Generac Holdings Inc. — Q3 2015 Form 10-Q
Business context and reporting period
Unaudited results cover the three and nine months ended September 30, 2015, compared with the corresponding 2014 periods. Generac designs and manufactures generators and other engine-powered products for residential, commercial, industrial, oil and gas, and construction markets. It reports one operating segment; U.S. sales were 88% of Q3 revenue and 86% of nine-month revenue.
On August 1, 2015, Generac acquired Country Home Products (CHP), maker of DR Power Equipment products, for approximately $74.7 million net of cash and debt acquired, funded with cash on hand. Its results are included from the acquisition date.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $359.3m | $352.3m | $959.5m | $1,056.9m |
| Gross profit | $130.3m | $130.3m | $328.8m | $377.8m |
| Gross margin | 36.3% | 37.0% | 34.3% | 35.7% |
| Operating income | $67.9m | $70.8m | $152.2m | $214.3m |
| Net income | $34.0m | $36.5m | $68.6m | $125.2m |
| Diluted EPS | $0.49 | $0.52 | $0.98 | $1.79 |
| Adjusted EBITDA | $81.2m | $83.1m | $190.7m | $245.1m |
| Adjusted net income | $63.4m | $57.9m | $133.1m | $165.7m |
Q3 sales increased 2.0%, while nine-month sales declined 9.2%. Q3 net income fell 6.7%; nine-month net income fell 45.2%. Adjusted EBITDA declined 2.3% for the quarter and 22.2% year to date. Adjusted net income is a non-GAAP measure; its Q3 increase was attributed primarily to lower cash income tax expense.
Q3 revenue growth reflected recent acquisitions, partly offset by lower home standby generator shipments and weaker mobile oil-and-gas demand. For the first nine months, residential revenue fell to $475.3m from $527.3m, and commercial and industrial revenue fell to $416.6m from $467.2m. Other product revenue rose to $67.6m from $62.4m.
Gross margin pressure reflected unfavorable product mix and acquisition effects in Q3. Year-to-date pressures also included west coast port-related costs, unfavorable manufacturing overhead absorption, and commodity contract mark-to-market adjustments. Pricing, lower commodity costs, and benefits from overseas sourcing partly offset these factors.
Cash flow, debt and liquidity
- Operating cash flow for the first nine months was $76.9m, down from $142.5m. Management cited lower operating earnings and increased working-capital investment, including higher finished-goods inventory, partly offset by lower taxes paid. Capital expenditures were $20.1m; operating cash flow less capital expenditures was approximately $56.8m.
- Investing cash outflow was $94.5m, including $74.5m for acquisitions. Financing cash outflow was $122.8m, including debt repayments and $64.4m of share repurchases. Cash declined by $143.3m from year-end 2014 to $46.5m.
- At September 30, cash was $46.5m and unused availability under the amended ABL revolving facility was $148.5m, net of letters of credit. Current assets were $654.4m and current liabilities were $225.0m.
- Balance-sheet borrowings and capital lease obligations were $1,054.6m, including $100m outstanding under the ABL facility; the term loan principal was $954m. The term loan matures in May 2020, as does the amended $250m ABL facility. The company reported compliance with both facilities’ covenants; the term loan has no financial maintenance covenants.
- Generac prepaid $150m of term-loan principal during the first half, partly funded by a $100m ABL borrowing. It recorded a $4.8m non-cash loss on debt extinguishment for the prepayments. Leverage rose above the 3.0x threshold in mid-2015, triggering a 25-basis-point increase in term-loan pricing and a $2.4m non-cash catch-up loss.
Outlook, risks and unusual items
No specific revenue, earnings, or other numerical guidance is provided. Management stated it believed operating cash flow, ABL availability, modest ongoing capital expenditure needs, and favorable tax attributes would provide sufficient capital to support growth. Management also noted that expansion may require additional capital and that debt service, repurchases, working capital, acquisitions, and capital expenditures compete for available funds.
- Demand is sensitive to the frequency and severity of power outages, residential and business investment, and oil-and-gas capital spending. Management attributed weak home standby demand to unusually low outage severity and noted reduced oil-and-gas spending amid lower energy prices.
- Risks include raw-material and component costs, interest and foreign-exchange movements, acquisition integration and synergy execution, competition, dependence on distribution partners, product liability or recalls, and changing regulations.
- A newly disclosed risk is implementation of a new enterprise resource planning system, which could increase costs, disrupt operations, or impair transaction processing and financial reporting.
- Commodity and foreign-currency derivatives are not designated for hedge accounting; losses are recorded in cost of goods sold. Interest-rate swaps had a reported fair-value liability of $4.4m at September 30.
- The company authorized a $200m share repurchase program for 24 months and repurchased 2.15m shares for $64.4m during Q3. Management may suspend or discontinue the program.
- Dealer floor-plan financing outstanding was approximately $35.7m, up from $26.1m at year-end. Generac’s arrangement includes repurchase commitments for products repossessed by the finance company, subject to the arrangement’s terms.
- Management said ordinary-course lawsuits were not expected to materially affect financial position, results, or cash flows. No material litigation was identified as of September 30, 2015.
Most important facts for investors to verify
- Whether demand and shipments recover from the low-outage environment, and how outage activity affects residential generator sales.
- Whether oil-and-gas and telecom weakness persists, and how the CHP acquisition contributes to sales, margins, and cash generation.
- Inventory levels and working-capital trends, given the year-to-date decline in operating cash flow and increase in finished goods.
- Debt, leverage, borrowing costs, ABL availability, and the cash impact of continued repurchases; assess non-GAAP results alongside GAAP earnings and cash flow.
- Execution and costs of the ERP implementation, and exposure to derivative losses, product warranties, and dealer floor-plan repurchase commitments.