Douglas Dynamics, Inc. — Q2 2018 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and six months ended June 30, 2018, compared with the same periods in 2017. Douglas Dynamics operates through Work Truck Attachments, which sells snow and ice management equipment under the FISHER, WESTERN, HENDERSON and SNOWEX brands, and Work Truck Solutions, which provides commercial work-vehicle upfitting under the DEJANA brand and related brands.
Work Truck Attachments is seasonal: sales and working-capital requirements generally increase in the second and third quarters due to the pre-season distributor program. The company attributed stronger 2018 results largely to near-average snowfall in the season ended March 31, 2018, versus below-average snowfall in the prior-year season.
Financial performance and metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $163.4 million | $139.4 million | $247.4 million | $211.6 million |
| Gross profit | $55.8 million | $45.0 million | $75.9 million | $62.2 million |
| Gross margin | 34.2% | 32.3% | 30.7% | 29.4% |
| Operating income | $32.4 million | $25.5 million | $33.5 million | $25.1 million |
| Operating margin | 19.8% | 18.3% | 13.5% | 11.8% |
| Net income | $21.2 million | $14.7 million | $19.3 million | $11.5 million |
| Net margin | 12.8% | 10.6% | 8.0% | 5.4% |
| Diluted EPS | $0.91 | $0.64 | $0.83 | $0.50 |
| Adjusted EBITDA | $40.1 million | $31.3 million | $47.2 million | $36.5 million |
| Free cash flow | $(6.1) million | $7.2 million | $6.9 million | $10.2 million |
Q2 sales increased 17.2%, gross profit increased 24.0%, operating income increased 27.1%, and net income increased 43.5%. Six-month sales increased 16.9%, while operating income increased 33.5% and net income increased 68.2%.
- Work Truck Attachments sales rose 20.7% in Q2 and 17.2% year to date; segment operating income rose 43.2% and 47.4%, respectively.
- Work Truck Solutions sales rose 6.5% in Q2 and 17.6% year to date, but segment operating income declined 80.0% and 44.1%, respectively, reflecting facility ramp-up costs, higher compensation and benefits, legal expenses and commissions.
- Interest expense declined to $4.1 million in Q2 and $8.0 million year to date, compared with $4.2 million and $9.5 million, respectively, primarily due to refinancing, lower debt and the absence of prior-year financing costs.
- The effective tax rate declined to 24.6% in Q2 and 22.7% year to date, compared with 34.0% and 30.0%, respectively, primarily due to the lower corporate tax rate under the Tax Cuts and Jobs Act.
- The company declared and paid dividends of $0.27 per share in Q2 and $0.53 per share year to date, compared with $0.24 and $0.48 in the prior-year periods.
Balance sheet, debt, liquidity and cash flow
- Cash and cash equivalents were reported at $0 at June 30, 2018, compared with $36.9 million at December 31, 2017. Management reported approximately $( $1.1 million) of cash for liquidity purposes because outstanding checks exceeded the cash book balance; this amount was included in accrued liabilities.
- Accounts receivable increased to $95.0 million from $79.1 million at year-end, and inventory increased to $84.6 million from $71.5 million, consistent with seasonal working-capital needs and higher sales.
- Total debt was approximately $282.2 million before deferred financing costs and discounts, including $279.5 million of term-loan borrowings and $2.7 million of current maturities. Debt decreased from approximately $313.6 million at December 31, 2017.
- The company had no revolver borrowings and $83.9 million of remaining revolver availability. Management reported total liquidity of approximately $82.8 million, subject to borrowing-base and minimum-availability requirements.
- Six-month operating cash flow was $11.0 million, down from $13.3 million, primarily because higher receivables and inventories absorbed cash. Capital expenditures were $4.1 million, compared with $3.1 million.
- The company made $31.6 million of debt repayments during the first six months, including a required $11.3 million excess-cash-flow payment and a voluntary $18.7 million payment, and paid $12.2 million of dividends.
Material changes, outlook and risks
The company adopted ASC Topic 606 on January 1, 2018 using the modified retrospective method, increasing opening retained earnings by $0.4 million. The principal effect was to recognize revenue over time for upfits of customer-owned chassis in Work Truck Solutions. The adoption increased year-to-date revenue by $0.3 million and had no material overall effect on reported results.
Management stated that cash on hand, operating cash flow and available credit are expected to fund operations, debt service, capital expenditures, dividends and other needs for at least the next 12 months. No formal quantitative revenue or earnings guidance was provided in the filing.
- Snowfall levels, timing and geographic distribution can materially affect demand, particularly fourth-quarter reorders.
- Work Truck Solutions remains exposed to execution and profitability risks from new-facility ramp-up, legal costs and higher variable compensation.
- Steel represented 8.6% of Q2 revenue-related purchases and 10.5% year to date; the company does not hedge steel prices and may be unable to pass cost increases through to customers.
- Variable-rate debt creates interest-rate exposure. The filing estimates that a 1% rate increase would have increased Q2 interest expense by approximately $0.5 million on the term loan, before considering hedging effects.
- Municipal sales were constrained by chassis-supply availability issues. Other risks include distributor and original-equipment-manufacturer relationships, supplier performance, competition, product liability, intellectual-property disputes, acquisition integration and dividend restrictions under the credit facilities.
- Pending litigation is primarily product-liability and intellectual-property related; management does not believe current matters will materially affect the company’s financial position. No environmental claims were reported.
- The company expects adoption of the lease standard effective January 1, 2019 to materially increase reported lease assets and liabilities.
Most important facts for investors to verify
- Whether the strong Work Truck Attachments performance is sustained if snowfall returns to lower-than-average levels.
- Whether Work Truck Solutions facilities achieve targeted utilization and restore segment operating margins.
- Current revolver availability, borrowing-base calculations, leverage covenant compliance and future mandatory debt repayments.
- The sustainability of dividends given seasonal working-capital requirements, debt restrictions and limited cash on hand.
- The impact of steel prices, tariffs, chassis availability and other supply-chain constraints on gross margins.
- The ultimate tax impact of the Tax Cuts and Jobs Act and the balance-sheet effects of the 2019 lease-accounting adoption.