Douglas Dynamics, Inc. — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and nine months ended September 30, 2018, filed November 6, 2018. Douglas Dynamics operates through 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, particularly for Work Truck Attachments, with sales generally concentrated in the second and third quarters and fourth-quarter results dependent on snowfall.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $124.8 million | $125.3 million | $372.2 million | $337.0 million |
| Gross profit | $34.9 million | $36.1 million | $110.8 million | $98.3 million |
| Gross margin | 28.0% | 28.8% | 29.8% | 29.2% |
| Operating income | $15.5 million | $20.1 million | $48.9 million | $45.2 million |
| Operating margin | 12.4% | 16.1% | 13.2% | 13.5% |
| Net income | $9.9 million | $9.3 million | $29.2 million | $20.8 million |
| Diluted EPS | $0.43 | $0.40 | $1.26 | $0.90 |
| Adjusted EBITDA | $20.5 million | $24.2 million | $67.7 million | $60.6 million |
| Dividends per share | $0.27 | $0.24 | $0.80 | $0.72 |
All dollar amounts are presented in millions except per-share data. The filing reports unaudited interim financial statements.
- Cash flow: Nine-month cash used in operating activities was $17.9 million versus $0.7 million used in the prior-year period. Capital expenditures were $6.3 million, producing negative free cash flow of $24.2 million versus negative $5.9 million in 2017.
- Balance sheet: Total assets were $712.7 million at September 30, 2018, including $128.2 million of receivables and $89.4 million of inventory. Cash and cash equivalents were reported as zero; outstanding checks exceeded the cash book balance by $3.7 million.
- Debt: Term-loan borrowings were $278.8 million, revolving-credit borrowings were $38.0 million, and net long-term debt on the balance sheet was $273.4 million. Remaining revolver availability was $61.4 million.
- Liquidity: Management reported total liquidity of $57.7 million, consisting of negative $3.7 million in cash and $61.4 million of revolver availability, compared with approximately $136.4 million at December 31, 2017.
- Tax rate: The effective tax rate declined to 10.4% from 38.1% in the quarter and to 18.9% from 33.9% for the nine-month period, reflecting the Tax Cuts and Jobs Act, releases of uncertain-tax-position reserves, and a pension-funding tax benefit.
Material changes versus the prior comparable period
- Third-quarter sales declined 0.4%, while nine-month sales increased 10.4%, primarily reflecting more normal snowfall in the 2017–2018 snow season, higher pricing, stronger commercial-product demand, and additional Work Truck Solutions facilities.
- Work Truck Attachments sales decreased 4.6% in the quarter but increased 8.6% for the nine months. Work Truck Solutions sales increased 7.6% in the quarter and 14.3% for the nine months.
- Third-quarter operating income declined 22.9%, mainly because of lower Work Truck Attachments sales, higher SG&A, and lower Work Truck Solutions profitability. Nine-month operating income increased 8.2%.
- Work Truck Solutions operating income fell 94.4% in the quarter and 60.8% for the nine months, reflecting higher headcount and wage costs for new facilities, legal expenses, and the absence of a $1.2 million earnout reversal recorded in 2017.
- SG&A increased 28.5% in the quarter and 19.6% for the nine months, while intangibles amortization was broadly stable.
- Interest expense decreased to $4.4 million from $4.9 million in the quarter and to $12.4 million from $14.3 million for the nine months, due to lower debt balances and more favorable borrowing terms.
- Cash generation deteriorated because of seasonal working-capital investment, higher receivables and inventory, a $7.0 million discretionary pension contribution, and a tariff-related inventory build. The company also repaid approximately $30.0 million of debt and borrowed $38.0 million under its revolver during the nine months.
- The company adopted ASC Topic 606 using the modified retrospective method. The adoption increased opening retained earnings by $0.4 million and increased 2018 nine-month revenue by $0.3 million, with no significant overall effect on reported results.
Outlook, commentary, risks and unusual items
- Management stated that cash generated from operations, cash on hand, and available senior-credit-facility capacity are expected to provide adequate funding for at least the next 12 months. No specific revenue or earnings guidance was provided.
- Seasonality remains significant: fourth-quarter Work Truck Attachments demand depends heavily on the level, timing, and geographic location of snowfall. Results for any quarter may not indicate full-year performance.
- Key risks include weak or delayed snowfall, economic deterioration, distributor and original-equipment-manufacturer relationships, chassis supply constraints, steel and fuel-cost inflation, tariffs, supplier execution, product liability and intellectual-property litigation, competition, financing availability, and integration or performance risks related to Henderson, Dejana, and Arrowhead.
- Borrowings carry variable interest rates. Interest-rate swaps hedge a portion of exposure, but a 1% change in the term-loan rate would have changed quarterly interest expense by approximately $0.5 million based on the filing’s sensitivity analysis.
- Steel purchases represented 10.3% of quarterly revenue and 10.4% of nine-month revenue. The company does not hedge steel prices and may be unable to fully recover cost increases through pricing.
- The company expects adoption of the new lease standard in the first quarter of 2019, with an estimated $25 million to $50 million increase in recognized lease liabilities and right-of-use assets.
- Pending litigation is described as ordinary-course product-liability and intellectual-property matters that management does not believe will materially affect financial position. No environmental claims were reported.
- Dividend payments are subject to board discretion and restrictions under the senior credit facilities. The filing states that the dividend policy may reduce cash available for unexpected liquidity needs, capital expenditures, or acquisitions.
Important facts for investors to verify
- Confirm the sustainability of positive net income and EBITDA given negative operating cash flow and negative free cash flow.
- Monitor fourth-quarter snowfall, distributor reorder activity, and the conversion of seasonal receivables and inventory into cash.
- Assess leverage, revolver availability, borrowing-base requirements, interest-rate exposure, and dividend restrictions.
- Evaluate whether Work Truck Solutions’ new facilities can improve profitability after the reported decline in segment operating income.
- Review the effects of steel prices, tariffs, chassis availability, and the company’s ability to pass cost increases to customers.
- Consider the unusually low effective tax rate and determine how much of the tax benefit is recurring.
- Verify the estimated balance-sheet impact of the 2019 lease-accounting adoption and the company’s continuing acquisition and integration risks.