Douglas Dynamics, Inc. — Q3 2016 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods. Douglas Dynamics manufactures snow and ice control equipment through its Work Truck Attachments segment and, following the July 15, 2016 acquisition of Dejana, operates a second Work Truck Solutions segment providing commercial vehicle up-fitting and storage solutions.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $123.6 million | $120.6 million | $286.1 million | $281.6 million |
| Gross profit | $36.6 million | $40.9 million | $92.3 million | $94.3 million |
| Gross margin | 29.7% | 33.9% | 32.3% | 33.5% |
| Operating income | $16.5 million | $26.6 million | $46.5 million | $53.5 million |
| Operating margin | 13.3% | 22.0% | 16.3% | 19.0% |
| Net income | $7.3 million | $15.5 million | $28.9 million | $29.0 million |
| Diluted EPS | $0.32 | $0.68 | $1.26 | $1.27 |
| Adjusted EBITDA | $25.1 million | $31.1 million | $64.0 million | $68.7 million |
Net sales increased 2.5% in the quarter and 1.6% year to date, primarily because Dejana contributed $27.1 million of post-acquisition revenue. Work Truck Attachments sales declined $18.5 million in the quarter and $20.1 million year to date, mainly because of below-average snowfall and different timing of preseason shipments.
Q3 net income declined 53.0% and year-to-date net income was broadly unchanged. Higher cost of sales, increased amortization, acquisition-related expenses, and higher interest expense more than offset the incremental Dejana revenue. The nine-month results include a nonrecurring $10.1 million litigation settlement; excluding that item, reported profitability was weaker year over year.
Operating cash flow was $11.2 million for the first nine months of 2016 versus negative $11.9 million in 2015. Free cash flow was $4.1 million versus negative $19.0 million. Investing cash flow included $175.9 million for the Dejana acquisition and $7.1 million of capital expenditures. Financing cash flow was $135.3 million, including $129.4 million of long-term borrowings, $26.0 million of revolver borrowings, and $16.1 million of dividends.
At September 30, 2016, cash was $0.3 million, total liquidity was $73.6 million, and revolver availability was $73.3 million. Total assets were $700.1 million, including $233.1 million of goodwill and $202.0 million of net intangible assets. Long-term debt, net of current maturities and financing costs, was $307.3 million, compared with $182.5 million at December 31, 2015.
Material changes versus the prior comparable period
- Dejana was acquired for total consideration of $186.1 million, creating the Work Truck Solutions segment. The preliminary purchase-price allocation included $72.2 million of goodwill and $82.2 million of intangible assets.
- Dejana contributed $27.1 million of revenue and a $2.3 million pretax operating loss from July 15 through September 30, 2016.
- Gross margin fell 420 basis points in Q3 and 120 basis points year to date, reflecting lower Work Truck Attachments volume and higher marginal production costs.
- SG&A and intangibles amortization increased due to Dejana operating costs, $2.8 million of year-to-date acquisition-related expenses, and higher amortization.
- Interest expense increased to $10.3 million year to date from $8.1 million because of incremental acquisition financing.
- Dividends increased to $0.24 per share in Q3 from $0.22 per share in the prior-year quarter; year-to-date dividends were $0.71 per share.
Guidance, outlook, risks, contingencies, and unusual items
The filing does not provide specific earnings or revenue guidance. Management expects cash on hand, operating cash flow, and available credit to fund operations, debt service, capital expenditures, dividends, and other needs for at least the next 12 months. The company was in compliance with its debt covenants at September 30, 2016 and was not required to make an excess-cash-flow debt prepayment.
Work Truck Attachments is highly seasonal and dependent on the level, timing, and location of snowfall. Fourth-quarter demand is particularly weather-sensitive. Other key risks include distributor relationships, end-user financing, steel and fuel costs, supplier performance, competition, product liability, intellectual property disputes, acquisition integration, and the ability to achieve projected performance from Dejana and prior acquisitions.
The company received a nonrecurring $10.1 million intellectual-property litigation settlement during the first nine months. Dejana’s purchase-price allocation and working-capital adjustment remained preliminary; $5.5 million was accrued for a working-capital true-up expected to be paid before year-end, and the estimated Dejana earnout was $10.2 million, with a maximum potential earnout of $26.0 million.
Variable-rate debt creates interest-rate exposure despite interest-rate swaps. The company had $314.3 million of term-loan borrowings and $26.0 million of revolver borrowings at quarter-end. Contracted cash obligations totaled $427.9 million, including debt, estimated interest, and operating leases. Management stated that pending litigation was not expected to have a material adverse effect, and no environmental claims were pending.
Important facts for investors to verify
- Whether Dejana integration improves profitability and converts its initial operating loss into sustainable earnings.
- The preliminary purchase-price allocation, working-capital true-up, and potential Dejana earnout payments.
- Fourth-quarter snowfall and its effect on replenishment orders and Work Truck Attachments revenue.
- Debt-service capacity, covenant compliance, revolver availability, and sensitivity to higher interest rates.
- Whether steel-cost increases can continue to be passed through without further margin erosion.
- The sustainability of dividends given only $0.3 million of cash, seasonal working-capital needs, and debt restrictions.
- The effect of the $10.1 million nonrecurring litigation proceeds when assessing underlying earnings.