Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2012

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from               to               .

 

Commission file number: 001-34728

 

DOUGLAS DYNAMICS, INC.

(Exact name of registrant as specified in its charter)

 

 

7777 North 73rd Street

Milwaukee, Wisconsin 53223

(Address of principal executive offices) (Zip code)

 

(414) 354-2310

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x  No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

 

Number of shares of registrant’s common shares outstanding as of November 6, 2012 was 22,130,996.

 

 

Table of Contents

 

DOUGLAS DYNAMICS, INC.

 

Table of Contents

 

PART I. FINANCIAL INFORMATION	3
Item 1. Financial Statements	3
Unaudited Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011 (Audited)	3
Unaudited Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended September 30, 2012 and 2011	4
Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011	5
Notes to Unaudited Consolidated Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3. Quantitative and Qualitative Disclosures About Market Risk	21
Item 4. Controls and Procedures	21
PART II. OTHER INFORMATION	22
Item 1. Legal Proceedings	22
Item 1A. Risk Factors	22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	22
Item 3. Defaults Upon Senior Securities	22
Item 4. Mine Safety Disclosures	22
Item 5. Other Information	22
Item 6. Exhibits	23
Signatures	24

 

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

 

Douglas Dynamics, Inc.

 

Consolidated Balance Sheets

(In thousands except share data)

 

		September 30,			December 31,
		2012			2011
		(unaudited)			(audited)
Assets
Current assets:
Cash and cash equivalents		$	1,842		$	39,432
Accounts receivable, net		70,678			34,019
Inventories		30,380			24,005
Deferred income taxes		4,945			4,952
Prepaid income taxes		1,211			—
Prepaid and other current assets		1,501			1,054
Total current assets		110,557			103,462
Property, plant, and equipment, net		20,246			21,340
Assets held for sale		1,732			1,732
Goodwill		107,222			107,222
Other intangible assets, net		117,846			121,747
Deferred financing costs, net		2,773			3,402
Other long-term assets		599			112
Total assets		$	360,975		$	359,017
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	2,101		$	5,040
Accrued expenses and other current liabilities		11,071			16,105
Income taxes payable		—			395
Short term borrowings		23,000			—
Current portion of long-term debt		971			11,071
Total current liabilities		37,143			32,611
Retiree health benefit obligation		8,116			8,053
Pension obligation		13,083			14,163
Deferred income taxes		30,581			26,957
Deferred compensation		756			912
Long-term debt, less current portion		111,237			111,866
Other long-term liabilities		1,537			1,066
Stockholders’ equity:
Common Stock, par value $0.01, 200,000,000 shares authorized, 22,130,996 and 22,020,694 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively		221			220
Additional paid-in capital		132,606			130,907
Retained earnings		33,162			39,742
Accumulated other comprehensive loss, net of tax		(7,467		)	(7,480		)
Total stockholders’ equity		158,522			163,389
Total liabilities and stockholders’ equity		$	360,975		$	359,017

 

See the accompanying notes to consolidated financial statements

 

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Douglas Dynamics, Inc.

 

Consolidated Statements of Operations and Comprehensive Income

(In thousands, except share and per share data)

 

		Three Months Ended						Nine Months Ended
		September 30, 2012			September 30, 2011			September 30, 2012			September 30, 2011
		(unaudited)						(unaudited)
Net sales		$	37,774		$	53,495		$	111,833		$	148,541
Cost of sales		26,208			37,001			75,387			96,639
Gross profit		11,566			16,494			36,446			51,902
Selling, general, and administrative expense		5,051			6,546			15,388			19,232
Intangibles amortization		1,300			1,300			3,901			3,901
Income from operations		5,215			8,648			17,157			28,769
Interest expense, net		(2,080		)	(2,332		)	(6,304		)	(6,678		)
Loss on extinguishment of debt		—			—			—			(673		)
Other expense, net		(44		)	(25		)	(277		)	(202		)
Income before taxes		3,091			6,291			10,576			21,216
Income tax expense		745			2,324			3,525			8,326
Net income		$	2,346		$	3,967		$	7,051		$	12,890
Less net income attributable to participating securities		19			51			51			271
Net income attributable to common shareholders		$	2,327		$	3,916		$	7,000		$	12,619
Weighted average number of common shares outstanding:
Basic		21,922,173			21,760,753			21,885,301			21,609,810
Diluted		21,979,015			21,838,062			21,958,473			21,755,552
Earnings per common share:
Basic		$	0.11		$	0.18		$	0.32		$	0.59
Diluted		$	0.10		$	0.18		$	0.31		$	0.57
Cash dividends declared and paid per share		$	0.21		$	0.20		$	0.62		$	0.97
Comprehensive income		$	2,371		$	3,649		$	7,064		$	12,508

 

See the accompanying notes to consolidated financial statements.

 

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Douglas Dynamics, Inc.

 

Consolidated Statements of Cash Flows

(in thousands)

 

		Nine Months Ended
		September 30, 2012			September 30,  2011
		(unaudited)
Operating activities
Net income		$	7,051		$	12,890
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization		5,998			6,146
Amortization of deferred financing costs and debt discount		763			627
Loss on extinguishment of debt		—			673
Stock-based compensation		1,700			1,210
Provision for losses on accounts receivable		208			454
Deferred income taxes		3,631			7,660
Changes in operating assets and liabilities:
Accounts receivable		(36,867		)	(46,420		)
Inventories		(6,375		)	(3,586		)
Prepaid and other assets and prepaid income taxes		(2,145		)	(821		)
Accounts payable		(2,939		)	985
Accrued expenses and other current liabilities		(5,429		)	2,480
Deferred compensation		(156		)	(120		)
Benefit obligations and other long-term liabilities		(533		)	(368		)
Net cash used in operating activities		(35,093		)	(18,190		)
Investing activities
Capital expenditures		(1,083		)	(1,585		)
Proceeds from sale of equipment		80			67
Net cash used in investing activities		(1,003		)	(1,518		)
Financing activities
Proceeds from exercise of stock options		—			1,277
Collection of stockholders’ notes receivable		—			482
Payments of financing costs		—			(3,454		)
Dividends paid		(13,631		)	(21,275		)
Revolver borrowings		23,000			24,000
Borrowings on long-term debt		—			123,750
Repayment of long-term debt		(10,863		)	(122,137		)
Net cash provided by (used in) financing activities		(1,494		)	2,643
Change in cash and cash equivalents		(37,590		)	(17,065		)
Cash and cash equivalents at beginning of period		39,432			20,149
Cash and cash equivalents at end of period		$	1,842		$	3,084

 

See the accompanying notes to consolidated financial statements.

 

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Douglas Dynamics, Inc.

 

Notes to Unaudited Consolidated Financial Statements

(in thousands except share and per share data)

 

1.                                                                                      Basis of presentation

 

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for fiscal year end financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. For further information, refer to the financial statements and related footnotes included in the Annual Report on Form 10-K (Commission File No. 1-34728) for the year ended December 31, 2011 of Douglas Dynamics, Inc. (the “Company,” “we,” “us,” “our”) filed with the Securities and Exchange Commission.

 

We operate as a single business unit.

 

Certain reclassifications have been made to the prior period financial statements to conform to the 2012 presentation.

 

Interim Consolidated Financial Information

 

The accompanying consolidated balance sheet as of September 30, 2012 and the consolidated statements of operations and comprehensive income for the three and nine months ended September 30, 2012 and 2011 and cash flows for the nine months ended September 30, 2012 and 2011 have been prepared by the Company and have not been audited.

 

The Company’s business is seasonal and consequently its results of operations and financial condition vary from quarter-to-quarter.  Because of this seasonality, the Company’s results of operations for any quarter may not be indicative of results of operations that may be achieved for a subsequent quarter or the full year, and may not be similar to results of operations experienced in prior years. The Company attempts to manage the seasonal impact of snowfall on its revenues in part through its pre-season sales program. This pre-season sales program encourages the Company’s distributors to re-stock their inventory during the second and third quarters in anticipation of the peak fourth quarter retail sales period by offering favorable pre-season pricing and payment deferral until the fourth quarter. Thus, the Company tends to generate its greatest volume of sales during the second and third quarters. By contrast, its revenue and operating results tend to be lowest during the first quarter, as management believes the Company’s end-users prefer to wait until the beginning of a snow season to purchase new equipment and as the Company’s distributors sell off inventory and wait for the pre-season sales incentive period to re-stock inventory. Fourth quarter sales vary from year-to-year as they are primarily driven by the level, timing and location of snowfall during the quarter. This is because most of the Company’s fourth quarter sales and shipments consist of re-orders by distributors seeking to restock inventory to meet immediate customer needs caused by snowfall during the winter months.

 

2.                                                                                      Fair Value

 

Fair value is the price at which an asset could be exchanged in a current transaction between knowledgeable, willing parties. A liability’s fair value is defined as the amount that would be paid to transfer the liability to a new obligor, not the amount that would be paid to settle the liability with the creditor.  Fair value measurements are categorized into one of three levels based on the lowest level of significant input used: Level 1 (unadjusted quoted prices in active markets); Level 2 (observable market inputs available at the measurement date, other than quoted prices included in Level 1); and Level 3 (unobservable inputs that cannot be corroborated by observable market data).

 

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The following table presents financial assets and liabilities measured at fair value on a recurring basis and discloses the fair value of long-term debt:

 

		Fair Value at 9/30/2012			Fair Value at 12/31/2011
Assets:
Assets (a)		$	—		$	—
Total Assets		$	—		$	—
Liabilities:
Long term debt (b)		$	110,805		$	122,709
Other non-current liabilities -
Interest rate swap (c)		600			621
Total Liabilities		$	111,405		$	123,330

 

(a)                                       The Company does not have any financial assets that are required to be measured at fair value on a recurring basis.

 

(b)                                       The fair value of the Company’s long-term debt, including current maturities, is estimated using discounted cash flows based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements, which is a Level 2 input for all periods presented.  Meanwhile, long-term debt is recorded at carrying amount, net of discount, as disclosed on face of the balance sheet.

 

(c)                                        Valuation models are calibrated to initial trade price. Subsequent valuations are based on observable inputs to the valuation model (e.g. interest rates and credit spreads). Model inputs are changed only when corroborated by market data. A credit risk adjustment is made using observable market credit spreads. Thus, inputs used to determine fair value of the interest rate swap are Level 2 inputs.

 

3.                                                                                      Inventories

 

Inventories consist of the following:

 

		September 30, 2012			December 31, 2011
Finished goods and work-in-process		$	29,115		$	22,630
Raw material and supplies		1,265			1,375
		$	30,380		$	24,005

 

4.                                                                                      Property, plant and equipment

 

Property, plant and equipment are summarized as follows:

 

		September 30, 2012			December 31, 2011
Land		$	960		$	960
Land improvements		1,768			1,768
Buildings		12,852			12,660
Machinery and equipment		23,801			23,253
Furniture and fixtures		7,300			7,255
Mobile equipment and other		1,227			1,216
Construction-in-process		627			748
Total property, plant and equipment		48,535			47,860
Less accumulated depreciation		(28,289		)	(26,520		)
Net property, plant and equipment		$	20,246		$	21,340

 

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5.                                                                                      Long-Term Debt

 

Long-term debt is summarized below:

 

		September 30, 2012			December 31, 2011
Term loan		$	112,208		$	122,937
Total long-term debt		112,208			122,937
Less current maturities		971			11,071
		$	111,237		$	111,866

 

The Company entered into its current term loan agreement on April 18, 2011.  The Company’s senior credit facilities consist of a $125,000 term loan facility and a $70,000 revolving credit facility with a group of banks.  The agreement for the term loan (the “Term Loan Credit Agreement”) provides for a senior secured term loan facility in the aggregate principal amount of $125,000 and generally bears interest at (at the Company’s election) either (i) 3.25% per annum plus the greatest of (a) the Prime Rate (as defined in the Term Loan Credit Agreement) in effect on such day, (b) the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers plus 0.50% and (c) 1.00% plus the greater of (1) the London Interbank Offered Rate for a one month interest period multiplied by the Statutory Reserve Rate (as defined in the Term Loan Credit Agreement) and (2) 1.50% or (ii) 4.25% per annum plus the greater of (a) the London Interbank Offered Rate for the applicable interest period multiplied by the Statutory Reserve Rate and (b) 1.50%.  The revolving credit facility (the “Revolving Credit Agreement”) provides that the Company has the option to select whether borrowings will bear interest at either (i) 2.25% per annum plus the London Interbank Offered Rate for the applicable interest period multiplied by the Statutory Reserve Rate or (ii) 1.25% per annum plus the greatest of (a) the Prime Rate in effect on such day, (b) the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers plus 0.50% and (c) the London Interbank Offered Rate for a one month interest period multiplied by the Statutory Reserve Rate plus 1%. The maturity date for the Company’s amended and restated revolving credit facility is April 18, 2016, and the Company’s term loan amortizes in nominal amounts quarterly with the balance payable on April 18, 2018.

 

The term loan entered into in the second quarter of 2011 was issued at a $1,250 discount which is being amortized over the term of the term loan.

 

At September 30, 2012, the Company had borrowings of $23,000 on the revolving credit facility and remaining borrowing availability of $46,964.

 

The Company’s senior credit facilities include certain negative and operating covenants, including restrictions on its ability to pay dividends, and other customary covenants, representations and warranties and events of default.  The senior credit facilities entered into and recorded by the Company’s subsidiaries significantly restrict its subsidiaries from paying dividends and otherwise transferring assets to Douglas Dynamics, Inc. The terms of the Company’s revolving credit facility specifically restrict subsidiaries from paying dividends if a minimum availability under the revolving credit facility is not maintained, and both senior credit facilities restrict subsidiaries from paying dividends above certain levels or at all if an event of default has occurred.  These restrictions would affect the Company indirectly since the Company relies principally on distributions from its subsidiaries to have funds available for the payment of dividends.  In addition, the Company’s revolving credit facility includes a requirement that, subject to certain exceptions, capital expenditures may not exceed $10,000 in any calendar year and, if certain minimum availability under the revolving credit facility is not maintained, that the Company comply with a monthly minimum fixed charge coverage ratio test of 1.0:1.0.  Compliance with the fixed charge coverage ratio test is subject to certain cure rights under the Company’s revolving credit facility.  At September 30, 2012, the Company was in compliance with the respective covenants.  The credit facilities are collateralized by substantially all assets of the Company.

 

In accordance with the senior credit facilities, the Company is required to make additional principal prepayments over the above scheduled payments under certain conditions. This includes, in the case of the term loan facility, 100% of the net cash proceeds of certain asset sales, certain insurance or condemnation events, certain debt issuances, and, within 150 days of the end of the fiscal year, 50% of excess cash flow, as defined, including a deduction for certain distributions (which percentage is reduced to 25% or 0% upon the achievement of certain leverage ratio thresholds), for any fiscal year. Excess cash flow is defined in the senior credit facilities as consolidated adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) plus a working capital adjustment less the sum of repayments of debt and capital expenditures subject to certain adjustments, interest and taxes paid in cash, management fees and certain restricted payments (including dividends or distributions). Working capital adjustment is defined in the senior credit facilities as the change in working capital, defined as current assets excluding cash and cash equivalents less current liabilities excluding current portion of long term debt.  As of September 30, 2012, the Company was not required to make an excess cash flow payment.

 

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Each of the senior secured facilities entered into in the second quarter of 2011 includes a hedge provision, which required the Company to enter into an interest rate hedge commencing 90 days after the closing date.  The hedging provision requires the Company to hedge the interest rate on at least 25% of the aggregate outstanding principal amount of the term loans.  The purpose of the interest rate swap is to reduce the Company’s exposure to interest rate volatility.  Effective June 20, 2011, the Company entered into an interest rate swap agreement with a notional amount of $50,000.  The interest rate swap negative fair value at September 30, 2012 of $600 is included in other long-term liabilities on the Consolidated Balance Sheet.  The Company has counterparty credit risk resulting from the interest rate swap, which it monitors on an on-going basis.  This risk lies with one global financial institution.  Under the interest rate swap agreement, effective as of July 18, 2011, the Company either receives or makes payments on a monthly basis based on the differential between 6.335% and LIBOR plus 4.25% (with a LIBOR floor of 1.5%).  The interest rate swap contract on the term loan expires in December 2014.

 

6.                                                                                      Accrued Expenses and Other Current Liabilities

 

Accrued expenses and other liabilities are summarized as follows:

 

		September 30, 2012			December 31, 2011
Payroll and related costs		$	2,306		$	4,756
Employee benefits		1,657			2,645
Accrued warranty		4,173			4,188
Other		2,935			4,516
		$	11,071		$	16,105

 

7.                                                                                      Warranty Liability

 

The Company accrues for estimated warranty costs as sales are recognized and periodically assesses the adequacy of its recorded warranty liability and adjusts the amount as necessary.  The Company’s warranties generally provide, with respect to its snow and ice control equipment, that all material and workmanship will be free from defect for a period of two years after the date of purchase by the end-user, and with respect to its parts and accessories purchased separately, that such parts and accessories will be free from defect for a period of one year after the date of purchase by the end-user.  Certain snowplows only provide for a one year warranty.  The Company determines the amount of the estimated warranty costs (and its corresponding warranty reserve) based on the Company’s prior five years of warranty history utilizing a formula driven by historical warranty expense and applying management’s judgment.  The Company adjusts its historical warranty costs to take into account unique factors such as the introduction of new products into the marketplace that do not provide a historical warranty record to assess.  The warranty reserve is included in Accrued Expenses and Other Current Liabilities in the accompanying consolidated balance sheets.

 

The following is a rollforward of the Company’s warranty liability:

 

		Three months ended						Nine months ended
		September 30, 2012			September 30, 2011			September 30, 2012			September 30, 2011
Balance at the beginning of the period		$	3,965		$	3,070		$	4,188		$	3,399
Warranty provision		293			890			1,066			2,521
Claims paid/settlements		(85		)	(184		)	(1,081		)	(2,144		)
Balance at the end of the period		$	4,173		$	3,776		$	4,173		$	3,776

 

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8.                                                                                      Employee Retirement Plans

 

The components of net periodic pension cost consist of the following:

 

		Three months ended						Nine months ended
		September 30, 2012			September 30, 2011			September 30, 2012			September 30, 2011
Component of net periodic pension cost:
Service cost		$	67		$	240		$	201		$	720
Interest cost		370			385			1,110			1,155
Expected return on plan assets		(318		)	(339		)	(954		)	(1,017		)
Amortization of net loss		192			113			576			339
Net periodic pension cost		$	311		$	399		$	933		$	1,197

 

The Company estimates its total required minimum contributions to its pension plans in 2012 will be $2,014.  Through September 30, 2012, the Company has made $2,014 of cash contributions to the pension plans in 2012 versus $1,570 through the same period in 2011.

 

Components of net periodic other postretirement benefit cost consist of the following:

 

		Three months ended						Nine months ended
		September 30, 2012			September 30, 2011			September 30, 2012			September 30, 2011
Components of net periodic other postretirement benefit cost
Service cost		$	70		$	66		$	210		$	197
Interest cost		90			102			270			306
Amortization of net gain		(4		)	(15		)	(12		)	(46		)
Net periodic other postretirement benefit cost		$	156		$	153		$	468		$	457

 

9.                                                                                      Earnings Per Share

 

Basic earnings per share of common stock is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share of common stock is computed by dividing net income by the weighted average number of common shares and common stock equivalents related to the assumed exercise of stock options, using the two-class method. Stock options for which the exercise price exceeds the average fair value have an anti-dilutive effect on earnings per share and are excluded from the calculation.

 

As restricted shares participate in dividends, in accordance with Accounting Standards Codification Topic (“ASC”) 260, the Company has calculated earnings per share pursuant to the two-class method, which is an earnings allocation formula that determines earnings per share for common stock and participating securities according to dividends declared and participation rights in undistributed earnings. Under this method, all earnings (distributed and undistributed) are allocated to common shares and participating securities based on their respective rights to receive dividends.

 

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		Three months ended						Nine months ended
		September 30, 2012			September 30, 2011			September 30, 2012			September 30, 2011
Basic earnings per common share
Net income		$	2,346		$	3,967		$	7,051		$	12,890
Less income allocated to participating securities		19			51			51			271
Net income allocated to common shareholders		$	2,327		$	3,916		$	7,000		$	12,619
Weighted average common shares outstanding		21,922,173			21,760,753			21,885,301			21,609,810
		$	0.11		$	0.18		$	0.32		$	0.59
Earnings per common share assuming dilution
Net income		$	2,346		$	3,967		$	7,051		$	12,890
Less income allocated to participating securities		19			51			51			271
Net income allocated to common shareholders		$	2,327		$	3,916		$	7,000		$	12,619
Weighted average common shares outstanding		21,922,173			21,760,753			21,885,301			21,609,810
Incremental shares applicable to stock based compensation		56,842			77,309			73,172			145,742
Weighted average common shares assuming dilution		21,979,015			21,838,062			21,958,473			21,755,552
		$	0.10		$	0.18		$	0.31		$	0.57

 

10.                                             Employee Stock Plans

 

Amended and Restated 2004 Stock Incentive Plan

 

As of September 30, 2012, 37,240 shares of common stock are reserved for issuance upon the exercise of outstanding options under the Company’s Amended and Restated 2004 Stock Incentive Plan (the “A&R 2004 Plan”).  All outstanding options are fully vested.  All options expire 10 years from the date of grant. No further awards are permitted to be issued under the A&R 2004 Plan.

 

Stock Options

 

There were no stock options exercised with respect to the Company’s stock under the A&R 2004 Plan for either the three or nine months ended September 30, 2012.

 

2010 Stock Incentive Plan

 

In May 2010, the Company’s Board of Directors and stockholders adopted the 2010 Stock Incentive Plan (the “2010 Plan”).  The 2010 Plan provides for the issuance of nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock awards and restricted stock units, any of which may be performance-based, and for incentive bonuses, which may be paid in cash or stock or a combination of both, to eligible employees, officers, non-employee directors and other service providers to the Company and its subsidiaries.  A maximum of 2,130,000 shares of common stock may be issued pursuant to all awards under the 2010 Plan.

 

Restricted Stock Awards

 

A summary of restricted stock activity for the nine months ended September 30, 2012 is as follows:

 

							Weighted
				Weighted			Average
				Average			Remaining
				Grant Date			Contractual
		Shares		Fair value			Term
Unvested at December 31, 2011		235,667		$	12.27		2.83 years
Granted		42,077		$	14.57		2.25 years
Vested		(68,921	)	$	12.61
Cancelled and forfeited		—		—
Unvested at September 30, 2012		208,823		$	12.63		2. 19 years
Expected to vest in the future at September 30, 2012		201,305		$	12.63		2. 19 years

 

The fair value of the Company’s restricted stock awards is the closing stock price on the date of grant. The Company recognized $265 and $827 of compensation expense related to restricted stock awards granted for the three and nine months ended September 30, 2012, respectively.  The unrecognized compensation expense calculated under the fair value method for shares expected to vest as of September 30, 2012 was approximately $1,950 and is expected to be recognized over a weighted average period of 2.19 years.

 

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Unrestricted Stock

 

The Company granted performance based awards under the 2010 Plan in the first quarter of 2012 which are subject to performance conditions.  Upon meeting the prescribed performance conditions, employees will be issued unrestricted shares in the first quarter of 2013.  In accordance with ASC 718 such awards are being expensed over 2012, from the date of grant through the requisite service period.  The fair value per share of the awards is the closing stock price on the date of grant, which was $12.94. The Company recognized $259 and $603 of compensation expense related to the awards in the three and nine months ended September 30, 2012, respectively. The unrecognized compensation expense calculated under the fair value method for shares that were, as of September 30, 2012, expected to be earned through the requisite service period was approximately $259 and is expected to be recognized throughout 2012.

 

Restricted Stock Units

 

Restricted stock units (‘‘RSUs’’) are issued to the non-employee members of the board of directors and carry dividend equivalent rights but do not carry voting rights. Each RSU represents the right to receive one share of the Company’s common stock and are subject to time based vesting restrictions. Participants are not required to pay any consideration to the Company at either the time of grant of a RSU or upon vesting.

 

A summary of RSU activity for the nine months ended September 30, 2012 is as follows:

 

							Weighted
				Weighted			Average
				Average			Remaining
				Grant Date			Contractual
		Shares		Fair value			Term
Unvested at December 31, 2011		18,893		$	15.20		2.00 years
Granted		14,367		$	14.35		2.25 years
Vested		(7,214	)	$	15.25
Cancelled and forfeited		—		—
Unvested at September 30, 2012		26,046		$	14.73		0.97 years
Expected to vest in the future at September 30, 2012		26,046		$	14.73		0.97 years

 

Vested RSUs are ‘‘settled’’ by the delivery to the participant or a designated brokerage firm of one share of common stock per vested RSU as soon as reasonably practicable following a termination of service of the participant that constitutes a separation from service, and in all events no later than the end of the calendar year in which such termination of service occurs or, if later, two and one-half months after such termination of service.

 

11.                                             Commitments and Contingencies

 

In the ordinary course of business, the Company is engaged in various litigation including product liability and intellectual property disputes.  However, the Company does not believe that any pending litigation will have a material adverse effect on its consolidated financial position.  In addition, the Company is not currently a party to any environmental-related claims or legal matters.

 

In the year ended December 31, 2011 the Company successfully asserted infringement and defended the validity of several of its patents.  On November 23, 2011, the U.S. District Court for the Western District of Wisconsin entered a judgment declaring that the Company’s U.S. Patent Nos. 5,353,530 and 6,944,978 are valid and had been infringed by a competitor and awarded the Company $1,018 in damages for pre-verdict infringement. In August 2012, the Company received a payment in satisfaction of the successful assertions of infringement and validity in the lawsuit with the competitor.  As a result of the satisfaction in August 2012, the Company received $1,018 in damages for pre-verdict infringement, without waiving the right to seek any additional damages or recourse from the competitor.  The amount received is included in selling, general and administrative expenses in the Company’s consolidated statement of operations in both the three and nine-month periods ended September 30, 2012.

 

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12.                                             Income Taxes

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.  The largest item affecting deferred taxes is the difference between book and tax amortization of goodwill and other intangibles amortization.  The Company estimates that the combined federal and state tax rate for 2012 will be approximately 37%.  The Company’s effective tax rate was 24.1% and 36.9% for the three months ended September 30, 2012 and 2011, respectively.  The Company’s effective tax rate for the nine months ended September 30, 2012 and 2011 was 33.3% and 39.2%, respectively.  The effective tax rate for the three months ended September 30, 2012 was lower than the corresponding quarter in 2011 due to the Company recognizing less income slightly offset by a decreased domestic productions activities deduction in the current period as compared to the prior year’s corresponding period. The Company also recognized an additional benefit related to 2011 Federal tax credits in the third quarter of 2012 with the filing of the Company’s 2011 Federal tax return. The effective tax rate for the nine months ended September 30, 2012 was lower than the corresponding period in 2011 due to the Company recognizing less income slightly offset by a decreased domestic productions activities deduction in the current year along with the Company adjusting the prior year’s net deferred tax liabilities to a higher federal rate for 2011 compared to the actual rate incurred in 2010.

 

Item 2.                       Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes which are included in Item 1 of this Quarterly Report on Form 10-Q, as well as the information contained in our Form 10-K (Commission File No. 001-34728) filed with the Securities and Exchange Commission.

 

In this Quarterly Report on Form 10-Q, unless the context indicates otherwise: “Douglas Dynamics,” the “Company,” “we,” “our,” or “us” refer to Douglas Dynamics, Inc.

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains certain “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  These statements include information relating to future events, product demand, the payment of dividends, future financial performance, strategies, expectations, competitive environment, regulation and availability of financial resources.  These statements are often identified by use of words such as “anticipate,” “believe,” “intend,” “estimate,” “expect,” “continue,” “should,” “could,” “may,” “plan,” “project,” “predict,” “will” and similar expressions and include references to assumptions and relate to our future prospects, developments and business strategies.  Such statements involve known and unknown risks, uncertainties and other factors that could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements.  Factors that could cause or contribute to such differences include, but are not limited to: (i) weather conditions, particularly lack of or reduced levels of snowfall or the timing of such snowfall; (ii) a significant decline in economic conditions or the speed of the economic recovery; (iii) our inability to maintain good relationships with our distributors; (iv) lack of available or favorable financing options for our end-users or distributors; (v) increases in the price of steel or other materials necessary for the production of our products that cannot be passed on to our distributors; (vi) increases in the price of fuel; (vii) the inability of our suppliers to meet our volume or quality requirements; (viii) inaccuracies in our estimates of future demand for our products; (ix)our inability to protect or continue to build our intellectual property portfolio; (x) our inability to develop new products or improve upon existing products in response to end-user needs; (xi) losses due to lawsuits arising out of personal injuries associated with our products; (xii) factors that could impact the future declaration and payment of dividends; and (xii) our inability to compete effectively against competition, as well as those discussed in the section entitled “Risk Factors,” set forth in Part I, Item 1A of our Annual Report on Form 10-K for the Year Ended December 31, 2011.  Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements.  These forward-looking statements do not include the potential impact of any acquisition that may be subsequently announced and/or completed.  In addition, the forward-looking statements in this Quarterly Report on Form 10-Q speak only as of the date hereof and we undertake no obligation, except as required by law, to update or release any revisions to any forward-looking statement, even if new information becomes available in the future.

 

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Results of Operations

 

Overview

 

During the three months ended September 30, 2012 and 2011, we sold 9,518 and 13,824 units of snow and ice control equipment, respectively, and during the nine months ended September 30, 2012 and 2011 we sold 27,618 and 35,835 units of snow and ice control equipment, respectively.  The following table shows our sales of snow and ice control equipment and related parts and accessories as a percentage of net sales for the three and nine months ended September 30, 2012 and 2011.

 

		Three months ended				Nine months ended
		September 30, 2012		September 30, 2011		September 30, 2012		September 30, 2011
Equipment		91	%	89	%	89	%	84	%
Parts and accessories		9	%	11	%	11	%	16	%

 

The following table sets forth, for the three and nine months ended September 30, 2012 and 2011, the consolidated statements of operations of the Company and its subsidiaries.  All intercompany balances and transactions have been eliminated in consolidation.  In the table below and throughout this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” consolidated statements of operations data for the three and nine months ended September 30, 2012 and 2011 have been derived from our unaudited consolidated financial statements.  The information contained in the table below should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q.

 

		Three Months Ended						Nine Months Ended
		September 30, 2012			September 30, 2011			September 30, 2012			September 30, 2011
		(unaudited)						(unaudited)
		(in thousands)						(in thousands)
Net sales		$	37,774		$	53,495		$	111,833		$	148,541
Cost of sales		26,208			37,001			75,387			96,639
Gross profit		11,566			16,494			36,446			51,902
Selling, general, and administrative expense		5,051			6,546			15,388			19,232
Intangibles amortization		1,300			1,300			3,901			3,901
Income from operations		5,215			8,648			17,157			28,769
Interest expense, net		(2,080		)	(2,332		)	(6,304		)	(6,678		)
Loss on extinguishment of debt		—			—			—			(673		)
Other expense, net		(44		)	(25		)	(277		)	(202		)
Income before taxes		3,091			6,291			10,576			21,216
Income tax expense		745			2,324			3,525			8,326
Net income		$	2,346		$	3,967		$	7,051		$	12,890

 

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The following table sets forth for the three and nine months ended September 30, 2012 and 2011, the percentage of certain items in our consolidated statement of operations, relative to net sales:

 

		Three Months Ended				Nine Months Ended
		September 30, 2012		September 30, 2011		September 30, 2012		September 30, 2011
		(unaudited)				(unaudited)
Net sales		100.0	%	100.0	%	100.0	%	100.0	%
Cost of sales		69.4	%	69.2	%	67.4	%	65.1	%
Gross profit		30.6	%	30.8	%	32.6	%	34.9	%
Selling, general, and administrative expense		13.4	%	12.2	%	13.8	%	12.9	%
Intangibles amortization		3.4	%	2.4	%	3.5	%	2.6	%
Income from operations		13.8	%	16.2	%	15.3	%	19.4	%
Interest expense, net		(5.5	)%	(4.4	)%	(5.6	)%	(4.5	)%
Loss on extinguishment of debt		0.0	%	0.0	%	0.0	%	(0.5	)%
Other expense, net		(0.1	)%	(0.0	)%	(0.2	)%	(0.1	)%
Income before taxes		8.2	%	11.8	%	9.5	%	14.3	%
Income tax expense		2.0	%	4.3	%	3.2	%	5.6	%
Net income		6.2	%	7.5	%	6.3	%	8.7	%

 

Net Sales

 

Net sales were $37.8 million for the three months ended September 30, 2012 compared to $53.5 million in the three months ended September 30, 2011, a decrease of $15.7 million, or 29.3%.  Net sales were $111.8 million for the nine months ended September 30, 2012 compared to $148.5 million in the nine months ended September 30, 2011, a decrease of $36.7 million, or 24.7%.  The decrease in net sales for the three and nine months ended September 30, 2012 was driven by a 31.1% and 22.9% decrease in unit sales of snow and ice control equipment, respectively.  In addition to the decrease in unit sales of snow and ice control equipment, there was a decrease in parts and accessories sales for the three and nine months ended September 30, 2012 compared to the corresponding period in 2011 of 42.3% and 48.6%, respectively.  The Company attributes the decreases in both equipment and parts and accessories to the significantly below average snowfall during the October 1, 2011 to March 31, 2012 snow season.

 

Cost of Sales

 

Cost of sales was $26.2 million for the three months ended September 30, 2012 compared to $37.0 million for the three months ended September 30, 2011, a decrease of $10.8 million, or 29.2%.  Cost of sales was $75.4 million for the nine months ended September 30, 2012 compared to $96.6 million in the nine months ended September 30, 2011, a decrease of $21.2 million, or 21.9%.  The decreases in cost of sales for the three and nine months ended September 30, 2012 compared to the corresponding periods in 2011 were primarily driven by decreases in volume as discussed above under “Net Sales”.  In addition, the Company experienced slightly higher cost of sales as a percentage of sales of 69.4% for the three months ended September 30, 2012 compared to 69.2% for the three-month period ended September 30, 2011.  The Company also experienced higher cost of sales as a percentage of sales of 67.4% compared to 65.1% for the nine-month periods ending September 30, 2012 and September 30, 2011, respectively.  The increase in cost of sales as a percentage of net sales for both the three and nine month periods was due to lower units sold which contributed to higher fixed costs per unit sold.  Positive performance variances and cost reductions slightly offset increased fixed costs per unit.  As a percentage of cost of sales, fixed and variable costs were approximately 18% and 82%, respectively, for the three months ended September 30, 2012 versus approximately 16% and 84%, respectively for the three months ended September 30, 2011, and approximately 17% and 83%, respectively, for the nine months ended September 30, 2012 versus approximately 15% and 85%, respectively, for the nine months ended September 30, 2011.

 

Gross Profit

 

Gross profit was $11.6 million for the three months ended September 30, 2012 compared to $16.5 million for the three months ended September 30, 2011, a decrease of $4.9 million, or 29.7%.  Gross profit was $36.4 million for the nine months ended September 30, 2012 compared to $51.9 million in the nine months ended September 30, 2011, a decrease of $15.5 million, or 29.9%.  The decrease in gross profit for the three and nine months ended September 30, 2012 was due primarily to the decreased unit sales of snow and ice control equipment described above under “Net Sales.”  As a percentage of net sales, gross profit decreased from 30.8% for the three months ended September 30, 2011 to 30.6% for the corresponding period in 2012 and decreased from 34.9% for the nine months ended September 30, 2011 to 32.6% for the corresponding period in 2012, primarily as a result of the factors discussed above under “Net Sales” and “Cost of Sales.”

 

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