Douglas Dynamics, Inc. — 2019 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
Douglas Dynamics manufactures and sells snow and ice control equipment and work-truck upfit solutions through two reportable segments: Work Truck Attachments, including FISHER, WESTERN and SNOWEX products, and Work Truck Solutions, including HENDERSON and DEJANA products and services. The filing covers the three and six months ended June 30, 2019; financial statements are unaudited and amounts are in thousands unless otherwise stated.
The Work Truck Attachments business is seasonal. Pre-season distributor sales are concentrated in the second and third quarters, while fourth-quarter demand depends substantially on the level, timing and location of snowfall.
Financial Performance and Key Metrics
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Net sales | $176.4 million | $163.4 million | $269.5 million | $247.4 million |
| Gross profit | $59.6 million | $55.8 million | $82.5 million | $75.9 million |
| Gross margin | 33.8% | 34.2% | 30.6% | 30.7% |
| Income from operations | $38.1 million | $32.4 million | $41.6 million | $33.5 million |
| Net income | $25.5 million | $21.2 million | $25.2 million | $19.3 million |
| Diluted EPS | $1.10 | $0.91 | $1.08 | $0.83 |
| Adjusted EBITDA | $44.1 million | $40.1 million | $53.1 million | $47.2 million |
| Free cash flow | $0.6 million | $(6.1) million | $(5.8) million | $6.9 million |
- Q2 revenue increased 8.0%, and six-month revenue increased 8.9%, primarily from higher volumes and positive demand.
- Q2 Work Truck Attachments revenue rose 8.4% to $112.2 million, supported by strong pre-season sales. Six-month revenue increased 7.8% to $138.1 million, also benefiting from parts and accessory sales following strong early-year snowfall.
- Q2 Work Truck Solutions revenue increased 7.0% to $64.1 million; six-month revenue increased 10.2% to $131.5 million. Growth reflected higher demand, recovery of higher material costs, and improved chassis supply predictability.
- Gross margin declined modestly because of material-cost inflation and a greater proportion of lower-margin Work Truck Solutions revenue.
- Operating margin improved to 21.6% in Q2 from 19.7% in the prior-year quarter and to 15.5% for the six-month period from 13.6%. SG&A, including intangibles amortization, declined 8.1% in Q2 and 3.5% year to date, mainly because of lower stock compensation, planned management-transition costs and lower legal expense.
- Q2 net income increased 20.4%; six-month net income increased 30.5%. The six-month effective tax rate rose to 23.7% from 22.7%, partly because of a smaller discrete tax benefit from stock compensation.
- Q2 Adjusted EBITDA increased 10.1%. Work Truck Solutions Adjusted EBITDA increased to $5.6 million from $3.0 million, while Work Truck Attachments increased to $38.5 million from $37.1 million. For six months, Work Truck Attachments Adjusted EBITDA declined to $40.8 million from $41.4 million, while Work Truck Solutions increased to $12.4 million from $5.7 million.
Cash Flow, Debt and Liquidity
- Cash used in operating activities was $0.3 million for the six months ended June 30, 2019, compared with $11.0 million of cash provided in the prior-year period. The change was driven primarily by working-capital investment, including a $34.1 million increase in accounts receivable and an $11.9 million increase in inventories.
- Capital expenditures were $5.5 million year to date, compared with $4.1 million in 2018. Free cash flow was negative $5.8 million, versus positive $6.9 million in the prior-year period.
- Cash declined to $5.0 million at June 30, 2019 from $27.8 million at December 31, 2018. The company paid $12.6 million of dividends, repaid $31.4 million of long-term debt, and borrowed $27.0 million under its revolving facility.
- Total liquidity was $77.4 million at June 30, 2019, consisting of $5.0 million of cash and $72.4 million of revolving-credit availability, compared with approximately $122.4 million at year-end 2018. Management attributed the decline primarily to seasonal working-capital requirements.
- Debt included $246.9 million of term-loan borrowings and $27.0 million of revolving borrowings. The company voluntarily prepaid $30.0 million of term debt in February 2019. Remaining revolver availability was $72.4 million.
- The company entered into a new $175.0 million interest-rate swap in June 2019, effective through May 2024, replacing four prior swaps. The new swap had a negative fair value of $6.8 million at June 30, 2019.
- Management stated that cash on hand, expected operating cash flow and available credit are expected to provide adequate funding for at least the next 12 months, subject to credit-facility requirements and seasonal fluctuations.
Material Changes Versus the Prior Comparable Period
- Revenue and earnings improved materially, but year-to-date operating cash flow and free cash flow deteriorated because of seasonal working-capital investment.
- Gross margins were slightly lower, reflecting material inflation and mix; operating and net margins improved because of lower SG&A and higher volumes.
- The company reorganized its reporting structure in the first quarter of 2019. Municipal snow and ice products formerly reported in Work Truck Attachments are now included in Work Truck Solutions, and prior periods were recast.
- Effective January 1, 2019, the company adopted ASC 842 for leases. Operating lease right-of-use assets and liabilities of approximately $22 million were recognized, with no material income-statement impact.
- Short-term borrowings increased to $27.0 million from none at December 31, 2018, while long-term debt declined following the voluntary prepayment and scheduled repayments.
- Quarterly dividends were $0.27 per share; year-to-date dividends were $0.55 per share versus $0.53 in the prior-year period.
Guidance, Outlook, Commentary and Risks
The filing does not provide a specific numerical revenue, earnings or Adjusted EBITDA forecast. Management cited ongoing positive demand, strong pre-season activity, improved chassis availability, operational efficiencies and material-cost price recovery. It also expects liquidity to remain adequate for at least the next 12 months.
- Results remain highly sensitive to snowfall levels, timing and geography, particularly in the fourth quarter.
- Key risks include distributor and original-equipment-manufacturer relationships, end-user and customer financing availability, economic conditions, steel and other input costs, tariffs, fuel and freight costs, supplier performance, demand-estimation errors, competition and product liability litigation.
- Management identified potential goodwill impairment risk related to Work Truck Solutions and execution risks associated with the Dejana and Arrowhead acquisitions.
- Variable-rate debt creates interest-rate exposure. The company mitigates part of this exposure through interest-rate swaps.
- Steel purchases represented 8.5% of revenue in Q2 and 11.1% year to date. The company does not hedge steel prices and may not always be able to pass cost increases through to customers.
- Dividend payments are discretionary and subject to financial condition, legal requirements and restrictions under the senior credit facilities.
- Warranty liability was $5.7 million at June 30, 2019. Ordinary-course product-liability and intellectual-property litigation was not expected by management to have a material adverse effect; no environmental claims were reported.
Important Facts for Investors to Verify
- Whether seasonal receivables and inventory convert to cash as expected during the second half of the year.
- The sustainability of Work Truck Solutions’ improved margins and Adjusted EBITDA.
- The effect of steel inflation, tariffs and other material costs on future gross margins and the effectiveness of price recovery.
- Fourth-quarter snowfall and its effect on distributor reorders and full-year results.
- Compliance with revolver borrowing-base, minimum-availability and dividend restrictions.
- Interest expense trends after the new swap and changes in variable interest rates.
- Potential goodwill impairment in Work Truck Solutions and performance or contingent liabilities associated with acquired businesses.
- The distinction between GAAP results and non-GAAP measures such as Adjusted EBITDA and free cash flow.