Business Context and Reporting Period
Douglas Dynamics, Inc. filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2019. The company manufactures and sells snow and ice control equipment and work-truck upfitting solutions through two reportable segments: Work Truck Attachments and Work Truck Solutions. Work Truck Attachments is highly seasonal, with significant sales typically occurring in the second and third quarters ahead of the winter season.
In the first quarter of 2019, the company reorganized its segment structure and recast prior-period segment information. The company adopted ASC 842 leases effective January 1, 2019, recognizing approximately $22.0 million of operating lease right-of-use assets and liabilities without a material income-statement impact.
Financial Performance and Position
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Net sales | $141.9 million, up 13.7% | $411.4 million, up 10.5% |
| Gross profit | $39.9 million; 28.2% margin | $122.5 million; 29.8% margin |
| Income from operations | $19.9 million; 14.1% margin | $61.6 million; 15.0% margin |
| Net income | $12.4 million; 8.9% margin | $37.6 million; 9.2% margin |
| Diluted EPS | $0.53 | $1.61 |
| Adjusted EBITDA | $25.1 million | $78.2 million |
| Free cash flow | $(23.2) million | $(29.0) million |
- Segment sales: Work Truck Attachments generated $75.6 million in quarterly sales and $213.7 million year-to-date; Work Truck Solutions generated $66.2 million and $197.7 million, respectively.
- Segment Adjusted EBITDA: Work Truck Attachments contributed $18.7 million in the quarter and $59.4 million year-to-date; Work Truck Solutions contributed $6.4 million and $18.8 million, respectively.
- Cash flow: Operating activities used $21.2 million year-to-date, primarily because accounts receivable increased $72.7 million and inventories increased $8.4 million. Capital expenditures were $7.8 million.
- Liquidity: Cash was $4.9 million at September 30, 2019. Revolver borrowings were $57.0 million, with $42.4 million of remaining availability, producing reported total liquidity of $47.3 million.
- Debt: Term-loan borrowings were $246.3 million, and total debt borrowings including the revolver were approximately $303.3 million before applicable discounts and deferred financing costs. The company made a voluntary $30.0 million term-loan prepayment in February 2019.
- Dividends: The company paid $18.9 million in dividends during the first nine months, or $0.82 per share.
- Balance sheet: Total assets were $766.9 million and stockholders’ equity was $300.0 million at September 30, 2019. Accounts receivable increased to $153.2 million from $81.5 million at December 31, 2018.
Material Changes Versus the Prior Comparable Period
- Sales increased $17.1 million in the quarter and $39.2 million year-to-date, reflecting higher volumes, price increases, improved chassis availability and continued demand.
- Work Truck Solutions was the principal Adjusted EBITDA growth driver, increasing $4.7 million in the quarter and $11.4 million year-to-date due to higher volumes, improved chassis predictability, operational efficiencies and lower spending.
- Work Truck Attachments sales increased, but Adjusted EBITDA declined slightly by $0.1 million in the quarter and $0.8 million year-to-date because inflation and business investments offset volume and pricing benefits.
- Quarterly gross margin improved from 28.0% to 28.2%; year-to-date gross margin was unchanged at 29.8%.
- Operating income margin improved from 12.4% to 14.1% in the quarter and from 13.2% to 15.0% year-to-date, supported by lower SG&A and amortization as a percentage of sales.
- Net income increased $2.5 million in the quarter and $8.4 million year-to-date. The 2018 comparison benefited from a $7.0 million pension contribution and related tax benefit, while 2019 had a higher effective tax rate.
- Year-to-date operating cash flow and free cash flow became more negative than in 2018 because of increased working-capital investment and higher capital expenditures.
Outlook, Risks, Contingencies and Unusual Items
The filing does not provide specific revenue or earnings guidance. Management expects cash on hand, operating cash generation and available credit to fund operations, debt service, capital expenditures and dividends for at least the next 12 months, although liquidity is expected to fluctuate with seasonal working-capital needs.
- Key risks include snowfall levels and timing, distributor and original-equipment-manufacturer relationships, customer financing availability, economic conditions, steel and other material costs, tariffs, fuel and freight costs, supplier performance, demand forecasting, competition, product liability, intellectual-property litigation and potential goodwill impairment in Work Truck Solutions.
- The company uses a $175.0 million interest-rate swap, effective through May 2024, to reduce variable-rate exposure. The swap had a negative fair value of $8.3 million at September 30, 2019.
- Warranty reserves were $6.3 million. Management stated that pending litigation, primarily product liability and intellectual-property matters, was not expected to materially affect consolidated financial position.
- The company intends to terminate its defined-benefit pension plans. On October 31, 2019, it made $15.7 million of lump-sum settlement payments and expected to purchase annuities in the fourth quarter. It reported $6.5 million of net unrecognized pension losses that may be recognized upon settlement, subject to final payout and market conditions.
- The company had no material off-balance-sheet arrangements and reported no significant changes to previously disclosed risk factors.
Investor Verification Points
- Verify the sustainability of Work Truck Solutions’ improved margins and Adjusted EBITDA, including the effects of chassis availability and operational efficiencies.
- Monitor seasonal collections, accounts receivable, inventory levels and revolver usage as the company moves through the winter selling period.
- Assess leverage, covenant requirements, dividend restrictions and the company’s ability to fund dividends while free cash flow remains negative.
- Review the financial impact of the planned pension-plan termination, including the final settlement loss and annuity purchase costs.
- Evaluate exposure to snowfall variability, steel prices, tariffs, freight costs and the company’s ability to recover cost inflation through pricing.
- Distinguish GAAP results from management’s non-GAAP Adjusted EBITDA, Adjusted Net Income and free cash flow measures.