Douglas Dynamics, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2013; filed November 5, 2013. The interim financial statements are unaudited. Douglas Dynamics operates as a single business unit focused on snow and ice control equipment, parts and accessories. Results are highly seasonal, with significant sales generally occurring in the second and third quarters and fourth-quarter results dependent on snowfall.
Financial performance and position
| Metric | Three months ended Sept. 30, 2013 | Three months ended Sept. 30, 2012 | Nine months ended Sept. 30, 2013 | Nine months ended Sept. 30, 2012 |
|---|---|---|---|---|
| Net sales | $52.0 million | $37.8 million | $121.3 million | $111.8 million |
| Gross profit | $15.0 million | $11.6 million | $38.2 million | $36.4 million |
| Gross margin | 28.9% | 30.6% | 31.5% | 32.6% |
| Income from operations | $2.9 million | $5.2 million | $10.7 million | $17.2 million |
| Net income | $0.6 million | $2.3 million | $3.1 million | $7.1 million |
| Diluted EPS | $0.02 | $0.10 | $0.13 | $0.31 |
| Adjusted EBITDA | $10.2 million | $7.8 million | $24.8 million | $25.5 million |
Sales increased 37.6% for the quarter and 8.5% year to date. Equipment unit sales increased 41.1% in the quarter and 7.5% year to date. Trynex products contributed $4.2 million of quarterly sales and $5.1 million of year-to-date sales. Parts and accessories sales increased 42.7% for the quarter and 46.9% year to date.
Profitability declined despite higher sales. Cost of sales rose faster than revenue, reducing gross margin by 170 basis points for the quarter and 110 basis points year to date. Selling, general and administrative expense increased substantially, primarily because of $3.8 million of Trynex-related earnout compensation in the quarter and higher ongoing Trynex expenses. Net income margin declined to 1.2% from 6.2% for the quarter and to 2.6% from 6.3% year to date.
Cash flow and liquidity: Net cash used in operating activities was $26.7 million for the first nine months, compared with $35.1 million in the prior-year period. Capital expenditures were $1.7 million, producing negative free cash flow of $28.5 million versus negative $36.2 million previously. The company paid $13.9 million in dividends and ended the period with $4.0 million of cash. Total liquidity was $28.3 million, consisting of cash and $24.3 million of revolver availability.
Debt: Long-term debt was $111.2 million, and revolver borrowings were $50.0 million at September 30, 2013. Total debt, including current maturities and revolver borrowings, was approximately $161.2 million. The company was in compliance with its credit-facility covenants and was not required to make an excess-cash-flow payment. A $50.0 million interest-rate swap hedges part of the term loan through December 2014.
Material changes versus the prior comparable period
- Trynex was acquired on May 6, 2013 for $26.7 million, financed with revolver borrowings. The preliminary purchase-price allocation included $5.7 million of goodwill and $13.0 million of intangible assets.
- Trynex contributed $5.1 million of revenue but a $4.6 million pretax operating loss through September 30, including $4.4 million of purchase-accounting expenses.
- An amendment to the Trynex purchase agreement triggered recognition of $3.6 million of 2014–2015 earnout consideration; total earnout liability was $3.6 million at September 30, with potential consideration capped at $7.0 million.
- Cash declined by $20.2 million from year-end 2012, while accounts receivable increased to $71.3 million from $25.4 million and inventories increased to $36.0 million from $30.3 million, reflecting seasonal working-capital needs.
- The company recorded a $0.6 million impairment charge on land and a building held for sale in the first quarter.
- Quarterly and year-to-date Adjusted EBITDA increased and decreased, respectively, primarily reflecting higher volume in the quarter but weaker margins year to date.
Outlook, commentary, risks and unusual items
Management estimated a 2013 annual effective tax rate of approximately 38% and stated that available cash, operating cash generation and credit capacity should fund expected needs for at least the next 12 months. No specific revenue or earnings guidance was provided.
Key risks include dependence on the level, timing and location of snowfall; economic conditions; distributor relationships and financing availability; steel and fuel costs; supplier performance; demand forecasting; competition; product development; intellectual-property and product-liability claims; dividend restrictions; and the ability to achieve projected financial performance from Trynex. Variable-rate debt creates interest-rate exposure, while steel-price exposure is not hedged.
The company’s senior credit facilities restrict dividends and transfers from subsidiaries and require minimum revolver availability under specified circumstances. The company stated that there were no material changes to contractual obligations, no material off-balance-sheet arrangements, no significant changes to previously disclosed risk factors, and no litigation expected to have a material adverse effect.
Important facts for investors to verify
- Whether Trynex achieves the expected revenue, profitability and synergies, including the impact of the $7.0 million maximum earnout.
- The company’s ability to reduce seasonal receivables and inventories and generate positive operating cash flow after the third-quarter working-capital peak.
- Revolver availability, borrowing-base calculations, minimum availability requirements and compliance with dividend-related covenants.
- Fourth-quarter snowfall and its effect on reorder activity, revenue and cash generation.
- Whether gross-margin pressure from Trynex purchase accounting, steel costs and product mix persists.
- The preliminary nature of the Trynex purchase-price allocation and any resulting adjustments to goodwill, intangible assets, taxes or earnings.
- The sustainability of the quarterly dividend given negative free cash flow, debt levels and credit-facility restrictions.