Douglas Dynamics, Inc. (NYSE:PLOW) Q3 2023 Earnings Call Transcript October 31, 2023
Operator: Hello, and welcome to the Douglas Dynamics Third Quarter 2023 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Nathan Elwell, VP of Investor Relations. Please go ahead.
Nathan Elwell: Thank you. Welcome, everyone, and thank you for joining us on today's call. Before we begin, I would like to remind you that some of the comments that will be made during this conference call, including answers to your questions, will constitute forward-looking statements. These forward-looking statements are subject to risks that could cause actual results to be materially different. Those risk include, among others, matters that we have described in yesterday's press release and in our filings with the SEC. Please note, earlier this morning, we filed a short supplementary set of slides to accompany this call, which can be found in the IR section of our website, douglasdynamics.com and in our SEC filings. Joining me on the call today is Bob McCormick, President and CEO; and Sarah Lauber, EVP and CFO.
I will provide an overview of our performance, followed by Sarah reviewing our financial results and guidance. After that, we'll open the call for questions. With that, I'll hand the call over to Bob. Please go ahead.
Robert McCormick: Thanks, Nate, and good morning, everyone. At first glance, this quarter's results don't look so positive. But if you look beneath the surface, the positives are there. The best news is that our Solutions segment improved its top and bottom line results significantly. Solutions sales increased double digits, and adjusted EBITDA margin improved to 7.3%, a big jump compared to the same period last year. Team was able to increase the velocity above fits moving through our facilities and operate more effectively, especially at our Dejana operations. As expected, as this year's preseason shipment mix shifted more heavily towards the second quarter, the attachments segment had a difficult comparison to a relatively strong third quarter 2022.
However, when combined, the second and third quarter attachments results were comparable to recent years. With that said, let me provide an update on the external headwinds facing our businesses over the past few years. The good news is we continue to see improvement in both component supply and labor availability. When it comes to the supply of components, we're in good shape for the most part at attachments. And while there still are issues with some products that our solutions teams use in their upfits, the situation is much improved. The labor market situation is significantly better than it was in previous years. We are seeing higher retention rates plus more and higher-quality candidates applying for open positions. So having said that, the most significant remaining headwinds for us are chassis supply and more recently, weather.
Let's talk about those in more detail. While we saw some improvement in chassis supply in the third quarter, we believe this was a temporary change and partly due to the OEMs sensibly building inventory ahead of the UAW strike. The tentative agreements that are now in place to end the strike are great news for the entire industry. To date, we have not seen an impact of the strike on our operations, but the truck plants going out on strike in October will have an impact on our business at some point in the future. At the moment, our best guess is in the first quarter of 2024. Trying to predict when chassis supply will return to historical levels has been a real challenge. The experts are now projecting that 2024 chassis supply will be similar to 2023.
At this point, we think it's prudent to assume no material improvement in chassis supply over the next few years. This really underlines the importance of our internal growth initiatives to achieving our long-term goals. Let's move on to weather, which has significantly impacted our financials in 2023. As you all know, our business has always been influenced by weather. Although the addition of the solutions business has lessened this influence, attachments is still the main profit driver at Douglas. This past winter was unique, and we are still navigating its impact on our business, both this year and next. As you can see on Slide 4 in the deck, Nathan mentioned earlier, weather patterns are changing. For the last 4 years, we have seen a El Niño weather pattern, which is not ideal as it tends to produce less precipitation in key regions of the snowbelt.
Now we are shifting into an El Niño pattern, which is projected to be in place for the next 3 years. And the weather experts we follow confirm, these are typical trends that have been seen many times before. Now while we know better than most that nothing is guaranteed with winter weather, and El Nino pattern typically brings more percipitation overall during the winter, which increases the odds of returning to average snowfall or better at some point during the El Nino cycle. We're proud of the fortitude being demonstrated consistently by our teams and continue to implement cost control initiatives as part of the low snowfall playbook plus continuous improvement projects, making the right moves internally to limit the impact of the snowfall headwinds, wherever we can.
Okay, let's look at each segment. Getting with work truck attachments. Sales were down compared to last year, due largely to lower volumes, which impacted profitability. As expected, pre-season order demand for our products was soft following a snow season that was one of the worst on record in our core markets along the eastern seaboard from Baltimore to Boston. For the 2023 preseason, the mix was very unusual coming in at approximately 65% to 35% compared to 2022, where the quarterly mix was a more typical 55% to 45%. However, when you look at the second and third quarters combined, the story is different. Adjusted EBITDA in 2023 was only slightly lower than the preseason last year and considerably higher than 2021. And even though our dealers corrected their retail inventories, through softer preseason orders, we suspected that additional inventory corrections may take place in Q3 and even into Q4.
Our recent dealer checks indicate overall inventory levels still remain above the 5-year average and our highest in the East Coast cities, which saw very little snow last winter. This is a direct result of a quiet start to the retail selling season late in the third quarter. Remember, a snow plows replacement cycle gets lengthened, when the blade doesn't hit the pavement in low snowfall environments, thus impacting retail sales at the beginning of the next season. So not only did we see reorder softness late in Q3, but expect to see additional softness in Q4 as well. I am pleased to say that both dealer sentiment and financial health remain positive. Like us, our dealers have dealt with low snowfall before and one of the great things about this business is that each snow season stands on its own.
We are ready to execute and look forward to the start of the 2023, '24 winter season. Our teams have been successfully controlling and delaying spending and managing costs, while still making the really necessary investments to fuel long-term growth. Based on our leading market position and the changing demand dynamics we've talked about previously, the medium- to long-term outlook for the Attachments business remains very strong. Turning to our Work Truck Solutions segment, where third quarter sales increased 18%, and we were pleased with the margin improvements, which were due to improved pricing volumes, chassis supply and operating efficiencies. The same applies on a year-to-date basis, with net sales increasing 15% and adjusted EBITDA approximately doubled compared to the previous year.
We did see higher volumes this quarter and more predictable supply of chassis and we were able to drive greater efficiency, particularly at our Dejana operations. As we previously said, improvements in profitability are expected for the full year, and we have now entered the solutions business's seasonally strong fourth quarter. And while we're delivering on those short-term profit improvements, there are still several positive trends that bode well for the long term. First, demand remains strong. As trucks get worn out, negatively impacting their productivity and are even in more need of being replaced. We still have a massive backlog to work through and cancellations are minimal. And finally, we continue to drive baseline profit improvements, a key component of reaching our long-term financial targets.
This quarter shows that our solutions teams continue to battle through headwinds and our hard work being done behind the scenes, does pay off as we drive more velocity through our facilities. In summary, we are executing well on the factors we control under challenging conditions. As you can see in our supplemental slides, overall, our internal growth drivers are on track to contribute significantly to EBITDA growth in 2023. These drivers include pricing actions, new product introductions and baseline profit improvement projects. On aggregate, the internal growth drivers contributed almost 50% more than we initially planned. We are incredibly proud of the entire team that worked hard to make this happen. Now let's go back to the two most significant external drivers, snowfall and chassis.
Snowfall is clearly impacting our 2023 results, essentially negating the positive impact of our internal growth drivers. It's also the reason we are lowering our guidance this year. If chassis supply remains stuck in neutral, it may take longer than we planned to get to our $3 EPS target. Sarah will speak to this later in the call. I would like to finish with these three thoughts: One, while external headwinds are hindering our success, our internal initiatives are driving earnings growth; Two, in solutions, we're meeting our objective of delivering margin improvement each quarter compared to the last year. Demand and backlog remains strong, positioning us for long-term growth; and three, the impact of low snowfall is temporary. And as our Attachments group has done many times over the years, they're improving their long-term profit profile.
Bottom line, ladies and gentlemen, our $3 EPS targets are achievable, and we are laser focused on getting there. With that, I'd like to pass the call to Sarah to walk through the financials.
An aerial view of a busy highway, cars and trucks passing underneath.
Sarah Lauber: Thanks, Bob. Overall, our results this quarter were lower than the third quarter of 2022, driven by the impact of last winter's low snowfall in the Attachments segment. Importantly, the story was positive at Solutions, which delivered top- and bottom-line growth with margin improvement compared to last year. On a consolidated basis, our third quarter net sales were $144.1 million compared to $166.1 million in the same period last year, driven by the lower volumes and attachment. Gross profit margin declined slightly to 22.3% compared to 24.8% in the third quarter of 2022. As the margin impact of lower volumes and attachments was partially offset by improved operating results at Solutions. SG&A expenses decreased 6.2% to $18 million during the third quarter due to a decrease in incentive and stock-based compensation and the impact of curtailing spending as part of our low snowfall playbook.
Interest expense increased to $4.6 million, primarily due to higher interest on revolver borrowing and the effective tax rate was 16.4% for the third quarter of 2023 compared to 17.9% in the same period last year. Both rates are lower than typical with the 2023 rate being impacted by a tax benefit related to the purchase of investment tax credits and the 2022 rate being impacted by a discrete tax benefit related to state income tax rate changes. The impact of lower volumes and attachments flowed through to the bottom line, with net income of $5.8 million, which equates to $0.24 of diluted earnings per share, both coming in lower than the same period last year. Adjusted EBITDA also decreased $7.8 million to $17.3 million when compared to the third quarter of last year.
These decreases were driven by lower attachment volumes, partially offset by pricing realization and baseline profit improvement in both segments. Now let's turn to the earnings information for the two segments. For the third quarter of 2023, attachments net sales were $75.9 million, lower than the $108.2 million in the prior year period. Adjusted EBITDA also decreased to $12.3 million due to the lower volumes and unfavorable product mix, which impacted profitability. In preseason shipments this year, the mix was quite unusual at 65% to 35% compared to 55% to 45% in 2022. While we knew the second quarter would be larger and more profitable than the third quarter, the swing was greater than we anticipated as a result of elevated dealer inventory and lower-than-expected reorder activity.
The shift to 65-35 was driven by lower dealer demand, not a result of operations. The result of the dealer inventory survey matches with the lack of reorder activity we saw, especially when combined with the quarter start to the retail season late in the third quarter. However, it's important to remember that our second quarter was excellent. And when you look at the combined second and third quarters in 2023, adjusted EBITDA was only slightly lower than the preseason last year, and higher than the preseason period in 2021. Our adjusted EBITDA margins in the combined period were also strong at 25.2% and which is in line with our mid- to high-20s margin goals. Turning to Solutions. Solutions had a great quarter compared to last year with net sales increasing approximately 18% to $68.2 million based on price realization, higher volume and improved chassis supply.
Adjusted EBITDA more than doubled to $5 million, and adjusted EBITDA margin improved considerably by 350 basis points to 7.3%. Again, this was due to improved pricing and volume plus operating improvements from the labor efficiencies. With the improved number of chassis available this quarter, our teams were able to drive greater efficiency, which drove improved in profitability. Overall, demand also remains positive, and we still have a very strong backlog to work through. Also, it's worth noting that on a year-to-date basis, the Solutions segment has delivered margin improvement each quarter compared to last year. At this point, we are on track to deliver mid-single-digit EBITDA margins for the year. All in all, great progress at Solutions.
Now let's look at our balance sheet and liquidity. Net cash used in operating activities for the first 9 months of the year decreased $10.3 million to negative $64.1 million from negative $74.5 million last year. The combination of elevated working capital and lower sales volumes resulted in a lower seasonal increase of receivables and inventory. On a year-to-date basis, free cash flow increased to negative $71.9 million from negative $83.4 million for the first 9 months of 2022. The increase of $11.5 million was largely due to the lower cash used in operating activities. At the end of the third quarter, we maintained $59.6 million of total liquidity comprised of $11.1 million in cash and $48.5 million of capacity on the revolver compared to $120.2 million in total liquidity at the end of 2022.
The change versus the end of '22 is primarily due to the seasonality of our business, as well as an increase of $50 million in borrowing capacity on our revolver following the amendment implemented at the start of this year. Inventories were $147.3 million at the end of the quarter, higher than the $133.8 million in the third quarter of '22 by considerably lower than the $184.6 million at the end of the first quarter 2023. Comparing to last year, we exited the third quarter with higher levels of snow and ice inventory due to the impact of low snowfall. Accounts receivable at the end of the quarter were $165.3 million, almost exactly the same as at the same point in 2022. Year-to-date, capital expenditures were $7.7 million, lower than the $8.9 million in the same period last year, and in line with our expectations after we deferred some investments as part of the Low snowfall playbook.
As you know, we implemented our low snowfall playbook earlier this year and expect total CapEx for the year to be on the lower end of our typical range of 2% to 3% of net sales. At the end of the quarter, we had a net debt leverage ratio of approximately 3.2x, temporarily above the top end of our targeted range of 1.5x to 3x. We paid our quarterly cash dividend of $0.295 per share at the end of the quarter, and the dividend remains our top priority as it has been for the past 13 years. Okay. Turning to our outlook. As you probably saw in our press release, we decided to reduce our guidance ranges for the year. We reduced the net sales outlook by $10 million and now expected to be between $610 million and $640 million. Adjusted EBITDA is now predicted to range from $77 million to $92 million, $8 million lower than the previous range.
That means our adjusted earnings per share are now expected to be in the range of $1.30 per share to $1.70 per share, $0.25 lower than the previous range. Finally, our effective tax rate is now expected to be approximately 24%. It's important to remember that our outlook assumes relatively stable economic conditions stable to slightly improving supply of chassis and components and that our core markets will experience average snowfall levels in the fourth quarter. Let me walk through our reasoning. There is one factor for the changes we've made for our guidance this year. Snowfall. The impact of low snow drove the change we made for our guidance in April and the change we're making to the guidance today, as we are now predicting further impact from the historically low snowfall on the East Coast this past winter, where snowfall totals were down up to 90% in some of our core markets.
The information we received in October from our dealer inventory checks indicated that despite our dealers placing lower preseason orders their inventories still remain above the 5-year average, which we noted could happen on our last earnings call. Dealers are telling us that initial retail activity at the start of the season have been light, especially on the East Coast. Therefore, we believe there will be a further impact on the fourth quarter cloud retail season. As always, the extent of that impact will largely depend on the snowfall we experienced across our core markets east of the Mississippi through the end of the year. Now that we're into the last quarter of 2023, the logical next question is, can we still reach our goal of $3 of adjusted earnings per share in 2025.
While it's still possible for us to get there, when we look at our latest internal projections, we recognize that the ongoing headwinds continue to hinder our progress and are turning what was an achievable goal into a stretch goal. In short, while we remain confident we will get to $3 per share, the timing is now in question. There are three key factors to discuss embedded in our longer-term $3 target: First are the baseline profit improvement and growth projects that our teams are focused on to get to the margin profile we have targeted in attachments and solutions. In 2023, we have been outperforming for our internal plans as we have been laser-focused on the things we can control. We will not slow down in these areas; Second is the assumption around chassis.
Our initial long-term goals assumed consistent chassis supply, which we just haven't seen in recent years. Probably more importantly, industry prognosticators are now predicting that chassis supply in 2024 is not expected to grow back to pre-pandemic levels, but rather expect supply to be flat to 2023. And although we applied the tentative agreement to end the strike, it's too early to tell what the OEM shutdown impact will have on our supply in 2024. We expect to know more in February when we lay out our 2024 guidance; Third is the assumption around average snowfall, which was significantly lower in this last snow season. Just returning to average snowfall should have a significant year-over-year earnings impact. To provide some initial context around this discussion in light of the many moving variables, I will say that with the assumptions that chassis supply is expected to be flat to 2023 and an assumed return to average snowfall, our expected 2024 guidance will be at or above our February 2023 guidance.
This would be a greater than 30% increase at the midpoint from our current guidance. This is only to put context around how we're currently thinking about 2024. We will provide our actual 2024 guidance in February. Finally, I want to talk to the positive. From an operational standpoint across the board, we executed effectively. The Solutions segment is showing strong improvement on a year-to-date basis and remains on track to show margin growth in 2023 versus a year ago. The ongoing positive demand dynamics we see in Solutions, coupled with the still strong backlog we have to work through, bodes well for the medium- to long-term. We're incredibly proud of what our team has accomplished under difficult circumstances. We know what we have to do with the internal growth drivers to accomplish our goals.
With that, we'd like to open the call for questions.
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