Douglas Dynamics, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2017; filed August 8, 2017. Financial statements are unaudited. Douglas Dynamics operates through Work Truck Attachments and Work Truck Solutions, with seasonal demand in the snow and ice control business.
Key Financial Metrics
| Metric | Q2 2017 | Q2 2016 | Six Months 2017 | Six Months 2016 |
|---|---|---|---|---|
| Net sales | $139.4 million | $113.8 million | $211.6 million | $162.6 million |
| Gross profit | $45.0 million | $41.5 million | $62.2 million | $55.7 million |
| Gross margin | 32.3% | 36.5% | 29.4% | 34.2% |
| Income from operations | $25.3 million | $28.5 million | $24.7 million | $30.0 million |
| Operating margin | 18.2% | 25.0% | 11.7% | 18.4% |
| Net income | $14.7 million | $16.3 million | $11.5 million | $21.6 million |
| Net margin | 10.6% | 14.4% | 5.4% | 7.2% |
| Diluted EPS | $0.64 | $0.71 | $0.50 | $0.94 |
| Adjusted EBITDA | $31.3 million | $32.7 million | $36.5 million | $38.9 million |
Cash Flow, Debt and Liquidity
- Six-month operating cash flow was $13.3 million, down from $28.3 million. Free cash flow was $10.2 million versus $23.5 million.
- Investing cash use was $10.7 million, including $7.6 million for the Arrowhead acquisition and $3.1 million of capital expenditures.
- Financing cash use was $16.9 million, including $11.0 million of dividends, a $5.5 million Dejana earnout payment, $1.6 million of term-loan repayment and $0.9 million of financing costs. Revolver borrowings provided $3.0 million.
- Cash declined to $4.3 million from $18.6 million at December 31, 2016. Total liquidity was $82.2 million, consisting of cash and $77.9 million of revolver availability.
- Term-loan borrowings were $312.2 million, and total net long-term debt reported on the balance sheet was $305.8 million. Revolver borrowings were $3.0 million, with a $100 million facility and maturity in June 2021. The term loan is payable in December 2021.
- The company was in compliance with its debt covenants and was not required to make an excess-cash-flow payment as of June 30, 2017. Debt facilities restrict dividends and certain subsidiary distributions.
Material Changes Versus the Prior Comparable Period
- Sales increased 22.5% in the quarter and 30.1% year to date, primarily from the Dejana acquisition and the new Work Truck Solutions segment. Arrowhead contributed $1.0 million of revenue from its May 1 acquisition date through June 30.
- Work Truck Attachments sales declined $8.3 million in the quarter and $13.3 million year to date, largely because of below-average snowfall and delays in truck-chassis supply at Henderson.
- Margins contracted materially. Management attributed the decline to lower Work Truck Attachments volume, higher marginal production costs, the higher-cost Work Truck Solutions mix, and less favorable commodity pricing than in 2016.
- Operating income declined 11.2% in the quarter and 17.7% year to date. Interest expense increased because of the $130 million incremental term borrowing used to finance Dejana and $0.9 million of debt-amendment costs.
- Six-month net income benefited from a lower effective tax rate of 30.0%, compared with 36.7%, due to a release of uncertain-tax reserves and a $616,000 excess stock-compensation tax benefit.
- Litigation proceeds were $1.3 million in 2017 versus $10.1 million in the first six months of 2016, creating a difficult comparison.
- On May 1, 2017, the company acquired substantially all assets of Arrowhead Equipment for $7.6 million. The preliminary allocation included $2.3 million of goodwill and $2.7 million of intangible assets.
Outlook, Risks and Unusual Items
- The filing does not provide a specific financial forecast or formal earnings guidance. Management expects cash on hand, operating cash flow and available credit to fund operations, debt service, dividends, capital expenditures and other needs for at least the next 12 months.
- Work Truck Attachments results are highly seasonal and depend on the level, timing and location of snowfall. Second- and third-quarter distributor pre-season orders are important, while fourth-quarter demand depends heavily on winter snowfall.
- Principal risks include weak snowfall, economic deterioration, raw-material and steel-price inflation, supply-chain constraints, customer and distributor financing availability, competition, product liability, intellectual-property disputes, acquisition integration and the ability to maintain dividends.
- Variable-rate borrowings create interest-rate exposure. The company has interest-rate swaps, but the swaps had a negative fair value of $2.7 million at June 30, 2017 and expose the company to counterparty risk.
- Steel purchases represented 9.0% of quarterly revenue and 11.3% of year-to-date revenue. The company does not hedge steel prices and may be unable to pass future increases to customers.
- Warranty liabilities were $5.6 million. Management stated that existing litigation is not expected to have a material adverse effect and that there were no environmental claims.
- Revenue recognition guidance under ASC 606 and lease accounting guidance were under evaluation; the filing states that the financial impact of ASC 606 had not yet been clearly determined.
Investor Verification Checklist
- Verify whether Work Truck Solutions can offset continued weakness and margin pressure in Work Truck Attachments.
- Monitor snowfall, pre-season orders, truck-chassis availability and inventory growth, including $85.9 million of core inventory and $8.7 million of floor-plan inventory at quarter-end.
- Assess leverage, variable-rate exposure, swap obligations and the $77.9 million of remaining revolver availability.
- Evaluate cash conversion and the sustainability of dividends given reduced cash, seasonal working-capital requirements and debt restrictions.
- Review the final purchase-price allocation and integration performance for Arrowhead, as the acquisition accounting remained preliminary.
- Adjust comparisons for the $1.3 million 2017 litigation settlement, the $10.1 million 2016 settlement, tax benefits and other nonrecurring items.