Good morning, ladies and gentlemen and welcome to the Douglas Dynamics Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] I would now like to turn the call over to Ms. Sarah Lauber, Chief Financial Officer of Douglas Dynamics. Please go ahead..

Thank you. Welcome, everyone. 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 Bob McCormick, our President and Chief Executive Officer.

In a moment, Bob will provide an overview of our performance then I will review our financial results. After that, we will open the call for your questions. With that, I will hand the call over to Bob..

First and most familiar, the impact of snowfall.

As expected, we saw lower preseason orders in our attachment segment, followed by two consecutive years of below average snowfall in key markets, particularly the Northeast; second, the impact of the pandemic from our shutdown to the impact on our OEM partners and the overall economy; and finally, ongoing chassis chain – ongoing supply chain constraints in the Solutions segment.

With that said, it’s important to remember that our organization is primed to continually adapt to changing external conditions, and we remain confident in our ability to maximize our performance, focusing on the factors within our control. Now I’ll talk in more detail about the segments.

First, attachments, following 2 years of below average snowfall in key markets, our preseason period unfolded essentially as we expected, albeit at lower volumes than last year.

As you would anticipate, some of our dealers are more conservative with their ordering this year and are likely to rely on our industry leading lead times to turn orders as they come in when the snow flies in the fourth quarter.

In terms of dealer activity, it’s encouraging to note that the approximate same percentage of dealers opted for cash terms this year as they have in previous years, indicating both the general financial strength and confidence in the future of our dealer base.

At this point, our network seems to be holding up well in the midst of this challenging economic environment.

One of the positive things about our Attachment segment is that because of the influence of weather for the past 70 plus years, this team is not only accustomed to, but actually thrives on the rigors of constantly changing business conditions.

Even prior to the emergence of the pandemic, our attachments team was expected a much tougher year than 2019 and had already pulled out the low snowfall playbook and began pulling levers to reduce costs and preserve cash.

While the lack of snowfall and the pandemic have occupied the spotlight so far in 2020, I remain impressed with our attachment team’s resilience and ability to remain focused on delivering on our long-term initiatives, including rolling out our new product launches.

Our half-ton deep plow offering was well received in the market, and we are very encouraged by the adoption and early order trends that we are seeing for this and other new products. That brings us to Work Truck Solutions.

As you may know, our facilities are located in areas that were originally heavily impacted by the coronavirus throughout the Northeast and mid-Atlantic during the spring and summer. Thankfully, this situation has stabilized and improved in some of the areas, although nowhere near back to normal.

As I said before, even in the Northeast, we were able to bring back 99% of our workforce in early May and are operating at near-normal levels to date. The teams at Dejana and Henderson have noted their appreciation of all of the safety initiatives that have been employed.

Overall, the restart is going according to plan, and we are in constant communication with our OEM partners and component suppliers, as they safely begin to ramp up production. Of course, each partner is going through their own specific start-up plan.

And while we are encouraged to hear their progress so far, we do expect there will be supply issues during the second half of the year. The good news here is that we still receive more pooled chassis than our competitors, and we have not seen cancellation of orders.

In fact, in June, we saw a noticeable uptick in commercial orders at Dejana, when compared to the same time last year. This is a positive sign that customers on the East Coast are getting back to business, and this bodes well for the long-term prospects at Dejana.

Despite pandemic related challenges, the municipal snow and ice control operations at Henderson are making good headway so far in 2020. We continue to have a strong order book and a healthy backlog, both of which we have seen for quite some time.

Additionally, we have not seen any canceled orders despite the challenging economic environment and do not expect this to become a major issue, given the recession-resistant nature of snow and ice control budgets due to the importance of safety and maintaining commerce.

As for Class 7 and 8 truck chassis, we began to see an increase in chassis availability in Q1 as expected.

Obviously, the pandemic driven OEM shutdowns will impact availability during the second half, but it’s important to note that we believe that when OEMs complete their production ramp-ups, our Class 7 and 8 chassis supply will improve significantly, and we’ll see improved financial performance as a result.

Overall, while we continue to work through these challenges, we remain confident in the long-term prospects for Henderson. I’ll touch on a couple of financial items, which Sarah will cover in more detail later. Importantly, we completed a $375 million debt refinancing near the end of the quarter.

Sarah and her team did a fantastic job navigating this process during a difficult time. And needless to say, we are very pleased with the results of their hard work.

This refinancing fortifies our already strong financial position, checks an item off of our to-do list, allowing us to focus on running the business, and provide us with enhanced flexibility to continue to make necessary investments to support our long-term profitable growth initiatives.

When it comes to our priorities for cash, despite these difficult times, we remain fully committed to the dividend, which we paid as usual at the end of the quarter. The fact that we’ve been able to increase it 12x over the past 10 years speaks to our ability to ride out a variety of challenges through different business cycles.

Finally, we are constantly monitoring the market for opportunities that will allow us to add important products and services to our portfolio and achieve our goal of continuing to expand our offering and grow market share. As always, we will carefully assess each situation with our thoughtful and disciplined approach and key eye on valuation.

So all in all, despite the typical challenges associated with the slower preseason and the unprecedented impacts of the pandemic our team continues to strive to put the company in the best possible position to succeed and achieve our long-term goals.

Finally, I just want to reiterate how much we appreciate the time and energy that our team extended getting our facilities back up and running this spring. We are very thankful that our workforce is healthy and that we have created a safe working environment for everybody to return to.

As I’ve said before, I have no doubt that our organization will learn valuable insights from this experience and come out on the other side stronger than when we went in. Before I finish, I just want to take a moment to mention something that we are very proud of.

We were recently recognized as the top workplace for the 11th consecutive year by the Milwaukee Journal Sentinel. Only 10 other companies have been recognized every year since they started the program 11 years ago.

I want to extend a huge thank you to our entire team of outstanding employees for their continual focus on integrity, teamwork and high performance, which has enabled us to create an ideal work environment for our employees, that promotes engagement and personal growth.

A critical part of our success formula on this front is due to Linda Evans, our Vice President of Human Resources, who really is the driving force behind our programs. When employees are engaged and motivated, business partners continually see the value in working with Douglas, driving sustainable growth opportunities for everyone involved.

And talking of awards, I also want to congratulate Sarah for recently being named CFO of the year by the Milwaukee Business Journal. This is a great achievement and very well deserved. We are grateful to have Sarah leading our finance group and being such an integral part of our senior leadership team.

With that, I will pass the call on to the CFO of the year. I kind of like how that sounds..

snowfall, pandemic and supply chain, our sales and gross profit declined versus last year. We generated second quarter net sales of $120 million and gross profit of $32.1 million compared to net sales of $176.4 million and gross profit of $59.6 million.

Sales and margins were impacted significantly by the shutdown, which equated to almost half of the quarter. In addition, lower volumes due to low snowfall and the pandemic impacted our operations upon return. SG&A expenses were $16.6 million $4.9 million lower than the second quarter of 2019.

After excluding the reversal of the potential earn-out mentioned earlier, the decline of $2.9 million was due to lower discretionary spending, including travel, advertising, promotions, all as a result of our income protection plan.

Interest expense was $5.7 million for the quarter, which was higher than the $4.2 million incurred in the same period last year. After excluding the $1.6 million mark-to-market adjustment mentioned earlier, the slight reduction is due to a lower principal balance.

The effective tax benefit was negative 14.4%, which was lower than the effective tax rate of 24.6% for the second quarter of 2019 due to the impairment of nondeductible goodwill related to the municipal reporting unit.

On an adjusted basis, we generated net income of $7.6 million and $0.33 per diluted share compared to adjusted net income of $26.5 million and $1.14 per diluted share. Similarly, we generated consolidated adjusted EBITDA of $20.3 million compared to $44.1 million in the corresponding period of the prior year.

I echo Bob’s comments we are pleased with our execution in the quarter under these extenuating circumstances. Now let’s turn to the earnings information for the two segments.

Within our Work Truck Attachments segment, we generated net sales of $73.8 million and adjusted EBITDA of $20.4 million during the second quarter compared to net sales of $112.2 million and adjusted EBITDA of $38.5 million in the prior year.

The decline relates to lower preseason sales, which were impacted by two consecutive winters of the low average snowfall in key markets, particularly in our core Northeast region. Similarly, the decrease in the segment’s profitability was mainly driven by lower volumes, coupled with the impacts of our shutdown.

As a reminder, our preseason order period started 2 weeks later in 2020 due to the emergence of the pandemic. But due to the efficient restart of our facilities in May, we were able to ship more products than originally expected in the second quarter.

That brings us to Work Truck Solutions, where we reported net sales of $46.2 million and adjusted EBITDA of negative $100,000 compared to net sales of $64.1 million and adjusted EBITDA of $5.6 million in the same period last year.

The decline was primarily related to the impacts of the pandemic, and the related shutdown of our facilities, coupled with the ongoing supply chain constraints, particularly for Class 4 through 6 work truck chassis.

Lower segment profitability was again attributable to the cost of our shutdown and reduced economic activity in our core markets on the East Coast, combined with the supply chain challenges and was partially offset by reduced discretionary spending.

Turning to the balance sheet and liquidity figures, net cash used in operating activities during the first 6 months of 2020 was $6 million compared to cash used of $300,000 during the same period in the prior year.

While free cash flow for the first 6 months of 2020 was negative $11.1 million compared to negative $5.8 million during the same period in 2019. The increase in cash used by operating activities and lower free cash flow overall, are both primarily attributable to overhead costs incurred during the shutdown, while volumes were low due to the pandemic.

Favorable changes in working capital, primarily due to these lower volumes, partially offset these costs. Accounts receivable at the end of the quarter were $76.8 million compared to $114.7 million in the second quarter of last year, primarily due to lower sales.

Inventory increased to $99.8 million at the end of the second quarter compared to $93.9 million at the same point last year, as we built up inventory in anticipation of supply chain constraints. Capital expenditures for the first half of 2020 totaled $5 million, slightly lower than the $5.5 million incurred in the first half of 2019.

Total liquidity has been increased substantially to $126.8 million at the end of the second quarter compared to liquidity of $77.4 million at the end of the second quarter of last year. We ended the quarter with $34.9 million in cash and $91.9 million in borrowing capacity under our revolver.

Our higher liquidity relates to the recent refinancing of our $375 million credit facility, consisting of a $275 million 6-year senior secured Term Loan B facility due June 2026 and a $100 million 3-year senior secured ABL revolving credit facility due June 2023.

The new refinancing allowed us to fortify our already strong financial position while providing us with liquidity and flexibility to continue to operate and execute to our long-term goals. We are very comfortable with where we stand with our debt, maintaining a net debt leverage ratio of 3.5x in comparison to 2.6x at the same time last year.

As we continue to navigate the challenging economic environment, we will continue to prioritize paying down debt at the most logical points in the years ahead. Finally, as you probably saw in our earnings release, we are not providing quantitative guidance at this time.

It is clear that significant uncertainty still exists across the country and the economic landscape, which is limiting our visibility and ability to forecast with any sense of accuracy. The exact operational and economic impact of the COVID-19 pandemic, coupled with supply chain disruption, is still unclear.

However, we have weathered many economic storms over the years. And while this situation is unique, we believe that we are well equipped to manage through effectively and emerge stronger as conditions improve. As we look to the rest of the year and beyond, what I can say is this.

Our Attachments segment is still mostly influenced by snowfall, with the economy being the second biggest factor. The preseason order period started 2 weeks later than normal, but our successful operational restart was executed effectively, which allowed us to ship more products than originally planned during the second quarter.

That means we anticipate a 55-45 split for the pre season across the second and third quarters, respectively.

As we noted last quarter, the preseason is expected to account for a lower portion of the segment sales compared to the average year, with an increased focus on the fourth quarter as dealers wait to see what the start of the retail season for snow and ice control product springs.

For solutions, the issue of chassis and components supply will continue, but we are hopeful that it will begin to stabilize and improve. We maintain a strong backlog in these businesses, which bodes well as the supply chain catches up.

We experienced sequential order improvement throughout the quarter with commercial orders, which is excellent news, but it will take some time to understand how quickly business will return. Overall, we also still maintain that we are comfortable noting that our free cash flow is expected to exceed the amount necessary to fund our dividend for 2020.

With that, I would like to open up the call for questions.

Operator?.

[Operator Instructions] Your first question comes from the line of Josh Chan with Baird..

Hi. Good morning, Bob and Sarah. Congrats on the successful restart on the external equity..

Good morning, Josh. Thank you. .

Thank you. .

Good morning. So, I guess my first question is on the Attachments business.

Have you sort of fully caught up to your order book, at least in terms of – by the end of the quarter? I guess the reason I am asking this is, as we look at the sales decline in the business, how should we think about sort of the relative impact between how much of it was the production being shut down and how much of it was just because of the snow?.

Yes. The way I would think about attachments, Josh, our preseason period of Q2, Q3. We delayed the preseason, but orders started coming in quickly after that delay.

I would say from the standpoint of us shipping more in the second quarter than we had originally anticipated that we are close to caught up on where we expect to be for the pre-season, we do expect the third quarter to be less shipments than the second quarter with the 55-45 split.

We also have a shutdown that we typically have every July in our attachment business. So that has occurred. So I think long answer to your short question, I would say, yes, we are caught up, and we are comfortable with that 55-45 split..

Yes. I would just add something that both Sarah and I mentioned, this just makes logical sense. I mean, typically, that pre-season order is 60% to 65% of what a dealer thinks they need for the year if they stock the shelves.

In this environment, dealers backed off a little bit because they are just not quite sure – so for the first time in a long time, we are going to be looking at the fourth quarter, and it will be – it will have a greater impact on our full year results than it normally does. I mean obviously, snowfall dictates some of that.

But just from a standpoint of we think dealers are going to go into the season a little lighter on inventory, which quite frankly, we encourage in this economic environment..

That makes sense.

Is there any discussion of sort of winter being a fairly healthy landscaping season? And maybe how the end user may potentially have more cash entering in terms of winter?.

Yes. That’s a terrific point. And while we don’t have any hard stats on that, we can all remember when the economy was shut down. You still saw the landscape trucks out there cutting grass and doing their trimming, plus you also have seen a significant investment in home improvement projects.

So again, logic tells you there that the landscapers were busier than they have been before, and that will put a few extra dollars in their pocket, come the snow season for sure..

Yes. And I think I mentioned this on the last call, Josh. Another thing that we look at is what our dealers choose for terms, whether they choose terms or they pay early in cash with a discount. I was thinking that maybe that would shift a little bit this year in light of the economic uncertainty. We did not see that.

We still have the same percentage of our dealers paying cash, which was good to see..

Alright. And if I can ask about the solutions business, you mentioned some improved order trends. Just, I guess, just wondering how long that takes the – so it’s translated through to the revenue. And then on the margin front in the second half, how should we think about that with the facilities being back online? Thank you..

Yes. I will take the order trends piece of it. Henderson’s order book has continued to be strong, gosh, for the last 2.5 years. As they have navigated through the Class 8 chassis supply constraints.

As I said, we were seeing that easy enough and improving in Q1 and we expect that when the Class 7 and 8 OEMs get back up to their pre-pandemic production levels, we are going to start flushing some of that backlog that we have built through the income statement. So we are pretty excited about Henderson’s prospects.

Now, how much of that occurs in the second half will be a wait and see kind of an approach. But certainly, as we get deeper into the second half of the year and certainly in the 2021, we think there’s exciting things ahead.

From a Dejana perspective, the information is still new, okay? As I mentioned, they were the hotspot when this pandemic first hit anywhere on the East Coast and mid-Atlantic areas.

And we have been really encouraged in June – both June and July that the order books – when the economy got turned back on, quite frankly, we have had nice increases year-over-year. And so again, we are building a nice backlog position there. The OEMs are going through their start-up phases.

And quite frankly, they are not very aggressive start-up plans, but they are on track. And again, I think we are anticipating not to get every chassis we need for the second half of the year, but to see some nice improvement as we turn the corner into 2021..

Yes. And then I would add, that’s what we would expect on the margin side, too. So when you look at solutions in the second quarter, we were pleased at the breakeven where we were for EBITDA with the length of the shutdown that we had. I expect that we will see sequential improvement each quarter through the end of the year.

The chassis constraint and/or the ability to get the chassis really is what will be the deciding factor on if we get back to last year’s margins, not necessarily the demand, as Bob does. We are seeing the demand. It’s really more on the supply side..

Alright. Great. Thank you, Bob..

Thank you, Josh..

Your next question comes from the line of Ryan Sigdahl with Craig-Hallum Capital..

Good morning, guys. Thanks for taking my question. .

Good morning, Ryan..

First, just on the impairment charge in the quarter, are you able to break out kind of how much of that related to Henderson versus Dejana? And then any detail on what kind of the biggest assumption changes were in the long-term model there?.

Yes, absolutely. I can say that we would not be talking about this, had it not been for COVID-19. That was a significant shift in our expectations for solutions for the year. And certainly, the uncertainty with the supply going forward, really is the trigger for that.

In total, the split between the two is it’s almost $50 million for Henderson and $80 million for Dejana. And I have to say, it doesn’t change any of our thoughts on the strategy of the acquisition. This is the growth platform for us. And so it does not change how we are thinking about the long-term goals and runway that we have with those businesses..

Good. Then on solutions, I think I heard you say that orders were up year-over-year in both June and July. Confirm that? And then, I guess how does the order translate into sales? I know there’s some chassis constraints, etcetera.

But just as we think about kind of the top line in that segment for the back half of the year?.

You are correct. We did see orders increase in June and July. We have a healthy backlog in both of those businesses. So a little bit hard to translate those order rates today to exactly when they will turn into sales.

I can just say that for the back half of the year, it’s really more inhibited by us getting all the supply coordinated after they have all been shut down than it is demand, right now..

I think the other thing I would add to Sarah’s comments, and this is look at each of the vehicle classes separately.

In the Class 7 and 8 where the over-the-road demand for the past 2.5 years has been through the roof because of government-mandated changes and how the vehicles operate, that was actually leveling off and allocation to the municipal side of those Class 7 and 8 chassis was starting to pick up.

And so when these restarts get completed during the second half of the year, we fully expect to be able to get access to all of the chassis we need on the Henderson side. When you go to the commercial side, Dejana side, we’ve talked in the past about capacity being allocated to SUVs because consumer demand was so strong.

And the margins are greater on SUVs than they are on work truck chassis and things along those lines. And so in a strange way, we will benefit from a little bit of a dip in the economic cycle because we believe capacity will be reallocated back to the work trucks that we need because take a little while for us to flush out.

But obviously, there’s going to be an economic softening that we’re going to feel for quite some time, and we think that bodes well for improved chassis availability on their Class 4 to 6 site..

Great. And just one last one for me and then I will hop back in the queue. It sounds like most of the workers are back 99%, so maybe not a lot of cost savings there.

But as you think about kind of the COVID and the cost cuts you made, are you able to quantify how much, or if any, are permanent kind of run rate going forward improvements? Thanks and good luck..

Yes, absolutely. We have been talking about our Income Protection Plan and the fact that from an attachment side, they already had their playbook started before COVID. They will flex up and down on their spending every year based on snowfall. So I would not say that anything that they’re doing is permanent, nor do we want it to be permanent.

On the solutions side, I would say, in the quarter, we had some furloughing of employees as we were shut down. We certainly were very prudent on all of our discretionary spending. I would say that I would not – I would expect a small portion of that to be permanent in nature.

It’s really more timing, tightening the first strings, I would say, until we navigate through this. But the team did a great job of doing that on the solution side. I think you saw the decrement was in the 30s, which is great for a group of individuals that have not had to use the Income Protection Plan historically because they’ve been growing..

Great, that’s it for me. Thanks guys. Good luck..

Thank you..

Your next question comes from the line of Chris McGinnis with Sidoti & Company..

Nice quarter and Sarah congrats on the award. .

Thanks Chris.

I was wondering if we could start off, maybe just – maybe a little bit more granularity around the increase in the orders in Dejana that you saw on the month-over-month or year-over-year in June, July and maybe any end market or any customers that are maybe stronger, just wondering if there was any more granularity in that strength you are seeing?.

No, the positive there, Chris, is that it wasn’t 1 or 2 significant orders. We didn’t land a whale kind of thing, and that’s what drove the numbers. What I’m most encouraged by is that sales team for Dejana, and this goes back to a year ago. We have a new Vice President of Sales and Marketing.

We have a new President coming into that job in a pretty short order. And they have embarked on what I would call more of a strategic selling proposition.

We are certainly going out and getting quotes and that sort of thing is what they do, but a much more disciplined approach to look at opportunities, look for gaps, capitalize on our strengths, fill those gaps where we think we can do better in certain markets. And that takes a long time for it to take hold.

And I think right about the time that the pandemic hit, they were starting to generate some momentum there. So I’m going to suggest this is more of an across the board increase, which makes me feel better about the sustainability of it longer term..

Great. I appreciate that. Thanks for the input.

Can you maybe just comment on the competitive landscape, probably more so on the Dejana side, but just – has there been any change given obviously, the pandemic and the impact on business?.

Yes. Nothing that we have seen yet Sarah and I were just talking before the call today, typically, when you go through cycles like this, the strong get stronger and the weak fall off to the side. So certainly, there will be some smaller competitors that are either less competitive or maybe may not make it longer term.

But we haven’t seen much of that to date. Again, I also think that in these uncertain environments when customers hear things like 99% of your employees are back at work, safe work environments, it just reinforces why they do business with Dejana or do business with Douglas.

And if they’re going to place a bet in these uncertain times, we’re a good sound in place to do that..

Great. And then just two more quick ones given the change, and I know it’s a strange, two years in a row, low snowfall.

But if there’s, say, pent-up demand to some degree or pent up, just a reaction to maybe a stronger snow season, how does that play out – or how could that play out in 2021 just in terms of order? I was just wondering if that changes anything, just given the pushback and maybe the timing of buying. Thanks..

Well, that’s interesting. We have got snowfall history that goes back longer than I’ve been alive, which isn’t a short amount of time by the way. And it is historically rare for there to be three below average snowfalls in a row, not to say it can’t happen. And we expect it to come back.

And when it comes back, there will be some pent-up demand without a doubt. As we were talking earlier, the landscapers, even in this environment, probably have a few more dollars in their pocket than most end users.

And so if we just get a little bit of help from other nature, starting in the fourth quarter, I think you can see a really nice rebound on the attachment side next year..

Okay, great.

And then just one quick one, just any update on the vertical integration?.

Yes. We had a board meeting last week and showed off the progress that we are making on the brand new facility. We’ve got equipment coming in. Designs are done on certain products. Prototypes have been built. Everything is proceeding according to plan. We should start seeing production coming out of that operation in the first quarter of 2021.

And again, I want to say a couple of things there. Number one, I want to congratulate the entire team of folks that is working on this important project, but also just to reiterate as Sarah said earlier, Douglas is used to seeing headwinds. Douglas is used to having to call audibles.

And one of the things we make sure of when we are pulling the levers to cut costs and conserve cash, we make sure long-term investment projects still get funded, and this was one of them. So even when we were shut down from middle of March to the first part of May, we still had progress being made in that endeavor. So we did not miss a beat.

It’s going to be an exciting part of our future, and we look forward to sharing more details on the specific products that are coming out of that building when we’re a little closer to launch in 2021..

Great, great. Thanks for taking my questions and good luck for Q3..

Thanks, Chris..

Thank you..

[Operator Instructions] And at this time, there are no further questions. I would like to turn the call back over to Mr. Bob McCormick, President and CEO..

Thank you and thank you for your time today. We sincerely hope that you are all staying healthy and are adapting well to all the new situations we are facing. And as always, we appreciate your ongoing interest in Douglas Dynamics. Have a terrific day..

This concludes today’s conference. You may now disconnect..