Sarah Lauber - CFO Jim Janik - President and CEO Bob McCormick - COO.

Ryan Sigdahl - Craig-Hallum Capital Josh Chan - Baird Chris McGinnis - Sidoti & Company.

Good day, ladies and gentlemen. Thank you for standing by and welcome to Douglas Dynamics Third Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I will now turn the conference over to our host, Sarah Lauber, Chief Financial Officer of Douglas Dynamics. You may begin..

Thank you. Welcome, everyone, and thank you for joining us on today's call. A few quick items before we begin. First, please note that some of the information 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 Discussion and Analysis of Financial Condition and Results of Operations included in our Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission and the impending updates to these sections in our 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're required to reconcile with the most directly comparable GAAP measure.

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 today is Jim Janik, our Chairman, President and Chief Executive Officer and Bob McCormick, our Chief Operating Officer, who will be available to answer questions.

Jim will begin by providing an overview of our performance. Then I will review our financial results before turning it back to Jim to discuss our outlook. After that, we'll open the call for your questions.

Jim?.

Thanks, Sarah, and good morning, everyone, and thank you for joining us. Overall, we're pleased with our performance for the quarter and year-to-date. And we are confirming our outlook for the year despite ongoing supply headwinds.

Results were in line with our expectations, producing net sales of approximately $125 million and net income of approximately $10 million or $0.43 per diluted share. As many of you know, our commercial snow and ice management products' preseason ordering period extends across the second and third quarters.

As we expected and stated last quarter, this year's preseason saw an approximate 60% to 40% sales split between the second quarter and the third quarter, which is a larger swing towards the second quarter when compared to historical averages of 55% to 45% split, which we've seen in recent years.

The main reasons for our strong preseason performance for our commercial snow and ice control products is that snowfall levels reverted to more historical averages this past winter after two years of below-average snowfall across North America. This created stronger demand and robust preseason orders.

Additionally, we slightly altered our order program this year to encourage a few more early orders in anticipation of material inflation growing later in 2018.

We continue to receive positive responses to the new products launched this year, which included completely redesigned heavyweight plows that focus on Class 3 through Class 6 trucks and two new versions of our productivity-enhancing expandable plows for both our FISHER and WESTERN brands.

Both the return to average snowfall and the great set of new products launched produce a stronger preseason overall compared to recent years.

In September, we completed our quarterly dealer field inventory and found that they were up slightly as dealers are expecting a stronger retail season compared to the last two years, which is in line with our expectations.

In addition, sales of select pickup trucks continue to be generally favorable, increasing 1% in the first nine months of 2018 compared to the same period last year. As we noted last quarter, chassis availability remains an issue for both our municipal products and our Work Truck Solutions segment.

The ongoing surge in demand for Class 4 through 8 trucks has limited our access to chassis, causing inefficiencies and delays.

While we are frustrated by these issues and believe they will continue for the entire industry for the foreseeable future, we remind ourselves that they are also the results of very encouraging demand, backlog and order trends. Overall, these industry-wide limitations do not impact the long-term growth prospects for Henderson and Dejana.

The Work Truck Solutions segment generated a positive revenue increase this quarter based on a generally stronger order pattern. However, the supply constraints I just mentioned are impacting efficiency, which is reflected in our lower margins.

Our teams are working with OEM partners, suppliers and colleagues across the industry to find solutions and do everything they can for our customers. Now, I'd like to share an example of how DDMS is positively impacting our company. As you've heard me say before, DDMS is most effective when it becomes embedded in a team's culture.

That process is well underway at both Henderson and Dejana. During the quarter, the van interior upfit team based in our Dejana facility in Baltimore, Maryland held cross-functional Kaizen events to create a series of planned activities to improve both vehicle and material flow within their facility.

By eliminating waste and consolidating warehouse storage, the team was able to double the number of production lanes in the same space footprint, allowing for higher velocity of throughput during any given shift. This also increased our storage density within the warehouse, allowing for more efficient picking of materials and inventory control.

Turning to our cash usage priorities. We paid a dividend of $0.265 per share of our common stock at the end of September. Our plan remains the same, to maintain and grow the dividend in a sustainable manner, in line with our commitment to returning excess cash to shareholders. Finally, I want to reiterate a point I made last quarter.

We continue to see a tightening of multiple supply lines throughout the industry. As an example, we've seen longer lead times for certain hydraulic components and assemblies across the board. We believe the entire supply chain is struggling to increase capacity to meet this near-term demand, particularly due to labor shortages.

In addition, steel inflation related to the tariffs imposed has been significant this year, and we're seeing other inflationary increases across our other direct material spend. While our use of domestic steel and smart purchasing practices have impacted us less than other manufacturers, we are monitoring the situation very closely.

We do expect to substantially recover the price inflation over time using pricing surcharges, and our quotes for new business reflect the current pricing of raw material.

The overall impact on our financials will fluctuate in the coming quarters, but we are well positioned to manage through the situation given our nimble business model that is used to adapt to and adjust to rapidly changing environments. It's usually snowfall, but the approach is the same.

Our structure, market position and DDMS culture will allow us to manage through these challenges as well as or better than the competition. With that, I'll turn the call over to Sarah to discuss the financial results in more detail.

Sarah?.

Thanks, Jim. I'll begin with our consolidated earnings and follow with a look at how our two segments performed and conclude with liquidity and the balance sheet.

Reiterating Jim's opening remarks, we capped off a strong preseason for our snow and ice control products during the third quarter and we look to continue the momentum into the end of the year and into 2019.

For the third quarter of 2018, we recorded net sales of 124.8 million, relatively flat when compared to net sales of 125.3 million in the same period last year. The slight decrease was primarily driven by the timing of preseason shipments and ongoing chassis availability issues in Work Truck Attachments.

However, to a large extent, this was offset by higher demand within our solutions segment. Gross profit for the quarter was 34.9 million compared to 36.1 million in the same quarter last year.

As a percentage of net sales, gross profit was 28% compared to 28.8% in the corresponding period of the prior year, mainly a result of inefficiencies due to chassis supply and increased volumes at Work Truck Solutions that operate at lower margins than Work Truck Attachments.

SG&A expenses were 16.6 million compared to 12.9 million for the third quarter of 2017. The increase in SG&A expenses was attributed to a non-recurring reversal in the prior year of an earn-out liability associated with the Dejana acquisition.

In addition, within attachment, there's a return to more typical spending compared to the last two years when we had implemented the low snowfall playbook. We produced adjusted EBITDA of 20.5 million compared to 24.2 million for the same period last year.

The decrease is primarily a result of lower municipal volumes due to chassis constraints and increased spending in Work Truck Attachments when compared to the low snowfall environment of 2017. Net income was 9.9 million or $0.43 per diluted share compared to net income of 9.3 million or $0.40 per diluted share in the same period of 2017.

On an adjusted basis, net income was 10.1 million or $0.44 per diluted share compared to 9 million or $0.39 per diluted share for the third quarter of 2017. The improvements reflect the impact of lower income tax expense.

Interest expense was 4.4 million for the quarter, a slight decrease compared to the 4.9 million incurred in the same period in the prior year. Our effective tax rate for the third quarter was 10.4% compared to 38.1% for the same period in 2017.

The decrease was due to the lower corporate tax rate resulting from the Tax Act that went into effect in last December plus discrete items in the current period that lowered our overall tax expense. Now that we have greater visibility, we believe our effective tax rate for 2018 will be in the range of 21% to 23%.

Looking ahead, we expect our effective tax rate to return to the new normal range of 25% to 27% in 2019. Turning to the results for the two segments. Work Truck Attachments recorded revenue of 93.5 million and income from operations of 18.5 million.

The segment's revenue and income from operations were 98 million and 23.1 million, respectively, in the same period in the prior year. The changes are mainly driven by the timing of shipments for commercial snow and ice control products and the ongoing chassis supply availability issues.

With this past winter producing snowfall amounts close to historical averages, results for commercial snow and ice products were stronger than the 2017 preseason and in line with our internal expectations.

Also as expected, 2018 preseason sales of commercial snow and ice products were more heavily weighted towards the second quarter versus the third quarter in an approximate 60% to 40% split compared to the more typical 55% to 45% split experienced in recent years.

The Work Truck Solutions segment recorded revenue of 34.7 million and income from operations of 100,000. In the same period last year, the segment's revenue and income from operations were 32.2 million and 1.8 million, respectively.

The increase in revenue is mainly attributed to generally improved demand, while the decline in operating income is a result of a non-recurring reversal in the prior year of an earn-out liability associated with the Dejana acquisition. Now, I will outline the balance sheet and liquidity figures for the quarter.

Net cash used in operating activities for the first nine months of 2018 was 17.9 million compared to the same period in the prior year net cash used in operating activities of 700,000. The increase in cash used in operating activities was mainly driven by two items.

First, we made a 7 million voluntary payment to our pension plans in order to take advantage of a higher tax deduction. With this payment, we expect our pension plans to be fully funded by this time next year.

Second, as we are actively managing through both tightening of supply chains and tariff inflation, we temporarily increased inventory levels to help ensure delivery times to our customers, and in some cases, opportunistically locking in pre-tariff pricing.

Accounts receivable at the end of the quarter were 128.2 million compared to 117.5 million last year, mainly due to higher sales this year compared to 2017. Inventory was 89.4 million compared to 77.4 million of inventory at the end of the third quarter of last year, related to the strategic buildup of inventory, as I just discussed.

Total liquidity at the end of the third quarter was approximately 61.4 million compared to last year's liquidity of 75.7 million. Net debt of 316.8 million at end of this quarter is down from 330 million in the same period last year. Our net debt to leverage ratio has declined from 3.6 times last year to 2.9 times at the end of this quarter.

In summary, we're very pleased with our preseason results for commercial snow and ice products and believe the demand trends we see across all areas of the company bode well for the future. We continue to work through tariff, inflation and supply availability challenges and are motivated by opportunities and the future potential that we see.

With that, I'll turn the call back over to Jim..

Thanks, Sarah. So far, 2018 is unfolding as we expected, and we feel positive about our long-term prospects for the future.

As you probably saw in the release, we are affirming our 2018 guidance based on our visibility into the positive demand trends in the market we serve, the ongoing stability of the overall economy and the continued strength of truck sales. Of course, we are assuming we see average snowfall during the quarter.

As we stated last quarter, net sales for the full year are predicted to be between 490 million and 535 million. This should produce adjusted EBITDA in the range of 90 million to 110 million. We are also maintaining the range for adjusted earnings per share of between $1.75 and $2.05.

Our full year adjusted earnings per share will benefit from the lower effective tax rate, as Sarah just discussed. In summary, we are well positioned to execute on our strategy going forward, deliver results in line with our 2018 guidance and manage the business effectively despite supply headwinds.

We will continue to leverage DDMS across all aspects of our business, to optimize our performance and ensure when chassis supply returns to normal, we are in a stronger operational position, able to capitalize on that demand.

Finally, as a reminder, this is my last earnings call as President and CEO before I transition to the Executive Chairman role at the end of the year. We announced in August that Bob McCormick will assume the President and CEO role on January 1.

Bob is a natural choice for the job given his demonstrated success in both the Chief Operating Officer and Chief Financial Officer roles at Douglas and his proven ability to enhance culture and ensure that our customers remain at the center of our strategy.

I know that Bob will hit the ground running, and I look forward to continuing the strong and effective working partnership we have forged over the past 14 years. Starting in January, I will focus primarily on strategy development, mergers and acquisitions, investor relations and executive talent development.

It really has been my privilege to lead this team and look forward to continuing to serve the company going forward in my new role, and I'll still participate in the next earnings call to answer questions and will remain involved in the IR program. With that said, we'll now open the call for questions.

Operator?.

[Operator Instructions] And our first question is coming from the line of Steve Dyer with Craig-Hallum Capital..

Ryan Sigdahl on for Steve. Congrats, Jim, and good luck going forward..

Thank you very much..

As it relates to the chassis and component shortages, I know you said you expect the headwinds to continue for the foreseeable future, but can you provide any more specific expectations maybe when we could see some easing there?.

Yes. This is Bob. That's a tough call. We've been seeing this in our Henderson business throughout the course of the year and most recently are seeing it more in our Dejana solutions segment. We've been tracking production capabilities of the OEMs.

And while they have increased production slightly, they are not increasing it at a pace robust enough to match existing demand. So from that standpoint, we believe we're going to have this chassis challenge, if I can call it that, during the fourth quarter and as we enter 2019. But here is how we think about this, okay.

This is no different than a low snowfall year playbook, okay. So when we have these challenges, and they certainly impact margins over the near term and things like that, we will double down on our DDMS initiatives so that when we exit this chassis challenge, we'll exit stronger than when we went in.

And I think the other point Jim made that I want to make sure is front and center for everybody here is that our backlog and order activity remain very strong.

So while we're affirming guidance for 2018 given these headwinds, when these chassis come back and when this thing eases up a little bit, we're going to be very well positioned to have a strong 2019 and beyond..

As we - maybe just a follow-up on that.

As we look into 2019, it sounds like although the headwinds will persist at the beginning of the year, for sure, is it - should we assume kind of a full year of headwinds maybe next year? And with that said, do you think the DDMS-driven productivity improvements are enough to kind of offset that headwinds and able to maintain or if not grow gross margins year-over-year?.

Yes. That's a very loaded question there. I mean, you've got 2 or 3 significant points. I think from a planning perspective, we are wise to assume that the chassis shortages are going to be with us for a decent part of 2019. We have made requisite adjustments in staffing levels inside of our businesses.

As I mentioned, we're doubling down on our DDMS efforts. And while we've seen the positive improvements of those things, it gets a little hidden.

When you've got Dejana as an example, where we've opened up four new locations in the last 18 months to support a growth initiative, we have the orders to support a growth initiative, but we have chassis constraints. That's going to have some near-term margin impact definitely.

I will suggest that we think solutions margins have seen their bottom at this point. And we would expect through the DDMS initiatives, we expect through the chassis becoming more available over the course of 2019 that we're going to see longer-term margin improvement for Dejana. And I would expect the same thing in Henderson..

Great. It's helpful. Switching to your contracts, I believe you're taking surcharges on steel.

But is there other raw materials that you also include? Or is it just primarily the steel? And then you try and price the contracts based on what the current price are of the other components?.

Yes. Excellent point. We have to be careful not to go out to the market multiple times with these increases. So we've kept our eyes on these tariff. There certainly has been other raw material inflation.

And so when we take a surcharge or when we take a permanent price increase or when we increase the pricing that's in our quotes, those price increases include all the material inflation that we see, the tariff impacts that we can predict and also the cost of labor inflation as well..

Great. Last one from me, and then I'll hop back in the queue.

Is it reasonable to assume a large chunk of the seasonally strong free cash flow in Q4 will be used to reduce debt? And then does the higher interest rates change your target leverage ratio or even your capital allocation strategy?.

Yes. Certainly. Great question. So yes, we have a strong seasonal fourth quarter from a free cash flow perspective. Our capital priorities haven't changed. We will still be looking at next year where our dividend level will be. And then we will next look to what our pay-down on debt is.

Being at 2.9 times now, and that will go lower through the end of the year with the cash coming in, I would say it doesn't really change our target level. We're comfortable with where we're going to be at the end of the year. We've taken a lot of strides in our debt structure with mitigating the variable interest exposure.

We go to 50% variable next year and then 30% variable the following year. So I guess that being said, I wouldn't say anything changes with our decision approach, very much on course with the way we've been thinking about things to date..

And our next question coming from the line of Josh Chan with Baird..

Can you hear me now?.

Yes, yes, we can..

I wanted to ask about the Henderson business. It sounds like that maybe the chassis constraints got a little worse in the quarter.

Is that the right read? And I guess to put a finer point on kind of that '19 expectation, should we assume maybe some declines kind of heading in the beginning of the year?.

Yes. That's an interesting point, Josh. Certainly, we've been speaking to lead times for Class 8 chassis being out 6, 9 plus months throughout 2018. But as Jim noted earlier, the entire supply chain even past the OEMs are seeing labor shortages and are missing even some of their stated lead times.

So if we have a slot to get a chassis, a Class A chassis 9 months after we placed the order, we are finding those OEMs are missing those promised dates by 30 to 45 days because they're having supply chain issues. So it's - there's a ripple effect throughout the entire industry.

We are getting - we are seeing some improvement in the fourth quarter chassis flow. But it still will likely be a challenging environment for a while. Again, I will reiterate at Henderson the same thing that I did for Dejana. Orders and backlog are at very robust levels. DDMS initiatives have been deployed.

They are taking advantage of our global sourcing capabilities through our China sourcing office. So we are positioning Henderson that when this chassis issue softens up a little bit, that we're going to exit strong..

All right. And then switching to the attachments business, it sounds like that the price increase next year might be larger than what it has been in the next - last couple of years.

So just wondering from a competitive perspective the envisioned - that being able to pass through entirely and that you'd be able to kind of fully offset the cost headwinds..

Josh, this is Jim Janik. We haven't decided yet what we're going to do on pricing next year. So I think that's probably a little premature. We're going to kind of see where inflation is, where competition is and sort of take that when we look at it next year..

And our next question is coming from the line of Chris McGinnis with Sidoti & Company..

I apologize if this has been asked. I've been on a couple of calls.

Just in relation to the chassis headwind you're running into, can you maybe talk or quantify how much of that is holding you back in growth in both of the segments?.

Yes, we're not going to get into that level of granularity, I guess. I guess the best way to think about it, Chris, directionally would be that both Dejana and Henderson, our businesses that have a long record of top line growth, and we envision those businesses to have a long future of top line growth.

And had we had chassis available in both of those businesses, we'd be seeing top line revenue growth in 2018 and 2019. And that's what we're focused on because that's what we can control. There isn't anything that changes in those two businesses from our long-term business model perspective..

Chris, this is Jim Janik. Let me add on to that. It's that why even ask the question, some had said, how does this - how do you look at the remainder of the year and '19? We look at things we can manage and things that we can't manage. And frankly, the things we can manage right now are very positive.

And even some of the things we can't manage right now are very, very positive. The only thing right now that is really that headwind that is - that we can't manage is truck availability and some of the supply chain issues that we have.

But I think we're doing an incredible job of managing through those to the point where we've reaffirmed for full year. And as we look at 2019, we're optimistic about '19 in spite of the headwinds because I think we're doing such an incredible job of managing it plus there are some things we can't manage that are still very, very positive.

So we're enthused about '19..

Great. And I guess just a follow-up on thinking about maybe next year. I know it's a little early, but you've had some time with the newer sites around Dejana.

Do you have any, I guess, thinking about 2019, even with the chassis concerns? Are you expecting maybe to start to grow that footprint a little bit more?.

Well, hey, listen, we bought this business partially because of the strong growth track record, and we consciously made investments in some new facilities with the longer-term growth outlook. So we could not predict the chassis limitations that we've had. So we've got some fixed costs in place. We've got some headcounts that are in place.

And from that standpoint, we are seeing some short-term margin degradation, but we really believe that the order book that will be allocated to these locations is going to play out just the way we hope it would once we have free access to chassis in 2019 and going forward. So no, no changes to our long-term plans there.

Sometimes you make investments and it hits - come out of the blocks. And sometimes it takes a little while longer. The other point that I would make, we've been referencing very strong orders and backlogs. We don't expect to lose many, if any, of these orders. These things will not be canceled.

If our teams can't get chassis, I promise you that our competitors are not getting chassis either. So this is just - it isn't a matter of if. It's a matter of when these orders finally get broken loose and upfit and shipped..

[Operator Instructions] At this time, I am showing no further questions. I would like to turn the call back over to Mr. Jim Janik, Chairman, President and CEO, for closing remarks..

Thank you, operator, and thanks to all of you for your interest in Douglas Dynamics. And we look forward to seeing some of you tomorrow at the Baird Conference in Chicago. Have a great day..

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone, have a great day..