Generac Holdings Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited condensed consolidated financial statements. Unless stated otherwise, amounts below are in U.S. dollars millions.
Business context
Generac designs and manufactures power-generation equipment and other engine-powered products for residential, commercial and industrial markets. It reports Domestic and International segments. In June 2018, it acquired Selmec, a Mexico-based industrial generator manufacturer, for a purchase price of $78.3 million, funded with cash on hand. Selmec’s results are included from June 1, 2018.
Financial results and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $494.9 | $394.9 | $892.6 | $725.4 |
| Gross profit / margin | $176.3 / 35.6% | $132.9 / 33.7% | $316.2 / 35.4% | $241.7 / 33.3% |
| Operating income | $85.5 | $51.8 | $141.8 | $82.7 |
| Net income attributable to Generac | $53.3 | $25.3 | $86.9 | $37.5 |
| Diluted EPS | $0.82 | $0.41 | $1.24 | $0.61 |
| Adjusted EBITDA | $102.2 | $69.7 | $174.0 | $116.4 |
- Q2 sales increased 25.3%; six-month sales increased 23.1%. Q2 growth included Residential products up 24.1% and Commercial & Industrial products up 26.9%.
- Operating margins were approximately 17.3% in Q2 and 15.9% for the first half, compared with 13.1% and 11.4%, respectively, in 2017. Management attributed margin gains to improved manufacturing leverage, favorable pricing and margin initiatives, partly offset by inflation in commodities, wages and logistics.
- Operating cash flow was $79.7 million for the first half, versus $54.3 million. Capital expenditures were $12.3 million; investing cash outflow was $82.1 million, including $71.9 million of acquisition payments. Financing cash outflow was $23.9 million. Cash declined by $26.8 million to $111.7 million.
- At June 30, current assets were $930.4 million and current liabilities $480.0 million. Current borrowings included $24.0 million of foreign subsidiary lines; the company also had $908.1 million of long-term borrowings and capital lease obligations. Approximate total carrying-value borrowings, including current amounts, were $933.4 million; cash less those borrowings was about $821.7 million.
- The Term Loan had $879 million outstanding and the ABL Facility $50 million. ABL availability was $192.2 million, net of letters of credit. The secured leverage ratio was 2.11x, and the company reported compliance with credit covenants. The Term Loan and amended ABL mature in 2023.
Changes versus the prior comparable period
- Higher shipments of home standby and portable generators, C&I products, and service parts drove growth. International sales also benefited from Selmec and a stronger euro.
- Adjusted EBITDA increased 46.6% in Q2 and 49.5% for the first half. Domestic and International segment margins both improved, primarily on volume leverage and favorable pricing or mix.
- The effective tax rate declined to 25.3% for both the quarter and first half, from 35.4% and 36.7%, respectively, mainly reflecting the lower U.S. federal corporate rate under the Tax Act.
- Cash used in investing rose substantially, principally because of the Selmec acquisition. Inventory increased to $479.9 million from $387.0 million at year-end as the company replenished stock ahead of the summer storm season.
Outlook, commentary and risks
- No specific revenue, earnings or Adjusted EBITDA guidance is provided in the filing. Management expected a 2018 combined federal and state effective tax rate of 25%–26%; adjusted-net-income calculations used an anticipated cash tax rate of approximately 14%–15% for 2018.
- Management said outages in the second half of 2017 supported strong generator demand into 2018, but major outages are unpredictable and may affect sales and profitability for subsequent periods. Other demand drivers include residential investment, business capital spending and equipment-rental trends.
- Key risks cited include raw-material, component and labor availability and costs; interest rates, foreign exchange, commodities and tariffs; reliance on distribution partners; acquisition integration and realization of expected benefits; global expansion; product liability or recalls; and changing regulation.
- In June, Generac amended its Term Loan to reduce applicable margins and amended and expanded its ABL Facility to $300 million, extending its maturity and reducing certain borrowing margins. It borrowed $50 million under the ABL and used the proceeds for a voluntary Term Loan prepayment, recording a $1.3 million debt-extinguishment loss.
- Other notable items include the $10.0 million first-half redemption-value adjustment for the Pramac noncontrolling interest, which affects EPS; and the preliminary Selmec purchase allocation, including approximately $76.5 million of intangible assets and $38.5 million of goodwill. Selmec goodwill is not tax deductible.
- Management said ordinary-course litigation was not expected to have a material effect. Dealer floor-plan financing arrangements had approximately $36.2 million outstanding; Generac may have to repurchase repossessed products but does not indemnify the finance company for credit losses. Management reported effective disclosure controls and no material change in risk factors.
Important facts for investors to verify
- Whether strong demand following prior-year power outages persists, and how shipment growth and seasonality affect future periods.
- Whether gross-margin improvements can be sustained amid commodity, wage, currency and logistics pressures.
- Selmec’s post-acquisition performance, integration, final purchase-price allocation and expected contribution beyond the small reported 2018 partial-period sales contribution.
- Working-capital and inventory levels, cash conversion, acquisition spending, and the company’s ability to balance buybacks with debt reduction and investment needs.
- The assumptions behind tax-rate and cash-tax expectations, and the effect of the Tax Act as accounting is completed.
- The terms and remaining capacity of the share-repurchase program; the filing reports $144.5 million remaining under the program at June 30, 2018.
- Adjusted EBITDA and Adjusted Net Income are non-GAAP measures; assess them alongside GAAP earnings and cash flows and their stated limitations.