fleet. Because if you think about it, fleet vehicles are constantly in for maintenance. They're down, they're being used for a variety of different reasons. And now you can really maximize your efficiency as a plower by matching up your vehicles.

Okay, thanks, that's helpful. And were any of the acquisition targets bought recently? I don't know if you can disclose that.

I think we'll stay away from that.

Okay. Thank you very much, and good luck for the fourth quarter.

Thank you. I'm showing no further questions at this time. I would now like to turn the call back over for closing remarks.

Great. Again, closing, thank you all for your interest in Douglas. We look forward to speaking with you again next year to discuss our fourth quarter results. And thanks again. Have a great week.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day.