Douglas Dynamics Leveraged Buyout

Company Overview

Douglas Dynamics (a subsidiary of AK Steel) specializes in the design, manufacturing, and distribution of snow plow and spreader vehicle attachments. The company sells products through its Western and Fisher brands and is the North American market leader in the snowplow manufacturing industry.

• Sells wholesale to an industry-leading distributor network of 475 distributors with an average tenure of 15 years
• No distributor accounts for more than 5% of Douglas' net sales
• Majority of end users are professional snow plowers (landscapers) contracted for residential and commercial snow removal
• Loyal customer base with over 450,000 installed snow plows
• Annual sales experience year-to-year volatility due to variance in snowfall, with significant intra-year seasonality

Key Financial Metrics (2003):

• Revenue: $269.4 million
• EBITDA: $48.2 million (~18% EBITDA Margin)
• 2001-2003 CAGR: ~4.1%

Capital Structure

The proposed LBO transaction is valued at $232 million with the following capital structure:

• Equity (53.9%): $125 million Aurora common equity
• Debt (46.1%):
  • Senior Debt: $92 million at 8% interest, amortized over 5 years
  • Subordinated Debt: $15 million with 8% cash interest, 5% PIK, 1.2% warrant
  • Revolver: $25 million facility ($0 drawn at close, 7.5% interest)
• Management Options: Worth 2% of equity post-exit in base case if management meets performance expectations

Investment Strategy

Our investment strategy for Douglas Dynamics focuses on four key areas:

1. Revenue Enhancement

Establish new product purchase, ownership, and leasing options for customers:

• Create an internal financing department to offer short-term POS installment loans
• Collaborate with distribution network to provide short-term rental and long-term leasing alternatives
• Offer insurance coverage for snow plow equipment at time of purchase
• Provide warranty services for snow plow and spreader products

2. Distribution Channel Scaling

Increase sales volume through exclusive partnerships with regional players:

• Establish official authorized distributor contracts with exclusive partners
• Partner with regional vehicle auto dealerships to provide Douglas attachment add-ons during truck sales
• Work with full-service vehicle upfitters as exclusive Western/Fisher distributors
• Collaborate with regional truck rental agencies for leasing and renting Douglas equipment
• Launch e-commerce webstore (D2C) for direct customer interaction

3. Cost Reduction

Apply Lean Manufacturing and Six Sigma principles to operations:

• Establish long-term material and parts supply contracts with bulk discounts
• Replace portion of full-time workers with contractors to make labor costs more variable
• Implement level production policy based on sales forecasting
• Pursue vertical manufacturing to gain greater control over production process

4. International Expansion

Fund expansion into Northern Europe (Norway, Sweden, Denmark):

• Create focused marketing strategy to raise awareness in the region
• Search for potential distribution partners to establish market presence
• Lease manufacturing plant in Northern Europe, optimally located near key distributors

Investment Rationale

• Macroeconomic Climate: US economy on expansionary trajectory with higher consumption and business profit; American Jobs Creation Act of 2003 reduced tax rates and included bonus depreciation provisions
• Inelastic Demand: Snow plows and spreaders are non-discretionary purchases for essential snow removal services in snow-belt regions
• Market Leadership: Douglas has majority market share in North America with strong brand loyalty and high customer retention
• Variable Cost Structure: Substantial portion of COGS driven by steel purchases that can be adjusted based on production needs; partially employs temporary workforce that can be expanded
• Fit with Aurora Expertise: Ideal candidate for Aurora management's expertise in Lean Manufacturing and Six Sigma to drive value in reducing costs

Risks and Mitigants

Steel Price Volatility

Risk: As steel is the most expensive and essential material, price increases during inflationary trends could significantly increase production costs.

Mitigants: Establish long-term agreement with AK Steel for reliable and discounted supply; consider outsourcing steel from China following removal of tariffs in 2003 (price of $220 per metric ton in China versus $390 per metric ton in US).

Snowfall Cyclicality/Seasonality

Risk: Sales are directly correlated with snowfall, leading to diluted sales in warmer seasons and years with lighter snowfall.

Mitigants: Implement pre-order opportunities to even out sales and distribution throughout the year, enabling better revenue forecasting.

Economic Downturn

Risk: Macroeconomic downturn can stifle sales due to decreased construction, population growth, disposable income, and business profits.

Mitigants: The macroeconomy is currently in recovery/expansion following the early 2000s recession, with growing construction, population, consumer confidence, and lower interest rates.

Management Transition

Risk: After becoming independent from AK Steel, Douglas may lose management talent or experience misalignment with Aurora management.

Mitigants: Implement performance-based management compensation with stock options; leverage Aurora's Investment Advisory Committee with expertise in specialized areas.

Geographic Expansion Challenges

Risk: Expansion into Northern Europe may face stiff competition from European rivals and preference for local products.

Mitigants: Create new brand names for Northern European customers, building on Western and Fisher brands; customize products to local needs.

Industry Overview

Douglas operates in the $2.2 billion snowplow manufacturing industry, which is part of the broader $70 billion snow removal service industry. The company produces snow plows and spreaders for clearing snow and ice from outdoor surfaces such as roads, driveways, and parking lots.

Key Industry Drivers:

• Snowfall: Directly dictates how often end users invest in new equipment
• Plowable Area: Commercial and residential real estate development increases need for snow removal
• Steel Prices: Most expensive input cost affecting variable costs and operating margins
• Consumer Income/Business Profits: Economic upticks encourage purchases of new equipment
• Geographical Footprint: Manufacturing and distribution locations in high-precipitation regions create competitive advantage

The North American snow plowing manufacturing industry is expected to grow at a 2% CAGR from 2004-2008, with Douglas targeting a 5.3% CAGR to increase market share.

Financial Projections

Base Case Assumptions:

• Sales Growth: 5.3% CAGR over 5 years (2004-2008)
• Gross Margins: Improvement of 160 basis points over 5 years
• SG&A: Increase of 130 basis points over 5 years
• CapEx: $1.5M higher in 2005 and $4.5M higher in 2006 compared to management expectations

Returns (Base Case):

• Aurora Equity IRR: 22.5%
• Subordinated Debt IRR: 16%

Sensitivity Analysis:

• Downside Scenario: Revenue decline at 1.1% CAGR over 5 years; IRR still positive and exceeds 10%
• Upside Scenario: Revenue growth at 6.5% CAGR over 5 years with faster margin improvement