Douglas Dynamics, Inc.
Q2 2020 Earnings Call Transcript

Published: 8 Aug 2020

[Operator:]

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.

[Sarah Lauber:]

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.

[Bob McCormick:]

Thanks, Sarah. Good morning, everyone. To start with, let’s discuss the most important point of our call today. Our 1,700 Douglas employees are healthy and back at work. After shutting down all of our U.S. facilities in mid-March, we began a rigorous process of creating a safe return to work environment. Upon reopening all facilities in early May, we had a 99% employee retention rate, that is something I’m very pleased to state and something that everyone at Douglas should be proud of because it took a real team effort to safely and successfully restart in May. As we discussed on our last earnings call in early May, we have and always will, focus on protecting the health and safety of our teams first. To date, we’ve only had a handful of people test positive for COVID-19 out of 1,700 spread over 20 locations. This is a testament to both our employees making good choices, plus the efforts of our teams to create and implement our safe return to work plan. Probability and data trends tell us to expect more cases in the future, but this situation was a good test of our systems and protocols and everything to-date has worked as intended. I am extremely proud of the way our teams have collectively responded to the pandemic. As an aside, after building a robust playbook, we chose to share these resources with our industry, including the National Truck Equipment Association by providing templates and examples of plans and procedures on our website for people that download and customized for themselves. The feedback has been nothing short of amazing. Today, we’ve had over 2,000 hits to the site from 9 different countries, including England, China and Australia. We take pride in the fact that other companies are implementing the frameworks that we’ve developed and that we are doing our part to help everyone get back to work safely across the country. With the pandemic discussion complete, let’s turn to our results for the quarter and more importantly, the future. Given the fact that we were shut down for half the quarter and faced additional external headwinds, we are generally pleased with our results. As we noted in the earnings release, there were three main headwinds to navigate, some familiar and some unique

[Sarah Lauber:]

Thanks Bob. So the best part of that title is the recognition given to the entire Douglas finance team, it was certainly possible because of their hard work. So getting to the financials, as Bob mentioned, from a financial standpoint, we navigated through a quarter that included a shutdown across all facilities, a ramp-up across all facilities, a preseason predicated on low snowfall and supply constraints within our Solutions segment. The impact of all of this is apparent in the quarterly results, but we have successfully focused on what is within our control, further strengthened our balance sheet, and we have remained focused on our long-term growth prospects. I am going to start with the more unusual items in the quarter, as there were several and they’re not necessarily indicative of our future operating results. Our GAAP net loss of $103.9 million or negative $4.55 per diluted share was impacted by the following four items. These items have been excluded for adjusted net income and adjusted earnings per share. First, we recorded a onetime non-cash goodwill impairment charge of $127.9 million on our Solutions segment. The impairment was triggered by the lower performance in the current year and projected future years as a result of the COVID-19 pandemic and supply chain constraints. This charge does not impact the strategic value that we have inherent in these businesses, and we remain confident that we will navigate through these external factors successfully. Second, due to the lower performance in solutions, we reversed a potential earn-out payment of $2 million. This lowered our GAAP SG&A expense. Third, as mentioned last quarter, the unprecedented drop in the forward LIBOR curve, have made our interest rate swaps ineffective. Therefore, we recorded a $1.6 million mark-to-market non-cash interest expense. Lastly, with the success of the refinance complete, we incurred $3.2 million of debt modification expense related to the termination of our prior term loan. Okay. With that, I would now like to focus on our segment and consolidated results in the quarter. Due to a combination of the three main factors

[Operator:]

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

[Josh Chan:]

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

[Sarah Lauber:]

Good morning, Josh. Thank you.

[Bob McCormick:]

Thank you.

[Josh Chan:]

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?

[Sarah Lauber:]

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.

[Bob McCormick:]

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.

[Josh Chan:]

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?

[Bob McCormick:]

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.

[Sarah Lauber:]

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.

[Josh Chan:]

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.

[Bob McCormick:]

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.

[Sarah Lauber:]

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.

[Josh Chan:]

Alright. Great. Thank you, Bob.

[Bob McCormick:]

Thank you, Josh.

[Operator:]

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

[Ryan Sigdahl:]

Good morning, guys. Thanks for taking my question.

[Sarah Lauber:]

Good morning, Ryan.

[Ryan Sigdahl:]

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?

[Sarah Lauber:]

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.

[Ryan Sigdahl:]

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?

[Sarah Lauber:]

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.

[Bob McCormick:]

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.

[Ryan Sigdahl:]

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.

[Sarah Lauber:]

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.

[Ryan Sigdahl:]

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

[Bob McCormick:]

Thank you.

[Operator:]

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

[Chris McGinnis:]

Nice quarter and Sarah congrats on the award.

[Sarah Lauber:]

Thanks Chris

[Chris McGinnis:]

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?

[Bob McCormick:]

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.

[Chris McGinnis:]

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?

[Bob McCormick:]

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.

[Chris McGinnis:]

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.

[Bob McCormick:]

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.

[Chris McGinnis:]

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

[Bob McCormick:]

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.

[Chris McGinnis:]

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

[Sarah Lauber:]

Thanks, Chris.

[Bob McCormick:]

Thank you.

[Operator:]

[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.

[Bob McCormick:]

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.

[Operator:]

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