Douglas Dynamics, Inc. — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and nine months ended September 30, 2017. The unaudited results cover two segments: Work Truck Attachments, which sells snow and ice management equipment, and Work Truck Solutions, which provides commercial work-vehicle upfitting and storage solutions. Results are seasonal, with Work Truck Attachments generally strongest in the second and third quarters and materially affected by snowfall.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $125.3 million | $123.6 million | $337.0 million | $286.1 million |
| Gross profit | $36.1 million | $36.6 million | $98.3 million | $92.3 million |
| Gross margin | 28.8% | 29.7% | 29.2% | 32.3% |
| Operating income | $20.0 million | $16.5 million | $44.7 million | $46.5 million |
| Operating margin | 16.0% | 13.3% | 13.3% | 16.3% |
| Net income | $9.3 million | $7.3 million | $20.8 million | $28.9 million |
| Diluted EPS | $0.40 | $0.32 | $0.90 | $1.26 |
| Adjusted EBITDA | $24.2 million | $25.1 million | $60.6 million | $64.0 million |
Nine-month net sales increased 17.8%, primarily because Work Truck Solutions was included for the full period in 2017 versus only after the July 2016 Dejana acquisition in the prior year. Nine-month net income declined 28.1%, principally because 2016 included $10.1 million of litigation proceeds compared with $1.3 million in 2017, while interest expense increased.
Cash flow, liquidity, debt and balance sheet
- Nine-month operating cash flow was negative $0.7 million, versus positive $11.2 million in 2016. The decline reflected increased working-capital investment, particularly accounts receivable and inventory, and lower earnings adjusted for noncash items.
- Free cash flow was negative $5.9 million, versus positive $4.1 million in the prior-year period.
- Capital expenditures were $5.2 million, compared with $7.1 million in the prior-year period.
- Cash and cash equivalents were $1.5 million at September 30, 2017, down from $18.6 million at December 31, 2016.
- Total reported liquidity was $75.7 million, consisting of cash of $1.5 million and $74.2 million of revolving-credit availability, compared with approximately $108.3 million at year-end 2016.
- Term-loan borrowings were $311.5 million, revolving borrowings were $23.0 million, and net long-term debt on the balance sheet was $305.4 million. The term loan matures December 31, 2021; the revolving facility matures June 30, 2021.
- Interest-rate margins on the term loan were reduced in February and August 2017. The company remained in compliance with its debt covenants and was not required to make an excess-cash-flow principal payment as of September 30, 2017.
- The company paid $16.5 million of dividends during the first nine months and declared and paid $0.24 per share for the third quarter.
Material changes and unusual items
- Work Truck Attachments sales declined $2.4 million in the quarter and $15.8 million year to date, primarily due to below-average snowfall in the season ended March 31, 2017. Segment nine-month operating income fell to $52.2 million from $62.6 million.
- Work Truck Solutions sales increased to $32.2 million in the quarter and $96.8 million year to date. Segment operating income was $1.8 million in the quarter and $5.1 million year to date, compared with a $0.4 million loss in the comparable 2016 quarter and period.
- Gross margins contracted because of lower Work Truck Attachments production volumes, less favorable Work Truck Solutions channel mix, and the absence of favorable steel pricing experienced in 2016.
- The company acquired substantially all assets of Arrowhead Equipment on May 1, 2017 for $7.4 million. Arrowhead contributed $3.4 million of revenue and a $0.1 million pretax operating loss from acquisition through September 30; the purchase-price allocation remained preliminary.
- The Dejana earnout agreement was amended to extend measurement periods through 2019 and 2020. The company paid $5.5 million during the period and recorded a $1.2 million reduction in the estimated earnout liability.
- The company received $1.3 million from an intellectual-property litigation settlement, versus $10.1 million in the prior-year period.
Outlook, commentary and risks
Management expects cash on hand, operating cash flow and available credit to provide adequate funding for at least the next 12 months. No specific revenue, earnings or EBITDA guidance is provided in the filing.
- Seasonality and snowfall timing can materially affect sales, fourth-quarter demand, working capital and full-year results.
- Primary operating risks include weaker economic conditions, customer and distributor financing availability, steel and fuel costs, supplier or original-equipment-manufacturer performance, competition, product development, intellectual-property disputes, product liability and acquisition integration or performance.
- The company has variable-rate debt and interest-rate swaps; a hypothetical 1% increase in the term-loan rate would have increased third-quarter interest expense by approximately $0.7 million before considering swap effects.
- Steel represented 8.5% of quarterly revenue and 10.3% of nine-month revenue in 2017. The company does not hedge steel prices and may be unable to pass cost increases through to customers.
- Ordinary-course litigation remains outstanding, but management does not believe pending matters will materially affect consolidated financial position. No environmental claims were reported.
- The company expects operating-lease accounting changes to materially affect the balance sheet upon adoption in 2019. Revenue-recognition implementation was ongoing, with adoption expected using the modified-retrospective method.
Most important facts for investors to verify
- Whether snowfall and fourth-quarter reorders improve Work Truck Attachments demand after the weak 2016–2017 snow season.
- Whether Work Truck Solutions and Arrowhead achieve sustainable profitability and expected integration synergies.
- Cash conversion and working-capital requirements, particularly accounts receivable and inventory levels during the seasonal peak.
- Debt reduction capacity, covenant headroom, refinancing needs and sensitivity to variable interest rates.
- The sustainability of dividends given low cash balances, negative year-to-date free cash flow and restrictions in the credit facilities.
- The final purchase-price allocation for Arrowhead, remaining Dejana earnout obligations and any resulting valuation adjustments.
- The effect of steel prices, channel mix and production volumes on gross margins.